Structured Note

What is a 'Structured Note'

A structured note is a debt obligation that also contains an embedded derivative component that adjust the security's risk/return profile. The return performance of a structured note will track both that of the underlying debt obligation and the derivative embedded within it. This type of note is a hybrid security that attempts to change its profile by including additional modifying structures, therefore increasing the bond's potential returns.

BREAKING DOWN 'Structured Note'

A structured note is a debt security issued by financial institutions; its return is based on equity indexes, a single equity, a basket of equities, interest rates, commodities or foreign currencies. The return on a structured note is linked to the performance of an underlying asset, group of assets or index.

All structured notes have two underlying pieces: a bond component and a derivative component. The bond portion of the note takes up most of the investment and provides principal protection. The rest of the investment not allocated to the bond is used to purchase a derivative product and provides upside potential to investors. The derivative portion is used to provide exposure to any asset class.

An example of a structured note would be a five-year bond coupled with a futures contract on almonds. Common structured notes include principal-protected notes, reverse convertible notes and leveraged notes.

Potential Structured Note Risks

Derivative products, on their own, are complicated. Products like mortgage-backed securities (MBS) and commodities futures contracts require knowledge on the part of the investor to understand the financial implications. This makes a structured note a very complex product, seeing as it is both a debt instrument and a derivative instrument. It's important to understand a structured note's payoff structure and payoff calculation.

Market risk is prevalent in all investments, and a structured note is sometimes exposed to high levels of this risk. Some structured notes are have principal protection, but for the ones that don't, it's possible to lose some or all of the principal, based on market risk. This risk arises when the underlying derivative becomes volatile, as is the case with equity or commodity prices and interest rates or foreign exchange rates.

Liquidity is a problem that comes up when investing in a structured note. These types of notes are not listed for trading on security exchanges. This makes it very hard to buy or sell a structured note on a secondary market. Investors who are looking at a structured note should expect to hold the instrument to its maturity date and should therefore be careful when choosing a derivative component.

RELATED TERMS
  1. Capital Structure

    A mix of a company's long-term debt, specific short-term debt, ...
  2. Structured Finance

    A service that generally involves highly complex financial transactions ...
  3. Equity Derivative

    A derivative instrument with underlying assets based on equity ...
  4. Capitalization Structure

    The proportion of debt and equity in the capital configuration ...
  5. Note

    A financial security that generally has a longer term than a ...
  6. Bond for Bond Lending

    A lending structure used in the Federal Reserve's security lending ...
Related Articles
  1. Investing

    Structured Notes: Buyer Beware!

    At first glance, this product looks like the answer to investors' prayers. In reality, it's just too good to be true.
  2. ETFs & Mutual Funds

    An Introduction To Structured Products

    Structured products take a traditional security and replace its usual payment features with a non-traditional payoff.
  3. Financial Advisor

    4 Structured Product Types Wealthy Clients Love

    High-net-worth investors find structured products appealing for a variety of reasons. Here's a look at four types.
  4. Trading

    Principal-Protected Investments: Risks, Fees And Regulations

    Discover if these instruments hit the right note for you.
  5. Trading

    What Is A Derivative?

    A derivative is a security whose price is dependent upon or derived from one or more underlying assets. Learn more on how investors can use this financial instrument in their trading strategies.
  6. Trading

    Derivatives 101

    A derivative investment is one in which the investor does not own the underlying asset, but instead bets on the asset’s price movement with another party.
  7. Financial Advisor

    SEC Derivatives Rule May Limit Diversification

    The SEC has proposed rules that will limit the use of derivatives by fund managers. Critics believe the rules will impede funds' ability to diversify.
  8. Trading

    Warrants

    Learn more about this derivative security.
  9. Financial Advisor

    Hedge Funds and Alternative Funds Are Not Evil, Here's Why

    While disclosures and investor education need improvement, alternatives provide a valuable way to increase yield and hedge against declines.
  10. Markets

    UPS Stock: Capital Structure Analysis

    Analyze UPS' capital structure to determine the relative importance of debt and equity financing. Identify the factors influencing financial leverage trends.
RELATED FAQS
  1. What does it signify if the term structure of an interest rate's curve is positive?

    Understand what the term structure of interest rates is used to measure. Learn what a positive term structure signifies to ... Read Answer >>
  2. What expiry months are typically available for derivatives?

    Discover more about the derivatives market and learn about the varying expiration months for derivatives in different financial ... Read Answer >>
  3. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Answer >>
  4. How big is the derivatives market?

    Examine the potential size of the total derivatives market, and learn how different calculations can reduce the estimate ... Read Answer >>
  5. Can mutual funds invest in derivatives?

    Find out about mutual fund investment options, and understand whether mutual funds are permitted to include investments in ... Read Answer >>
  6. What kinds of derivatives are traded on an exchange?

    Learn about the different types of derivatives traded on exchanges, including options and futures contracts, and discover ... Read Answer >>
Hot Definitions
  1. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  2. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  3. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  4. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  5. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  6. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
Trading Center