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2008 FIRMA National Conference
Why You Should Know About Structured Products
By Eric Miller Managing Director
Date April 7, 2008
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Contents
What Are Structured Products? Industry
Trends Current Market for Structured
Products Looking Ahead Emerging Themes for
2008 Challenges Opportunities
Section 1 Section 2 Section 3 Section 4 Section 5
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What Are Structured Products?
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Structured Products Overview

• Tools for Shaping Client Portfolios
• What Are Structured Investment Products?
• Structured investment products are investment
  vehicles which allow investors convenient and
  tailored exposure to a specified reference asset.
• Both upside and downside exposure to the
  reference asset can be modified to suit
  investors investment preferences.
• About half of all structured products issued in
  the U.S. provide full downside protection for the
  invested amount, but partially protected and
  unprotected structures are gaining popularity.
• Most structured products can be cleared and
  settled via DTC or Euroclear.
• Properly applied, structured products can be used
  to
• Selectively take on desired risk exposures while
  shedding undesired risks
• Customize investments according to specific
  market views
• Conveniently gain access to alternative
  investment classes that may be difficult to
  invest in directly
• Eliminate or hedge specific portfolio risks or
  business risks
• Currency risk of foreign investment assets
• Inflation linked notes to hedge rising cost of
  liabilities for defined benefit pension plans

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Structured Products Overview
Reference Assets Many Choices The return on a
structured product investment can be linked to
any major asset class. In addition to the most
popular asset classes listed below, credit-linked
and emerging market-linked products are gaining
interest among more sophisticated investors.
Equities Interest Rates Foreign Exchange Hedge Funds Commodities
SP 500 NASDAQ 100 DJ Industrial Average Nikkei 225 DJ EuroStoxx 50 Hang Seng China Enterprises Stocks, ETFs ADRs 3mo 6mo LIBOR 10yr CMT 10yr 2yr CMS CPI EUR (Euro) JPY (Japan) CNY (China) GBP (UK) BRL (Brazil) Fund of Funds Permal MAN Tremont HFR Global Hedge Fund Index Private Hedge Fund Portfolios DJ-AIG Commodity Index GS Commodity Index Gold
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Structured Products Overview
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Structured Products Overview

• What are the building blocks of Structured
  Products?
• The pricing components of an Index-linked
  Principal Protected Structured CD are
• A zero coupon bond
• An equity or index option

Principal Protected Structured Product
Zero Coupon Bond
Option
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Structured Products Overview

• What are the building blocks of Structured
  Products?

Assume 100 is invested in a 5 year Principal
Protected Structured Note, a 5-year interest rate
of 5 and a face (or par) value
of 100.The current value of the zero coupon
bond is 75. The zero coupon bond will accrete to
a value of 100 in 5 year and guarantee the full
repayment of principal. Thus, 75 is the
current cost of providing the principal
protection.Difference of the 100 invested in
the Structured Note and the 75 set aside for
principal protection is 25. HSBC allocates
24 to an option linked to the underlying asset
to provide the potential for an index linked
return and if applicable, a minimum
guaranteed return at maturity. The remaining
1 is paid to Dealer. Investors return is
based on the initial 100 investment, not 99.
100
75
24

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Industry Trends
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Structured Products Issuance US
The SPA reported a 78 increase in US structured
product issuance between 2006 2007
US Structured Products Volume SPA Data
Source Structured Products Association
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Structured Products Issuance North America
Registered and unregistered notes, CDs and GICs
(excludes EIAs)
US/Canada Structured Products Volume Arete Data
Source Arete Consulting Canada issuance volumes
converted to USD using respective end-year
USD-CAD cross-rates
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Structured Products Issuance Industry Comparison
Structured products issuance is now on par with
other forms of retail investment product
2007 New US Issuance Volume
Sources Arete Consulting, ICI (Investment
Company Institute), First Trust Portfolios LP
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Industry Trends - Wrappers
The trend toward unlisted registered notes
continues CD issuance gained, despite a bull
market in US and international equities
US Structured Product Issuance Volume
2005
2007
19 billion
34 billion
Source Arete Consulting
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Market Trends - Underlyings
Non-equity products have gained market
share Interest rate and FX-linked structures
have grown in popularity over the past two years
US Structured Product Issuance Volume
2005
2007
Interest rates
89
80
Source Arete Consulting
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Market Trends Top Underlyings
US single index underlyings are consistently
popular, but a trend towards FX, commodities and
global index baskets is also evident
US Structured Products Issuance
Source Arete Consulting
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Market Trends Principal Protection
Significant growth in reverse convertible volumes
and a bull market in US equities have driven down
the market share of principal protected structures
Distribution of US Deals by Capital Protection
Level
Source Arete Consulting
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Current Market for Structured Products
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Current Market for Structured Products

