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Definition: Structured Note
It is a hybrid type of security that combines various financial products such as Stocks, Bonds and Derivatives. An example could be a long position in a stock along with a 10 year Government Bond combined with a Short position in a Call position. The presence of an option in the contract changes the risk-returns characteristics of the payoff and since it is combined with a Government Bond which is essentially risk-free, it induces the investors to induce in such a contract as it reduces the negative potential in case the option doesn’t work as expected.
By providing an option of investing across various asset classes such as Equities, Commodities, Currencies, Derivatives, Bonds and Indices it provides more alternatives for investors and is Tailor-made and customised according to the customer needs. The pay-out may be either linear or non-linear. It helps in diversification and provides principal protection and participation in pay-out.
Also, banks can use structured note as a tool to reduce counterparty risk or credit risk to the bank by passing risk to end investor, buyer of Structured note
There are two main ways by which structured notes are created:
1. Option based strategy: This type of product is created by combining a Zero Coupon Bond along with options. While the payoff from the Zero Coupon Bond is the payoff, the option contract provides an exposure to the specific asset class
2. Delta One Strategy: This strategy involves investing the proceeds into the required asset classes directly