How is a Structured Product put together?

Mar 2009

Content

IntroductionExample 1 – Zero Coupon Bond + CallExample 2 – Zero Coupon Bond + Geared CallWhat determines Structured Product pricing?Option pricing summary

Introduction

Using examples, this presentation aims to illustrate how seemingly

complicated structured products can be decomposed into simpler

component parts.

Having determined the component parts of these sample products,

the pricing parameters that determine the value of these Component parts are then discussed.

Example 1 – Zero coupon bond + call

In Pictures

GBP1.00Investor’s

Cash

Share Price at Issue 100.00p

Zero-Coupon Bond 75.00p

Aggregate Costs 1.50p

Option Premium 23.50p

GBP1.00Zero-coupon

Bond

OptionProvidingEconomic

Return

Example 1 – Zero coupon bond + call

In Numbers

• Amount to spend = 100p• Zero coupon bond cost = 75p• Costs = 1.5p• Therefore cash remaining to spend = 100 – 75 – 1.5 =

23.5p• Cost of one FTSE atm call option = 23.5p• Therefore number of FTSE options bought = 23.5/23.5 = 1

• Therefore structured product is 1 x ZCB + 1 x FTSE call

Example 2 – Zero coupon bond + geared call

In Numbers

• Amount to spend = 100p• Zero coupon bond cost = 75p• Costs = 1.5p• Therefore cash remaining to spend = 100 – 75 – 1.5 =

23.5p• Cost of one SPX atm call option = 11.75p• Therefore number of FTSE options bought = 23.5/11.75 =

2

• Therefore structured product is 1 x ZCB + 2 x SPX call

What determines Structured Product pricing?

• Two Price Components

• Zero Coupon Bond Price• Interest rates• Credit

• Option Price• Volatility• Time to expiry• Spot price• Strike price• Dividends• Interest rates

What determines Structured Product pricing?

Volatility – It’s all about the bell curve!

What determines Structured Product pricing?

Or in simple terms!

High ImpliedVolatility

Low ImpliedVolatility

What determines Structured Product pricing?

Time to expiry – it’s all about the bell curve – again!

What determines Structured Product pricing?

The remaining parameters are:

• Spot price• Strike price• Dividends• Interest rates

• These are all used to generate the forward price

Option pricing summary

In summary, the input parameters for option pricing break down into the three categories below:

• Volatility – Most important parameter• Higher vol = more expensive option

• Time to expiry• Longer dated = more expensive option

• Forward price• Found using spot, rates and expected dividends

Disclaimer

The information in this document is derived from sources believed to be reliable but which have not been independently verified. Catley Lakeman

Securities makes no guarantee of its accuracy and completeness and is not responsible for errors of transmission of factual or analytical data, nor is it

liable for damages arising out of any person’s reliance upon this information. All charts and graphs are from publicly available sources or proprietary data.

The opinions in this document constitute the present judgment of Catley Lakeman Securities, which is subject to change without notice.

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