Structured Products Flashcards
Liquidity Facilities
Active Users: Fund-of-Hedge Funds
Purpose: provide working capital to bridge the cash-flow timing mismatch between fund-of-hedge fund’s allocations to new funds and receipt of proceeds from redemptions from old investments. Structures can have the following formats:
Traditional Credit Products – Revolvers
Securities – Variable Funding Notes (“VFNs”)
Subordination: gap risk limited to 10%-30% of the borrower’s net asset value (70%-90% equity cushion)
Protections: Like any borrowing base deal, covenant packages govern the following risk factors: Diversification, Liquidity of underlying investments, Volatility and performance drawdown, Leverage and equity cushion (debt-to-equity ratio, maximum equity capital decline, etc.)
Principal Protection
Active Underlying: Single Name and Fund-of-Hedge Funds
Purpose: Principal protection structures guarantee return of 100% of investor client’s principal on a pre-determined maturity date while increasing assets under management for issuer clients.
100% of invested principal is invested in the risky hedge fund asset and Principal Protection Provider monitors the fund’s NAV relative to the present value of the protected amount
- If the buffer increases, the Protection Provider can provide additional leverage to increase hedge fund allocation (subject to cap. If the buffer is depleted, the fund repays leverage or allocates to cash. This dynamic leverage/de-leverage mechanism is based upon a formula
- SPI entails the Principal Protection Provider purchasing the underlying reference fund shares as a delta hedge
- CPPI entails Principal Protection Provider taking a security interest in the reference fund shares or accessing them through control agreements
Subordination: gap risk generally ranges from 75% to 80% of portfolio value (20% - 25% equity cushion)
Protections: Covenant packages similar to liquidity and leverage structures, along with other “lock-in events” allowing JPM to substitute the underlying for another fund or cash-index.
At-the-Money Option-based Transactions
Active Underlying: Single Name and Fund-of-Hedge Funds
Purpose: allow investors to customize payoffs in a variety of ways to gain increased leverage, tax efficiency, targeted coupon streams, averaging features (a/k/a Asian calls) and out performance among a basket of asset classes, etc. Structures include:
- European or Asian Call Options with at-the-money strike providing leverage and long-term tax treatment;
- Alpha TaRN (Targeted Annual Redemption Note): provides 100% capital gtee and regular income through annual coupon payments that are fixed for the 1st year and linked to the performance of the underlying fund of hedge funds thereafter.;
- Pick-n-Drops provide both 100% capital gtee along with a final coupon based on the best performing asset return in a diversified basket.;
- Investible Global Asset Rotator (“IGAR”) similar to pick-n-drops in that the product allows investors to maximize the performance of a broadly diversified basket of indices/funds through momentum based rebalancing..
Implied leverage (equity cushion): can be 5x or greater (<10-20% equity cushion or reserve).
Risks: an increase in volatility of underlying, inability to adjust hedges timely for price changes.
Protections: Substitution rights and packages similar to principal protection structures.Active
Leverage Transactions
Active Underlying: Single Name and Fund-of-Hedge Funds
Purpose: allows investor client to enhance return-on-equity and increases AUM for issuer clients. Customized structures can have the following formats:
- Traditional Credit Products – Revolving Credit Facilities or Term Loans
- Securities – VFNs
- Derivatives – Total Return Swaps (TRS), Call Spread Options, out-of-the-money Call Options, etc.
Subordination: gap risk generally ranges from 33% to 75% of portfolio value (67%-25% equity cushion)
Protections: Covenant packages similar to liquidity facilities (if not stronger)
