This section will detail how various building blocks are combined to offer a structured product offering at maturity a minimum return on the capital invested, plus a potential upside linked to an equity market. The two basic approaches we examine are: a Zero Coupon Bond + Option combination, or via an equity swap + rolling short term deposits.
We will take the example of a product offering after 5 years a minimum capital return of 100% plus 100% of any rise in the FTSE100 over the investment period.
The traditional way to build a guaranteed equity product would be to split the money received from the investor into two main building blocks:
- An upfront deposit also known as a Zero Coupon Deposit or Zero Coupon Bond, which is guaranteed (as long as the deposit taker or bond provider does not default on its obligations) to grow to 100% at the maturity date
- An option premium used to purchase at-the-money call options on the FTSE100, offering upside exposure. For example, if the FTSE was at a level of 1000 at the start of the investment, and rises to 1500 after 5 years, the option will pay out the difference between the strike price, that is the initial index level of 1000, and the final index level, resulting in a gain of 500 points (1500 minus 1000), i.e. the rise in the index over the investment period. Otherwise, if the index falls the option expires worthless.