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AGENDA
Who are Catley Lakeman?
Structured Investments Overview & Composition
Overview
Composition: How is a Structured Investment put together?
Structured Investments Pricing & Risks
Pricing: Volatility
Pricing: Counterparty Credit
Pricing: Overview
Pricing: Structured Investment Pendulum
Risks: What are the risks associated with Structured Investments?
WHO ARE CATLEY LAKEMAN?
Founded July 2008
Team of 7
Combined investment sales experience – 42 years
Combined structured Investment trading experience – 19 years
Combined structured Investment specific experience – 34 years
FSA authorised securities and futures firm
Outsourced origination and distribution business that sells and supports private placement securitised
derivative investments to professional asset managers and institutions in the UK
Represent eight banks on a contractual basis
STUART CHANDLER
RUSSELL CATLEY
ANDREW LAKEMAN
NINA GILL TOM MAY CHRIS DAGGJONATHAN
DAGG
Non-Executive Chairman
Sales SalesSales &
ResearchTrading &
StructuringTrading &
StructuringTrading & Research
T 020 7043 0101M 07977 917 238
T 020 7043 0102M 07812 527 172
T 020 7043 0104M 07974 990 280
T 020 7043 0103M 07876 716 067
T 020 7043 0105M 07841 332 701
T 020 7043 0505M 07921 003 583
CITIGROUPCREDIT SUISSE
HSBC JP MORGAN NOMURA RABOBANKROYAL BANK OF CANADA
UBS
CDS 197 bps CDS 145 bps CDS 136 bps CDS 98 bps CDS 277 bps CDS 117 bps CDS 118 bps* CDS 167 bps
Credit Default Swap (CDS) levels relate to basis points over LIBOR per annum, referencing the 5yr CDS level Funding is ordinarily related to a bank’s CDS, although it will differ between Investment and term
*RBC’s CDS is an estimate, based on where their 5yr bonds are currently trading
Source: Bloomberg, as at 23-Mar-12
The truth about Structured Investments in general..
o Certainly need to be managed in a portfolio
o The risks are easily definable, as are the costs
o Majority of payoffs are actually very simple to understand
o Are almost universally adaptable
o Have proved to be pretty much the most liquid asset you can hold
o Tend to do exactly “what it says on the tin”
STRUCTURED INVESTMENT OVERVIEW
You, as the investor, set the parameters..
STRUCTURED INVESTMENT OVERVIEW
Funds / Absolute Return
Volatility / Correlation / Dividends
Inflation / Commodities
Interest Rates
Currencies / Credit
Equities / Indices
Predictable paths
Conditional/ Unconditional
return
Defined Risk & Return
Reduced Volatility
Capital Protection
Liability Driven
JP Morgan Nomura RabobankRoyal Bank of Canada
UBSHSBCCredit Suisse
Citigroup
STRUCTURED Investment
STRUCTURED Investment
Income or Growth
Underlying Asset
Investment Objective
Wrapper Taxation
Investment Term
Counterparty
Risk Management
How is a Structured Investment put together?
Share Price at Issue 100.00p
ZCB / Swap 87.00p
Aggregate Costs 1.00p
Option Package 12.00p
STRUCTURED INVESTMENT COMPOSITIONHard Protection
GBP1.00Investor’s
Cash
GBP1.00Zero-
couponBond/Swap
Option packageProvidingEconomic
Return
How is a Structured Investment
put together?
Share Price at Issue 100.00p
ZCB / Swap 87.00p
Aggregate Costs 1.00p
Net Option Package 12.00p
[Sell put risk premium - 15.00p][Buy options for return 27.00p]
Option packageProvidingEconomic
Return
Sell EuropeanPut Option RiskAt 50% Strike (‘Knock-In Put’)
GBP1.00Investor’s
Cash
GBP1.00Zero-
couponBond/Swap
Option packageProvidingEconomic
Return
GBP1.00Zero-
couponBond/Swap
STRUCTURED INVESTMENT COMPOSITIONSoft Protection
HSBC 6 year Fixed Rate Bond
46% Knock-In-Put (capital eroded if
FTSE falls more than 54% of its
initial level at maturity)
Digital option paying 47.1% coupon if
FTSE is above 46% of its initial
level
HSBC 367 6yr FTSE Digital 47.1%
Step 1: Zero Coupon Bond Start with a fixed rate bond from the counterparty in question, and remove the
fixed coupons
Step 2: Downside: Sell a Knock-In Put Put capital at risk by incorporating an x% European Knock-In Put, where
capital is eroded if the underlying Index has fallen by more than x% between
the trade date and maturity
Step 3: Upside: Buy an Option Package For example: add a final coupon, the payment of which is conditional on the
Index is above x% of its initial value. This is called a ‘Digital Option’.
Fixed Rate Bond – Fixed Coupons – Knock-In Put + Digital Option
Example: Constructing a Digital Structured Investment Secondary Market Example
STRUCTURED INVESTMENT COMPOSITIONStep by Step Construction
Or in other words.. Volatility - It’s all about the bell curve!