• Credit Crisis Challenges Investor Confidence
• Investors initially enjoyed better structured
  product terms due to issuer funding difficulties
  (Merrill Lynch, Lehman, Bear Stearns)
• Then, the unthinkable almost occurs could one of
  the largest US commercial or investment banks
  fail?
• Bear Stearns bailed out by the Fed, JPM
• Structured product investors now increasingly
  choosy about issuer credit quality

What a difference a year makes
Source Bloomberg NB CDS spreads and USD share
prices from 15 March 07 and 17 March 08
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Current Market for Structured Products

• Stock Market Volatility Up
• VIX Index 5 Years, Weekly Data

• Stock Market Performance Down
• SP 500 1 Year, Daily Data

Investors are uncertain as to the direction of
the stock market in the short to intermediate
term.
Source Bloomberg
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Current Market for Structured Products

• Reverse Convertibles Perform Poorly
• More reverse convertibles are returning stock
• Sales volumes begin to plateau in 2nd half of
  2007
• Apple Inc. falls 40 from peak to trough in past
  3 months
• Apple Inc. 6 Months, Daily Stock Price

Even Apple Inc. stock takes a dive
Source Bloomberg
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Current Market for Structured Products

• Searching for Safety
• Increased demand for principal protection
  especially via CDs as FDIC insurance comforts
  credit fears
• Partial protection OK as long as protection is
  firm, not contingent
• Performance Through Uncertain or Sideways
  Equity Markets
• Absolute return notes for equity cash on the
  sidelines
• Accelerated return notes more bang for the buck
• Quest for Yield Continues
• Autocallable notes gaining popularity beyond
  Latam and Private Banking marketplace
• Return of the LIBOR range accrual note

Brokers and advisors are looking beyond Reverse
Convertibles
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Looking Ahead Emerging Themes for 2008
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Emerging Themes for 2008 - Convergence

• New Wrappers for Structured Investments
• Mutual funds and Unit Investment Trusts (UITs)
  offering principal protection
• Closed-end funds offering buy/write yield
  enhancement strategies
• Active Management Offered via ETFs
• Recent regulatory approval for the first
  actively-managed ETFs
• Formerly the territory of mutual funds and SMAs
• New Strategy-based Indices
• Replicating active management techniques for
  structured notes
• SPs DTI and CTI indices (HSBC)
• SEVENS Index (UBS, MS)
• Citibank Country Selection Index (Citi)
• Adagio Index (Bear Stearns)

The asset management industry continues to evolve
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Emerging Themes for 2008 Access via Structured
Products

• Market Volatility Encourages Search for
  Uncorrelated Investments
• Hedge funds still inaccessible to many retail
  investors
• Advisors more willing to consider other
  (non-equity) asset classes
• Investors Round Out Equity Portfolios
• Emerging markets have these economies de-coupled
  from G7?
• Access to Frontier markets
• Customized Indices Provide Access to Sectors
  Themes
• Increasing development of new indices by Issuers
  in conjunction with SP and Dow Jones
• Daily pricing via Bloomberg/Reuters and
  independent calculation agent instill investor
  confidence

As interest rates fall and the bull market in
equities fades, investors look elsewhere for
returns often in hard-to-access investment areas
Source Prospect News NB YTD data through March
24 of each year
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Challenges Opportunities
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Todays Challenges...

• Credit Crisis
• Avoid the taint of problems in the structured
  credit market (SIVs, CDOs, etc)
• Restore confidence in the credit-worthiness of
  Issuers
• Taxation of ETNs
• Aggressive marketing of ETNs has led to increased
  scrutiny
• Clearer guidance as to tax treatment of certain
  structured products may benefit industry
• Poor Performance of Reverse Convertibles
• Independent broker-dealer channel most vulnerable
• Current Market Environment Unfriendly for New
  Equity-linked PPNs
• Low interest rates, high equity volatility
• Opportunity for more interest-rate and FX linked
  principal protected notes/CDs

Todays challenges will lead to new opportunities
and encourage continued innovation
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...and Tomorrows Opportunities

• Get the Word Out!
• Increased broker awareness of structured products
  through education
• Nearly ¾ of structured product volume in 2007
  sold via Issuers with internal distribution
  channels1
• Great Time for Structured Products to Shine
• The current market environment highlights the
  many benefits of structured products
• Attractive combinations of risk and reward
• Access to uncorrelated asset classes and
  hard-to-reach markets
• Returns linked to customized and/or
  strategy-based indices

Todays challenges will lead to new opportunities
and encourage continued innovation
1Source Structured Products Association