24 - Structured Products Flashcards
What are the 3 main types of PPNs?
- Index-linked notes
- Mutual fund-linked notes
- Hedge fund-linked notes
What are the five main types of structured products?
- Principal-protected note (PPN)
- Index-linked GICs
- Split shares
- Asset-backed securities (ABS)
- Mortgage-backed securities (MBS)
What are maturity terms for Index-linked vs Mutual fund-linked notes?
Index: 3-5 years
MF: 6-8 years
What three entities are involved with bringing PPNs to market?
- Guarantor (sched I or II banks)
- Manufacturer (big six banks)
- Distributor (invest/MF dealers)
How does a zero-coupon bond plus call option PPN protect the principal and provide return?
Most funds go into a zero coupon bond with maturity date in several years to protect principal. The rest goes into buying call options on the underlying asset (growth potential).
How does a “constant proportion portfolio insurance” (CPPI) structure work?
Shifts the portfolio’s allocation between a risky asset and a risk-free one, based on changes in interest rates and the value of the risky asset.
What are 5 risks related to PPNs?
- Liquidity risk
- Performance risk
- Call risk
- Credit risk
- Currency risk
How is a PPN taxed if it is held to maturity?
Any gain in NAV is treated as interest income in the year it matures.
How is a PPN taxed if it is redeemed before maturity?
CRA hasn’t decided. Most in the investment community think it should be a cap gain/loss, but who knows what CRA will decide?
What does a “maximum cap on returns” provision mean?
The investment cannot yield more than the maximum return allowed by the issuer. (Index-linked GICs)
What is a participation rate?
It means the performance of an index-linked GIC will be equal to a percentage of the underlying index’s performance. (E.g. If index returns 20% and participation rate is 80%, then GIC returns 16%)
What is the formula to determine total interest earned on an Index-linked GIC?
Principal x ((end - initial)/initial x 100) x (Participation Rate)
What are a couple risks of Index-linked GICs?
- The index might not increase
2. Cannot redeem prior to maturity
How are Index-linked GICs taxed?
As interest income in the year of maturity.
How do split shares work?
Purchases common stock of a dividend yielding company, and splits them into: preferred shares (only dividends, no cap gains) and capital shares (no dividends, only cap gains)