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INTRODUCTION
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What is a Structured Financial
product?
Structured
Financial
Product
Securities that provide investors with an redemption amount .Redemption Amount includes full or partial capital protection with a certain
type of return.
Return depends on the selected underlying security
Variety of debt +
other instruments
COMBINED
VEHICLE
Issued as
Secured Bonds
Specific Coupon
Rate and Principal
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What is a Structured Financial
product?
Structured
FinancialProduct
They are synthetic investmentsSynthetic investments simulate return of actual
investments.
Return is actually created using a combination of
financial products.
Eg: Options Contracts, Equity Index
Why Structured Financial Products?
To meet specific needs that cannot be met from the
standardized financial instruments available in the
markets.Structured products can be used: as an alternative to a
direct investment
As part of the asset allocation process to reduce risk
exposure of a portfolio
to utilize the current market trends.
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History and Origin
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Terms and Structures associated with
Structured Products
Various Types of Contractual
Debt
Residential Mortgages
Commercial MortgagesAuto Loans
Credit card Debt Obligations
Financial Pooling
and Selling to
Investors
Bonds
Pass-through
securities Collaterized Mortgage
Obligations (CMO)
Securitization
Securitization involves conversion of assets that are not readily marketable into
rated securities that that are tradable in the secondary market.
It involves sale of cash flow generating assets to a Special Purpose Vehicle
(SPV)which has been created specially for the purpose, which then issues
notes which are tradable.
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Terms and Structures associated with
Structured Products
A piece, portion or slice of a deal or structured financing.
This portion is one of several related securities that are offered at the same time but
have different risks, rewards and/or maturities.
A senior tranche may be rated AAA or AA while junior unsecured tranches may be
rated below investment grade (
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Terms and Structures associated with
Structured Products
Structured products have a defining features: they can split the bulk of funds with the
SPVs into different tranches.
With the help of credit rating agencies the are ranked from the highest (AAA) to less
than BBB or junk bond.Some of the other techniques used are overcollateralization, An excess spread between
the interest rate on the underlying security and treserve accounts etche issued notes,.
Credit Enhancement and Credit Rating Agencies
Over collateralization:An excess spread between the interest rate on the underlying security and reserve
accounts etche issued notes,.
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A sample SFP
Auto Loan
Home loan
Student loan
Credit Card
Debt
Other
Receivables
SPV
Tranche 1
(Senior)
Tranche 2
(Mezzanine)
Tranche 3
(Mezzanine)
Tranche 4
(Mezzanine)
Tranche 5
(Subordinate/J
unk)
Risk
&
Return
Increase
Banks AssetsBonds
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Instruments and Products
Structured products have a defining features: they can split the bulk of funds with the
SPVs into different tranches.
With the help of credit rating agencies the are ranked from the highest (AAA) to less
than BBB or junk bond.Some of the other techniques used are overcollateralization, An excess spread between
the interest rate on the underlying security and treserve accounts etche issued notes,.
Credit Enhancement and Credit Rating Agencies
Over collateralization:
An excess spread between the interest rate on the underlying security and reserve
accounts and issued notes.
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Instruments and Products
Asset backed securities are bonds which are based on underlying pools of assets. They
are secured by assets other than mortgages, such as auto loans, home loans, banks
receivables, credit card payments due etc
1. Asset Backed Securities (ABS)
Mortgage backed securities are the original forms of structured financial products.
They are similar to asset backed securities, the only difference being that the underlyingsecurities are mortgages.
These mortgages are almost always secured (By the government or a mortgage insurer).
An MBS pays out the cash flows from the pool of assets
2. Mortgage Backed Securities (MBS)
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Instruments and Products
CDOs are a type of ABS whose value and payments are derived from fixed income
underlying assets. They are backed by a collateral, and deal mainly in debt
instruments.The types/classification of CDOs are:
Prime: Where the collateral is fixed through the life of the CDO and known to the
investor
Managed: Where a portfolio manager is appointed to actively manage the collateral
Balance sheet CDO: Used by institutions especially banks to offload assets from
their balance sheets.Arbitrage CDO: Where the institution issuing the CDOs attempts to gain from the
interest spread between the CDO and the underlying security
1. Collateralized Debt Obligation
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Instruments and Products
A CMO is a type of MBS in which bonds are issued and investors are paid fixed
interest amounts in accordance with the bond they hold. CMOs differ from other MBS
instruments in the way that they are not instruments for Mortgage pass throughs
4. Collateralized Mortgage Obligation (CMOs)
CLOs (Commercialized Loan Obligations) that have only loans as the underlying
security
CBOs (Commercialized Bond Obligations) that have bonds as the underlying security
5.Others
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Le Meridien Hotels
Two-horse race between Nomura and Marriott in2001
The hotels made a sales of 493m. Estimated EBITDA
was 247m.
Offers for the hotel chain had been 2.2 billion pounds.
Fear of a slowdown in the United States
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Nomura's Principal Finance Group secured theleasehold interest in the 120-property of Le Meridiengroup from Compass Group PLC
Sale/leaseback arrangement with the Royal Bank ofScotland.
Nomura got hold of the hotels without actuallyhaving to pay for them.
Le Meridien Hotels
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Deal StructureAmount
Equity
Nomura International plc's Finance Group 227 million
Royal Bank Private Equity 100 million
Alchemy Investment Plan 35 million
Abbey National Treasury Services 15 million
Juergen Bartels 10 million
Royal Bank of Scotland (Sale & Lease Back) 1.25 billion
CIBC and Merrill LynchSenior Debt GBP 750 million
Revolving Credit GBP 25 million
Capex Facility GBP 110 million
Mezzanine (PIK) GBP 160 million
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The deal included a GBP160m "payment-in-kind"mezzanine tranche arranged by Lehman Brothers,chosen instead of ABS
Cost of redeeming these bonds early and achieving arapid realization of the assets made mezzanine amore attractive option in this instance.
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Securitization Funding For Toyota Motors
Toyota Motor Corp., through its finance arm,sold $1.29 billion of bonds backed by autoloans
Toyota
MotorsReceivables
(Auto Loan)
Remote
SPE
QSPE
TrustInvestor
Bonds
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Credit Enhancement
Internal Credit Enhancement
Subordination
Excess spread Overcollateralization
External credit enhancement
Surety bonds (CDS)
Wrapped securities
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Structured Products for Retail Investors
Equity linked structured products
-- principal protected notes
-- enhanced yield notes-- reverse convertible notes
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What is the problem with retail investors
Does not understand the risk-return tradeoff
Cost incurred
retail investors consider principal protection avery attractive feature
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Say no to Retail structured products
Over priced at the offering
There after thinly traded
Exposed to the credit risk of the issuing brokerage
firms without adequate compensation Opaqueness obscured their true risks and costs and
the high fees earned by underwriters andsalespersons
The potential for high fees and commissions createdstrong incentives to develop and sell ever morecomplex variants of these inferior investments
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Conclusion
Simple portfolios of stocks and bonds can bepurchased and periodically rebalanced which willyield more wealth at maturity than an investment inany of the structured products we have analyzed at
issuance whatever the level stock price.
These products add nothing to retail investorsportfolios that cant be acquired from investmentsalready available in the market in the form of less
risky, less complicated, or less costly products andtherefore fail the reasonable-basis suitabilityrequirement for sale to retail investors.