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Structured Products

Our Staff has compiled our extensive research into Structured Products into one central resource. Additionally, we have created a searchable database of research reports completed by our staff regarding different individual structured products.

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The Rise and Fall of Apple-linked Structured Products

By: Geng Deng, Tim Dulaney, Craig McCann, and Mike Yan

The rise in Apple's market capitalization in 2012 coincided with a dramatic increase in single-observation reverse convertibles, reverse convertibles and autocallable notes linked to Apple's stock price. These notes all transfer the downside risk of owning Apple to investors but cap the upside at somewhat more than corporate bond yields.

Issuers use individual stocks like Apple as the reference obligations for reverse convertible structured products because investors underestimate the risk of suffering losses when the individual stock's price falls.

The decline in Apple's stock price from over $700 in September 2012 to $450 in January 2013 has resulted in over one hundred million dollars of losses in Apple-linked structured products. In this paper, we summarize our published reports on over 650 Apple-linked structured products and identify the impact of Apple's recent stock price decline on investors in these structured products.

Dual Directional Structured Products

By: Geng Deng, Tim Dulaney, Tim Husson, and Craig McCann

We analyze and value dual directional structured products (DDSPs) issued by several major banks since January 2011. We find that DDSPs can be valued using an option decomposition approach similar to those used with other structured products.

We confirm our analytic results using Monte Carlo simulation and use both techniques to value a large sample of DDSPs issued between January 2011 and May 2012. Our results indicate that like many types of structured products, DDSPs tend to be priced at a significant premium to present value across issuers and underlying securities and that the present value of the decomposition is smaller than the face value net of commissions. In addition, we find empirically within our sample that DDSPs with leverage on upside returns have a significantly lower average value than their un-leveraged counterparts.

Modeling Autocallable Structured Products

By: Geng Deng, Joshua Mallett, and Craig McCann

Since first introduced in 2003, the number of autocallable structured products in the U.S. has increased exponentially. The autocall feature immediately converts the product if the reference asset's value rises above a pre-specified call price. Because an autocallable structured product matures immediately if it is called, the autocall feature reduces the product's duration and expected maturity.

In this paper, we present a flexible Partial Differential Equation (PDE) framework to model autocallable structured products. Our framework allows for products with either discrete or continuous autocall dates. We value the autocallable structured products with discrete autocall dates using the finite difference method, and the products with continuous autocall dates using a closed-form solution. In addition, we estimate the probabilities of an autocallable structured-product being called on each call date. We demonstrate our models by valuing a popular autocallable product and quantify the cost to the investor of adding this feature to a structured product.

The Anatomy of Principal Protected Absolute Return Barrier Notes

By: Geng Deng, Ilan Guedj, Joshua Mallett, and Craig McCann

Principal Protected Absolute Return Barrier Notes (ARBNs) are structured products linked to an underlying security or an index. While these notes guarantee principal protection - return of face value - their upside potential is dependent on the level of the underlying security never falling outside of a predefined range. This, combined with the credit risk of the issuer to which all structured products are subject, makes these products difficult to value.

In this paper we value ARBNs by decomposing the note into a zero coupon bond and double barrier linear segment options. We derive closed form solutions for ARBNs and their Greeks, then value 214 publicly-listed ARBNs issued by six different investment banks between 2006 and 2009. We find that the ARBNs' fair price is approximately 4.5% below the actual issue price on average.

What TiVo and JP Morgan teach us about Reverse Convertibles

By: Geng Deng, Craig McCann, and Edward O'Neal

Prior research on structured products has demonstrated that equity-linked notes sold to retail investors in initial public offerings are extraordinarily poor investments. In this paper, we review recent literature and market events and extend our previous work to document the systematic over-pricing of a particular type of enhanced-yield structured product - Reverse Convertible Notes.

We show that these complex notes are typically significantly overpriced when sold in initial public offerings. As a result of their complex payoffs and the lack of a secondary market to correct the mis-pricing, reverse convertible notes continue to be sold at inflated prices because investors do not fully understand these products.

Despite this substantial overpricing, and the significant losses on the reverse convertible notes issued in 2008 that matured later in 2008 and 2009, there have been a substantial number of new issues of these dubious investments by JP Morgan, Barclays and many others brokerage firms in 2010. We offer JP Morgan's May 14, 2010 TiVo-linked reverse convertible as an extended illustration of the per se unsuitability for individual investors of many retail reverse convertible structured products.

Malliavin Calculus in Calculating Delta for Structured Products

By: Geng Deng, Sherry Liu, Ilan Guedj, and Joshua Mallett

Malliavin Calculus [3, 6], also known as Stochastic Calculus of Variations, is a useful tool for calculating sensitivities of financial derivatives to a change in its underlying parameters, such as Delta, Vega, and Gamma. In this article, we discuss how to use Malliavin Calculus to calculate Delta for structured products.

Structured Products in the Aftermath of Lehman Brothers

By: Craig McCann and Dengpan Luo

In a previous research paper, we illustrated the two general types of equity-linked structured products sold to retail investors in the United States - principal protected notes and enhanced yield-notes. By way of examples of our general thesis that retail structured products were over-priced at their initial offering, we reported on the valuation of Merrill Lynch's 7-Year S&P 500 MITTS® issued on August 30, 2002, JP Morgan's 5-Year Capped Quarterly Observation Notes linked to the S&P 500 issued on June 22, 2004 and Citigroup's 3-Year, Intel-linked TARGETS® issued on February 15, 2005.

Our 2006 working paper on structured products has been joined by work from other authors demonstrating that structured products sold to retail investors in initial public offerings were extraordinarily poor investments.

Are Structured Products Suitable for Retail Investors?

By: Craig McCann and Dengpan Luo

Equity-linked notes - a type of structured product - are securities issued by brokerage firms and traded in the secondary markets like shares of common stock. These investments offer part of the upside from owning stocks but limit nominal losses if held until maturity.

Once sold only to sophisticated investors, structured products are increasingly being sold to unsophisticated retail investors. Equity-linked notes are difficult to evaluate and monitor, have high hidden costs and are illiquid. They are therefore virtually never suitable for unsophisticated investors.