With every investment, the day of truth comes at some point. Whereas with a direct investment, for example in a share, the holder is free to choose the time of sale, structured products are largely designed for a fixed term. Although they can also be sold on the secondary market at any time, most structures only develop their true earnings potential at the end of their term. The final fixing then determines whether the investment ends with a profit or loss.
To avoid any unplanned surprises at the end of the investment, it is essential to take a look at the term sheet when buying a structured product. The terms of repayment are described in detail in the termsheet. In order to familiarize you with the relevant technical terms and possible scenarios, in the current issue of "Leonteq Know-how" we take a look at the redemptions of Switzerland's favorite child: the Barrier Reverse Convertible (BRC).
The definitive end of a structured product is determined by the maturity date. On this date, which is fixed before the issue date, the final fixing takes place. Redemption usually takes place a few days later. Investors then receive the respective amount plus coupon credited to their settlement account.
The amount of the redemption depends on the performance of the underlying instrument. Two scenarios are possible with a BRC. First, the barrier remained intact or second, the threshold was touched. In the first case, the redemption is relatively simple: If no barrier event occurred, the issuer pays back 100 percent of the denomination in cash. This ends the investment with the maximum return, which is determined by the amount of the coupon. However, if the barrier is breached, scenario two occurs. In the event that the underlying closes above the strike price at the end, the issuer again pays back the full nominal amount. Holders therefore achieve the maximum return despite the barrier breach.
However, if the underlying does not make it back to the strike price, the partial protection no longer applies. In this case, 100 percent of the nominal can no longer be paid and the underlying is physically delivered in accordance with the conversion ratio. A note: In the case of indices and commodities as underlyings, corresponding ETFs can be delivered as an alternative to cash settlement.
Example: Redemption scenarios for a single BRC
In the case of multi-structures, the so-called "worst-of" principle is applied in the event of a threshold violation. Accordingly, the weakest security of the basket decides on the repayment. Caution: The worst performer does not necessarily have to be the underlying that caused the barrier event. For the determination of the redemption, the only decisive factor is which has the worst performance at the final fixing.
The calculation of the underlying with the weakest performance is relatively simple. The current stock market price or closing price on the maturity date is set in relation to the initial fixing and the percentage result is the price performance. While distributions such as dividends do not play a role in the performance calculation, events such as stock splits must be taken into account.
Example: Repayment scenarios for a Multi BRC
With regard to the redemption modalities, it is also important to keep an eye on the currencies. If the denomination and the underlying are quoted in the same currency, the conversion ratio is the quotient of the denomination and the strike price of the respective underlying. If different currencies are involved, the conversion ratio is calculated by dividing the denomination (currency A) by the strike price of the respective underlying (currency B) multiplied by the exchange rate on the maturity date (exchange rate B/A). This is the so-called quanto mechanism, which describes that the product is a currency-hedged product. This is because the conversion on the expiration date means that the performance of the underlying is reflected 1:1 in the redemption. Therefore, no conversion ratio can be given for underlyings that are quoted in a currency other than the product currency at issuance.
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