Posted in Finance, Accounting and Economics Terms, Total Reads: 251
Definition: Globally Floored Contract
A structured investment product is a type of a pre-packaged investment product that gives a specific payoff with respect to a reference portfolio which maybe an index/ security/ stock/ derivatives etc. These products are sold by banks and other Financial Institutions. These kind of structured instruments have become very popular.
A Globally floored contract is a kind of a guarantee that is found in such structured investment products that helps in receiving a minimum amount of payoff at maturity. In case the investment in the underlying instrument loses its value, such a provision will protect the investors to recover some value by minimising the loss and hence placing a floor on the downside potential. However, the downside is that activating such a provision will lead to the maximum amount of payoff not being realised if the trade ends up on the positive side. The guarantee is referred to as a global floor because it is applicable for the entire life of the contract.
Payoff of a locally capped globally floored contract:
Let the Initial investment be Rs. 5,000.
Maturity of the instrument = 10 years
Let r = 10% be the guaranteed minimum rate at the time of maturity
Let the quarterly local cap, c= 5%
There are many potential risks involved with structural products as their value is highly correlated to market movements. As a result of such risk present, clients’ approval must be obtained explicitly for such investments and trading.