Structured notes terminology FAQ

April 20, 2015 / Knowledge Centre

Below we explain some of the most frequently used terms that you can find on a structured note fact-sheet.

  • Name

    The name of a note is usually designed to indicate the theme of the note. It also usually indicates the type of note that you are looking at.

  • Coupon

    This is the yield, usually expressed as an annual percentage that the investor can expect if the conditions for the coupon payment are met. Like anything in life the higher the percentage on offer, the more scrutiny the investor should apply to the note structure before his decision to invest is made.

  • Basket

    The basket of underlying assets is vital for the success of a note. The combination of assets determines the yield of the note. The type of underlying asset further adds to this. For instance a basket that consists of four indices can be more attractive than a basket that consists of four equities. Equities are inherently more volatile than an index and thus offer a better yield potential.

  • Less is more

    Less is more when it comes to baskets. The reason is simple; the more assets are added to the basket the more elements of risk and return are added to the calculation. This allows for the issuer to present an attractive yield even when the market is very calm. However, this also means additional risks of one of the assets breaching the barrier. When markets are more volatile the issuers can obtain more attractive returns per underlying asset and thus can use less elements per basket and still obtain an attractive offer.

  • Barrier

    The barrier is an important aspect of any note. The most common barrier level equals to 50% of the strike price. However, to increase the yield on a note the issuers can also set higher barriers of 60% or even 75% from the strike price. This reduction in maturity protection is cheaper to purchase for the issuer therefore leaving room for higher yields. It is vital to assess the price volatility of every underlying asset in combination with the recent market performance and determine if the barrier level is sufficient.

  • “Worst-of” or “Combined” basket

    This is a very important detail and is easily overlooked by advisers and clients alike. The most common structured note uses a ‘worst-of’ basket. This means that the performance of the entire note depends on the worst performing individual asset of the basket. If your basket consists of correlated assets this would be the preferred structure. A less desirable structure would be the ‘combined-performance’ basket as the performance of all underlying assets is combined and then measured.

    Let’s look at an example, if your basket contains four equities and the barrier is set at 50% all that is required for the barrier to be hit is a 12.5% drop in price across all equities. Such notes look secure at first sight, but are not secure at all, if the performance is correlated!

  • “European” or “American” barrier

    This is an important technical detail that affects the capital protection at maturity. At maturity the final values of the underlying assets are compared to the start price, called the strike price. The European barrier type of notes will only observe the barrier at maturity. Whatever happened to the assets’ value during the life of the note is irrelevant. The American style barrier is observed throughout the entire term of the note. If, for instance, one of your underlying assets of a five year note would break the barrier in year two the capital protection is lost and the final value will depend on the worst performing basket member. As you can imagine American-style barriers are riskier than European-style barriers.

  • Observation Frequency

    The observation frequency effectively determines how many chances the note has to “auto-call” and thus how likely you are to get your coupon and capital back. Markets constantly move so a more frequent observation, such as quarterly, is usually favored over semi-annual or annual observation dates.

  • Memory Coupon?

    Sometimes a term called “Snowball Coupon” or “Memory Coupon” can be found on the fact-sheet. This means that if at the observation date the conditions for coupon payment are not met that the coupon will carry over to the next observation date. Once the coupon payment conditions are met at a future observation date all previously missed coupons are also paid out, not just the single coupon for that observation date. This feature adds an extra level of protection for the investor and increases the likelihood of receiving a great return on your note even if there is a market downturn during the term of the note.

Shoreline offers regular structured notes to clients via its many partners. If you would like to receive regular updates on structured notes all you need to do is to register on our mailing list. Contact us directly to discuss about investing in structured notes or if you wish to tailor a personal structured note.