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Structured Products Canadian Annual Derivatives Conference August 17 th -19 th 2005. Why Structured Products?. Access to strategies unavailable to Mutual Funds Repackaging of securities Tax benefits Access to offshore securities and funds Access to enhanced manager ‘tool kit’

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Structured Products

Canadian Annual Derivatives Conference

August 17th -19th 2005


Why structured products
Why Structured Products?

  • Access to strategies unavailable to Mutual Funds

  • Repackaging of securities

  • Tax benefits

  • Access to offshore securities and funds

  • Access to enhanced manager ‘tool kit’

    • short selling

    • options

    • derivatives

    • Leverage

  • Exposure to previously unattainable investments

    • Offshore property

    • Hedge Funds


Forms of structured products
Forms of Structured Products

Listed:

  • Income Trusts

  • Split Share Corporations

  • Closed End Funds

  • Flow through LP’s

  • Exchange Traded Funds (ETF’s)

    Unlisted:

  • Market linked instruments


Listed structured products ending dec 2004 41 5 billion 3 of tsx 228 products
Listed Structured ProductsEnding Dec 2004: -$41.5 Billion-3% of TSX -228 products

Source: TSX Group Inc.


Listed structured products ending dec 2004 sp s 9 5b corp 3 2b it s 2 9b
Listed Structured ProductsEnding Dec 2004: -SP’s: $9.5B-Corp: $3.2B -IT’s: $2.9B

Source: TSX Group Inc.


Unlisted structured products growth yr yr ml gics 0 5 linked notes 29
Unlisted Structured ProductsGrowth yr/yr: ML GICs: -0.5%Linked Notes: 29%

Source: Investor Economics


Unlisted structured products
UnlistedStructured Products

Source: Investor Economics


Unlisted structured products1
Unlisted Structured Products

Source: Investor Economics


Principal protected notes
Principal Protectednotes

  • A debt security issued by an agent (Investment manager and backed by a guarantor (usually Schedule I or II bank)

  • Guarantees 100% of principal if held to maturity (a range of 6 to 10 years)

  • At maturity, pays original principal plus appreciation from the underlying ‘linked’ asset.

  • May pay a coupon (variable or fixed) with no correlation between value of this coupon and return of the underlying asset


Ppn underlying assets
PPN underlyingassets

Underlying assets that are ‘linked’ to notes include:

  • Mutual funds

  • Group of funds

  • An index

  • Basket of equities

  • Pools of income trusts

  • Hedge funds

  • Funds of funds

  • Emerging markets

  • Currencies

  • Commodities

  • etc


Growth in ppn s cagr since dec 1999 70 3
Growth in PPN’sCAGR since Dec 1999: 70.3%

Source: Investor Economics


Ppn s two approaches 1 zero coupon bond
PPN’s: two approaches1.Zero Coupon Bond

  • Strip bond with option: (example $100 note)

    • $70 into zero coupon or strip bond

    • $30 into long term option on underlying asset

    • Leverage x option ≈ $100 notional exposure to asset

  • Issues:

    • A Low interest environment requires large portion of the investment to be applied to zero coupon bond

    • May not get leverage on call option to get $100 notional exposure

    • Call option tied to expected volatility of asset (conservative but can be costly)

    • Selling before maturity can be costly as the strip bond is heavily discounted to start.


Ppn s two approaches 2 constant proportion portfolio insurance cppi
PPN’s: two approaches2.Constant proportion portfolio insurance (CPPI)

CPPI (a monitoring approach)

  • Two components

    • Underlying investment

    • A guarantee, notionally related to a zero coupon bond that matures at 100%

  • Formula monitors the NAV of the underlying asset against a reference curve or ‘floor’ that increases over time.

  • Starting floor value = cost of zero coupon bond calculated to yield 100 at maturity. Over time, zero coupon bond cost increases.

  • As long as the investment NAV remains a specific distance above this floor (delta), all cash is kept in the investment.

  • Allows for leverage to be applied if NAV gains in value and removed if NAV falls below the delta (dynamic leverage)


CPPI

Example: 8 yr term, $100 note

At Time 0:

Annual yield on 8yr zero coupon bond = 3.0625%

Over 8 years this = 24.5%

Cost of zero coupon = $75.50 (floor) rises over time

Starting delta (distance between zero coupon cost and 100) 100-75.50 = 24.5

To keep $100 in the investment, the NAV of the investment must not fall below 24.5% above the floor.


CPPI

De-leveraging begins

Knock out

delta

guarantee

Asset return


Cppi enhancements
CPPI:enhancements

  • Some enhancements to the CPPI structure:

    • Lock-ins to periodically crystallize gains above the delta

    • Payouts or coupon payments (return of capital until initial capital amount met)

    • Options on CPPI for offshore exposure within FIE constraints

    • Conversion of income to capital gains through derivatives


Risks
Risks

  • Credit rating of guarantor

    • Mitigated by using rated schedule I and II banks

  • Level of participation in underlying asset

    • CPPI investment can be reduced by poor initial performance (de-levered). Harder to get back returns due to lower investment base

    • locked out early (end up sitting in a bond for a few years)

      (assessment of underlying asset is very important !)

  • Cost of guarantee

    • Driven by interest rates

      • lower interest rates = lower yield = higher cost of guarantee

  • In unlisted PPN’s, the secondary market is at the mercy of guarantor (availability, gates, discount)


Structured product fees
Structured Product:Fees

  • Strategy dependant on value of CPPI structure to an investment

  • Fees for guarantee (discounted to pay guarantor)

  • Fees for option

  • Plus trailers, expenses, management fees, front end fees and commissions to investment manager and advisor etc


More information acknowledgements
More information & Acknowledgements

  • TSX Group (www.tse.com)

  • Investor Economics (www.investoreconomics.ca)

  • Fund Library (www.fundlibrary.com)

  • Investment executive (www.investmentexecutive.com)

  • AIMA (www.aima.org)

  • Various regulators


Thank you

Contact details:

Andrew Doman

Chief Operating Officer

Abria Alternative Investments Inc.

20 Adelaide Street East, Suite 300

Toronto, Ontario, Canada

M5C 2T6

Tel: 1-416 367-9993

Fax: 1-416 367-4555

website: www.abriafunds.com


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