Posted in Finance, Accounting and Economics Terms, Total Reads: 141
Definition: Globally Capped Contract
A globally capped contract is a particular kind of contract option that ensures a minimum return, but as a tradeoff puts a cap on the profits possible. The cap here is on the total returns. In simpler words, globally capped contracts are structured financial/investment products that merge guaranteed payoff with the possible appreciation of the underlying assets(portfolio/index) upto a capped level.
Negative returns are accounted for fully, but positive returns are capped for at a threshold level. This makes valuation of such kinds of contracts tedious. The cap on the contract indirectly pays for the global floor.
As with any financial derivative product which derives its value from its underlying asset, globally capped contracts put a limit on the profits attainable on the underlying investment or reference portfolio. Hence, in a sense, a globally capped contract is a kind of a embedded option present in certain derivative products that limit the upside potential of the product over its lifetime. Globally it is seen that these kind of contracts are popular amongst investors who prefer structured investment products which are more stable compared to straight options.
Globally capped contracts differ substantially as compared to locally capped contracts in that the cap on profits if for the life of the investment product as against the immediate/quarterly returns. Secondly globally capped contracts end up being more popular than locally capped contracts because locally capped contracts tend to be more complex path dependent which investors find inconvenient. The disadvantage with such kind of contracts is that the incumbent investor will not participate fully in the potential upside of the underlying investment, and hence there is a semblance of an opportunity loss. Therefore, the underlying investments’ performance is not tracked accurately in the case of these kinds of capped contracts. The advantage however of globally capped contracts, is that capital protection of the investment is done to some extent.