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Structured Products Canadian Annual Derivatives Conference August 17 th -19 th 2005

Structured Products Canadian Annual Derivatives Conference August 17 th -19 th 2005

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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’ - PowerPoint PPT Presentation

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Page 1: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Structured Products

Canadian Annual Derivatives Conference

August 17th -19th 2005

Page 2: 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’short sellingoptionsderivativesLeverage

Exposure to previously unattainable investmentsOffshore propertyHedge Funds

Page 3: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Forms of Structured Products

Listed:Income TrustsSplit Share CorporationsClosed End FundsFlow through LP’sExchange Traded Funds (ETF’s)

Unlisted:Market linked instruments

Page 4: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Listed Structured Products

Ending Dec 2004: -$41.5 Billion-3% of TSX -228 products

56%

1%

21%

9%

13%Fund of Funds 166 issuers

MF partnerships 101 issuers

ETF's 17 issuers

Split Share Corps 27 issuers

Capital Trusts 8 issuers

Source: TSX Group Inc.

Page 5: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

TSX New issues market

0

2

4

6

8

10

12

14

16

18

1999 2000 2001 2002 2003 2004

In $Billions

Structured products Corporate Income trusts

Source: TSX Group Inc.

Listed Structured ProductsEnding Dec 2004: -SP’s: $9.5B-Corp: $3.2B -IT’s: $2.9B

Page 6: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Assets in Billions

8.7

15.8 15.7

5.3

0.7

4.1

0

5

10

15

20

25

Dec 1999 Dec 2003 Dec 2004

Market linked GIC's Linked notes

Source: Investor Economics

Unlisted Structured ProductsGrowth yr/yr: ML GICs: -0.5%Linked Notes: 29%

Page 7: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Number of market linked instruments

36 57 66

216

31

145

0

50

100

150

200

250

300

Dec 1999 Dec 2003 Dec 2004

Market linked GIC's Linked notes

Source: Investor Economics

Unlisted Structured Products

Page 8: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Number of market linked sponsors

16 17 19

27

4

22

0

5

10

15

20

25

30

35

40

45

50

Dec 1999 Dec 2003 Dec 2004

Market linked GIC's Linked notes

Source: Investor Economics

Unlisted Structured Products

Page 9: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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

Page 10: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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

Page 11: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Number of market linked sponsors

0.6

4.87

8.86

16

5

17

3539

35

0

5

10

15

20

25

30

35

40

45

Dec 1999 Dec 2002 Dec 2003 Dec 2004

Assets in $B No. of sponsors No. of notes

Source: Investor Economics

Growth in PPN’sCAGR since Dec 1999: 70.3%

Page 12: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

PPN’s: two approaches

1.Zero Coupon Bond

Strip bond with option: (example $100 note)

$70 into zero coupon or strip bond$30 into long term option on underlying assetLeverage x option ≈ $100 notional exposure to asset

Issues:A Low interest environment requires large portion of the investment to be applied to zero coupon bondMay not get leverage on call option to get $100 notional exposureCall 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.

Page 13: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

PPN’s: two approaches

2.Constant proportion portfolio insurance (CPPI)

CPPI (a monitoring approach)Two components

Underlying investmentA 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)

Page 14: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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 timeStarting 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.

Page 15: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

CPPI

CPPI

0

20

40

60

80

100

120

140

1 6 11 16 21 26 31 36 41 46 51 56 61 66 71 76 81 86 91 96

months

%

De-leveraging begins

Knock out

guaranteeAsset return

delta

Page 16: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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

Page 17: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Risks

Credit rating of guarantorMitigated by using rated schedule I and II banks

Level of participation in underlying assetCPPI investment can be reduced by poor initial performance (de-levered). Harder to get back returns due to lower investment baselocked out early (end up sitting in a bond for a few years)

(assessment of underlying asset is very important !)

Cost of guaranteeDriven 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)

Page 18: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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

Page 19: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

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

Page 20: Structured Products Canadian Annual Derivatives Conference August 17 th  -19 th  2005

Thank you

Contact details:Andrew DomanChief Operating OfficerAbria Alternative Investments Inc.20 Adelaide Street East, Suite 300Toronto, Ontario, CanadaM5C 2T6Tel: 1-416 367-9993Fax: 1-416 367-4555website: www.abriafunds.com