We will take the example of a FTSElinked product offering a guaranteed coupon of 7% p.a., with a capital return of 100% if the final index is the same or has risen over the investment period, or a capital return reduced by 1% for every 1% in the fall of the index otherwise.
With interest rates around 5%, the cost of offering a 7% per annum coupon comes up to £29.9 out of each £100 placed by the investor into the product, while the value of offering a capital return of 100% at maturity is £75.9 out of each £100.
The total cost comes up to £105.8, which is more than the product provider has received from the investor for the product. To make the structure possible therefore, the product provider sells an atthemoney put option, for which it receives £8 for each £100 placed into the product. Therefore, the overall cost of the structure is decreased from £105.8 to £97.8, allowing for £2.2 to be left over for the provider’s margin and administrative costs.
At maturity, if the index has fallen however the capital return will be reduced by 1% for every 1% fall in the index.