STRUCTURED INVESTMENT PRICINGVolatility
HIGH IMPLIED VOLATILITY
LOW IMPLIED VOLATILITY
The graph below shows 5 Year Credit Default Swaps (CDS)
Credit Default Swap (CDS) levels relate to basis points over LIBOR per annum, referencing the 5yr CDS level Funding is ordinarily related to a bank’s CDS, although it will differ between Investment and term
Source: Bloomberg, as at 23-Mar-12
STRUCTURED INVESTMENT PRICINGCounterparty Credit
0
100
200
300
400
500
600
700
800
Cre
dit
De
fau
lt S
wa
p (
CD
S)
leve
ls [
ba
sis
po
ints
ove
r L
IBO
R p
er
an
nu
m]
Credit Spreads since June-2008 - Trading Ranges
close
1360
high
low
The table below shows 5 Year Credit Default Swaps (CDS)
Credit Default Swap (CDS) levels relate to basis points over LIBOR per annum, referencing the 5yr CDS level Funding is ordinarily related to a bank’s CDS, although it will differ between Investment and term
Source: Bloomberg, as at 23-Mar-12
STRUCTURED INVESTMENT PRICINGCounterparty Credit
Bank23-Mar-12
CDS23-Feb-12
CDS31-Dec-10
CDS1 month
Performance
Performance since
31-Dec-10JP Morgan 98 119 147 +0 -49Rabobank 117 118 122 -1 -5HSBC 136 131 142 +5 -6Credit Suisse 145 143 148 +2 -3Deutsche Bank 153 152 193 +1 -40UBS 167 168 180 -1 -13Lloyds TSB 176 268 342 -92 -166Barclays 183 172 197 +11 -14BNP 197 206 258 -9 -61Citi 197 239 285 -42 -88Commerzbank 204 204 285 + -81BoA 216 274 412 -58 -196Goldman Sachs 241 274 325 -33 -84Credit Agricole 247 250 264 -3 -17Soc Gen 267 275 339 -8 -72Nomura 277 265 354 +12 -77RBS 284 277 346 +7 -62Morgan Stanley 311 342 419 -31 -108Banco Santander 348 273 353 +75 -5
Why counterparty credit always matters..
Credit Default Swap (CDS) levels relate to basis points over LIBOR per annum, referencing the 5yr CDS level Funding is ordinarily related to a bank’s CDS, although it will differ between Investment and term
Source: Bloomberg, as at 16-Jan-12
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
90.00%
100.00%
110.00%
Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11
SPX Performance
HSBC 289 US Supertracker Performance
Morgan Stanley 5.5 Years S&P 500 Enhanced Tracker Notes
HSBC 289 US Supertracker
ISIN: GB00B3Z2023
Start date: 16-Feb-11
Performance to 28-Nov-11: -10.76%
5.5 year term
60% soft protection
179% upside participation
Morgan Stanley 5.5 Years S&P 500
Enhanced Tracker Notes
ISIN: XS0593913212
Start date: 14-Feb-11
Performance to 28-Nov-11: -36.13%
5.5 year term
60% soft protection
190% upside participation
STRUCTURED INVESTMENT PRICINGCounterparty Credit
What affects secondary market pricing, once a structure has traded?
The table below illustrates how changes in each parameter will affect the value of each
component, from the investors’ point of view
STRUCTURED INVESTMENT PRICINGOverview
Parameter MovementZero Coupon Bond
(Bought)Digital Option
(Bought) Knock-In-Put
(Sold)Structure
Up or
Down or
Up (credit spread up)
Down
Shorter or
Longer or
Up
Down
Up
Down
Interest Rate
Credit
Time to Expiry
Market Spot
Implied Volatility
Ongoing focus on yield-based structured products – issuance can be a key driver for long-end
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jan-
12
Eurostoxx Since 2001
Spot
0
1
2
3
4
5
6
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Jan
-02
Jan
-03
Jan
-04
Jan
-05
Jan
-06
Jan
-07
Jan
-08
Jan
-09
Jan
-10
Jan
-11
Jan
-12
Rates vs Vols - Should drive structured-products demand
2y ATM Implied Vol
2y € Rates
Higher yields, lower vols - participation should be
more attractive
High vol, lower rates- yield products appeal
Sources: UBS Equity Derivatives Strategy, Bloomberg, Jan 2012
Participation Demand
high interest rates
low option prices
strong market trend
Income Demand
low interest rates
high option prices
weak market trend
Participation NotesTwin-Win
Autocallables / BRCs
STRUCTURED INVESTMENT PRICINGPendulum
What are the risks associated with Structured Investments?
1.Market Risk Self evident and common across all risk investment vehicles
2. Credit Risk The investor is reliant on each individual bank being in a position to repay each structure at maturity. As a general
rule, the lower-rated the issuer, the more funding they will pay you within the pricing of the structure.
The 5yr Credit Default Swap (CDS) is often used as an indication of credit risk and is essentially the rate at which
institutions insure credit risk against each other (see appendix)
3. Liquidity / Mark-to-Market Risk If structured correctly, there will be full intra-day liquidity, proven in extremis Intra-day “live” prices available on websites, Bloomberg, Reuters Very easy to trade through Crest/Euroclear by DFM trading teams Accurate modeling and scenario analysis is used to assess the mark-to-market risks before issuance
STRUCTURED INVESTMENT RISKS
The information in this document is derived from sources believed to be reliable but which have not been independently verified. Catley Lakeman Securities makes no
guarantee of its accuracy and completeness and is not responsible for errors of transmission of factual or analytical data, nor is it liable for damages arising out of any
person’s reliance upon this information. All charts and graphs are from publicly available sources or proprietary data. The opinions in this document constitute the
present judgment of Catley Lakeman Securities, which is subject to change without notice. This document is neither an offer to sell, purchase or subscribe for any
investment nor a solicitation of such an offer. This document is intended for the use of institutional and professional customers and is not intended for the use of
private customers. This document is not intended for distribution in the United States of America or to US persons. This document is intended to be distributed in its
entirety. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient.
Catley Lakeman Securities is a LLP registered in England and Wales, Registered Office : One Eleven Edmund Street, Birmingham, B3 2HJ. Registration
Number: OC336585, FSA Reference: 484826
DISCLAIMER