What is a structured financial product?

Answer 1

Structured financial product is a product designed to give the user of such a product the return he needs based on the risk he is willing to make.
Suppose you are a Corporate Tressurer, you have $50 million need in debt. You want to reduce the yield by say 1/2 a percentage point less or more. So you do something like you enter into a contract with a Bank willing to lend you with the rates pegged to something like say the variation in exchange rate of another countries exchange rate. Suppose if the exchange rate don't vary you will wind up with lower intererst payments and if it goes up you will wind up with higher payments and like wise opposite if it goes down. The advantage to the lender is if the exchange rate of the alien country fluctuates high they make more else they make the contracted return. Of course this is for a fee involved in arranging the debt. In reality it is slightly more involved and there are different types of structured debts available or possibly one can create. The one I described above is called the 'inverse floater',

Answer 2

A structured product takes two or more "vanilla" securities (stocks, bonds, etc.) and combines them to create a new security that is more tailor-made for the customer's risk/return requirements.

For example, a customer may like the upside that he gets from the stock market, but wants a little more income and also is worried about the risk of a price drop. Instead of buying an S&P 500 index fund that yields 2%, he would buy a product that is some combination of a stock, a bond and/or an option.

This product may yield 4% and maybe only suffer 50% of the downside of a price drop in the S&P 500. However, the buyer of this product may only get 50% of any price appreciation. There are many, many ways to do this, because it is based on the customer's view of risk and reward.

The way that they are constructed could be duplicated by the customer, (i.e. they can just buy some combination of stocks bonds and options to create the same profile) but investment banks have access to a wide variety of securities and also have the analytical talent to really "dial in" what you need.

This sounds like a commercial for structured products, but I actually would not recommend them, as a) you probably could get 90% percent of the way there by building a diversified portfolio yourself, b) the products come with a pretty big markup, c) you have "counterparty risk", since most of the time you are buying these products directly from the investment bank, and not through an exchange and even the exchange-traded products have counterparty risk. d) you probably really don't know what your risk/reward profile is until you take a big loss or receive a big gain, so why try to get so precise?

Large institutions such as pension funds and insurance companies are a better fit for these products, since they have very specific requirements to match their investments with liabilities.