Explaining a Digital Synthetic to my Dad
Factsheet - For Professional Intermediaries Only
This document is intended to be a factsheet that discretionary asset managers can use to explain this Structured Investment to a client. Before deciding to trade on behalf of a client, investorsshould read the final termsheet and prospectus from the bank in question.
Background
Structured Investments allow investors to tailor their exposure to an equity market. And as such are a common way of investing in equities, whilst having clear and defined potential returns. This particularinvestment gives a potential return as capital gain that is linked to the FTSE 100/ S&P 500 index in a way described in this piece below.
Index
The FTSE 100 is an index of 100 large, blue chip, UK stocks. The S&P 500 is an index of 500 large, blue chip, US stocks. At the beginning of the trade, the level of the index is measured and this level is then used to determine what returns the Structured Investment makes throughout the life of the investment.
Structured Investment Return
The return is the maturity value, based on the performance of the two indices, described below using a recent example (struck on 23rd April 2014).
1)Returns
  • The maximum return of this Structured Investment (the “structure”) that can be generated at the end of the 6 years is 36.5%. The return is paid in full at maturity. There are no annual returns. In principle, this structure would pay roughly 6.1% per annum (uncompounded).

2)Maturity Value
  • The maturity value depends on the level of the indices at maturity; baring the impact on your mark-to-market, the level of the indices during your trade does not affect the level of return.
  • If both the indices are above 50% of their initial level (3,337 for the FTSE, 937 for the S&P) the maturity value will be 136.5%.
  • If one of the indices are below 50% of its initial level, the maturity value will be less than 50%, and will be equal to the level of the worst performing index at maturity as a percentage of its initial value. For example, if the index has fallen 60% at maturity (6-year term of the trade), the index can be said to be at 40% of its initial value.
  • The question is whether this fits with our market view.
Too good to be true?
No, there is a risk that the indices could fall 50%, meaning some or all of the capital could be lost, although you are taking less risk on the downside than by owning the index outright. You are also capping your returns at 36.5% and the market can grow bymore than this. This investment simply aims to give an attractive capital gain given the view that the UK and US equity markets will neither rise by more than 36.5%, nor fall more than 50% over the course of the next few years. This is considered a fairly defensive investment, and there are more adventurous versions of these structures.
What are my risks?
Your number one risk here is the strength of the bank. Do you believe the bankwill be around to pay you back the returns due? Putting the market risksembedded in the structure to one side, the risk against the bank is similar to owning a corporate bond, as you are ranked alongside them in the queue ofcreditors. Furthermore, webelieve it’s also important to distinguish between stronger and weaker counterparties. We need to consider where the equity market would be if the bankingsystem did implode. If we believed this we would be looking to sell your equity-linked investments and buy tangible assets!
Does this Structured Product have those awful OTC derivatives I always read about in it?
This isn’t relevant. The bank on the other side hedges their risks in the market with those instruments it deems most suitable. The bank does not have aview per se on whether the UK market will be range bound or not. The bank simply believes they can hedge themselves and make a small profit throughselling and hedging this product. As I pointed out earlier, your number one concern should bewhether or not you feel comfortable that the bank from whomyou buy the investment will be solvent and able to pay you the returns generated when they fall due.

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