Handbook RBS 2012 PDF

Structured Products Handbook
2012-2013
In Association with RBS
Contents
Welcome 3 How to Trade RBS Structured Products 22
Introduction to FVC 4 Major Product Types

Introduction to Product Types 23
Background to Structured Products
Capital Protected 24
What is a structured product? 5
Accelerated Tracker 26
History and the Current Market 6
Reverse Convertible 28
Common Features in Structured Products 7
Autocall 30
How a Structured Product is Constructed 8
Defensive Autocall 32
Analysing and Rating Structured Products 10
Bull Bear 34
Key Elements Range Accrual 36
Asset Classes and Underlying Assets 11 Synthetic Zero/Growth Certificate 38
Credit Quality of Issuers 12
Product Comparison 40
Single and Multi-Asset Products 14
Dividends and the Cost of Protection 15 Five Reasons to Recommend
Different Pricing Regimes 16 Structured Products 41
Bringing Products to Market 17 Key Risks 42

Secondary Markets 18
Use of Structured Products within a Portfolio 19 Glossary 43
Regulation and Compensation Schemes 20
2 | FVC Structured Products Handbook

Welcome May 2012
Dear Financial Professional,
At Future Value Consultants we have sought to provide wealth managers and financial advisers with
accessible and relevant services. This is the fourth version of our popular structured products handbooks
and we are delighted to bring this latest edition to you in association with the Royal Bank of Scotland.
Royal Bank of Scotland selected Future Value Consultants because of our experience in the UK through
our research channel as the most widely used source of analysis on structured products available to
wealth managers and financial advisers.
In turn Future Value Consultants is pleased to help Royal Bank of Scotland disseminate information to
wealth managers, advisers and salespeople about structured products as we believe that education has
an important part to play in this industry.
This is a critical time in the investment world with the advent of RDR and other regulatory changes
coupled with technology advances and product innovation. In addition, the financial climate remains
turbulent and difficult.
RBS have proven themselves a major force in UK structured products over many years with a broad
range of products and a commitment to innovation and service. FVC has been providing research on
structured products in the UK since 1999, covering over 2000 products in that time.
This handbook aims to explain how structured products work and what they can achieve for investors.
We have divided the content into fifteen individual sections covering different aspects of structured
products followed by an in-depth look at some of the most important product types.
If you have any comments or feedback about this handbook please contact us, we would very much like
to hear from you.
Yours faithfully,
T.M. Mortimer
Managing Director, Future Value Consultants Limited Contact details for the Royal Bank of Scotland
tim.mortimer@futurevc.co.uk • www.futurevc.co.uk can be found on the back cover of this handbook.
FVC Structured Products Handbook | 3

Introduction to FVC
Future Value Consultants (FVC) is a research, product design and analytics
consultancy specialising in structured products and algorithmic strategies.
FVC’s flagship service is its structured products research reporting FVC also performs independent valuations and index calculation
service, which now covers the whole of the UK and US markets, as services that are used by many institutional clients. It provides
well as products from other markets globally. Its methodologies, valuations, consultancy and support to its clients on their
analysis and web-delivered tools have been used by many derivatives and structured products portfolios. FVC believes that
thousands of professionals in the industry. It pioneered the concept good valuation services require a combination of reliable models,
of quantitative analysis of structured products in 1999 and remains accurate data and sound business experience. This enables it to
the market leader. provide valuations in line with market practice and to provide
reconciliation and insight when there is a discrepancy between
FVC has taken the concept of consistent and independent
the issuer and valuation agent. The index calculation business
analysis, which is common in the mutual fund and bond world,
specialises in both algorithmic and bespoke indexes. FVC started
and extended those techniques to analyse structured products.
its index calculation business in 2007 and first acted as calculation
Concentrating on price, returns and risk, FVC produces clear,
agent for complex algorithmic indexes. This leverages its expertise
accessible analysis that is useful to all those in the structured
in complex instruments and analysis from its structured
products market, from issuers to advisers.
products business.
These services are used by advisers and wealth managers in
All of FVC’s services combine usability, the latest web-delivered
particular to enable them to assess structured products by using
technology and cutting-edge techniques in research and analysis
the independent research and analysis that FVC provides. In a
in structured products, derivatives and other related areas. It is
marketplace with many different investments issued constantly
the goal to provide clients with total solutions addressing all of
such a service provides a vital role as advisers seek to provide
their requirements.
the best service for their investors and satisfy their own
compliance requirements. FVC supports industry conferences, education initiatives and media
events, and has been selected to contribute analysis to Structured
In the UK over 2000 products have been assessed by a service
Products Magazine since 2007. It has developers and business
that has a track record of over ten years. It is accessed by many
analysts with a wide range of experience. Its clients include many
thousands of advisers and features prominently in the selection
of the largest global investment banks as well as product providers
process of adviser networks and wealth management groups.
and institutional buyers of structured products.

1 What is a structured product?
Structured products are investment products designed to offer a predefined
payoff profile from the performance of an underlying asset.
Structured products are created to meet the requirements of many They allow investors to make returns on markets over a given
types of investors. This is achieved through offering different levels period of time while still maintaining a level of risk control.
of exposure, risk, return and protection to a particular asset or A structured product linked to a non-traditional asset class can also
assets to satisfy an individual investor’s requirements. These offer offer the investor a lower risk way of accessing that underlying.
investors a chance to meet their specific goals, some of which With a suitable choice of underlying assets and risk profiles,
cannot be achieved through investing in simpler financial products structured products extend the range of investments in a way
available in the market. Structured products are commonly used which unlocks a whole class of investment opportunities.
as a form of enhanced investment to be included in a diversified
Generally products are backed by major financial institutions.
portfolio. Most UK structured products are equity-linked and offer
Listed products are traded on an exchange where they can be
either full capital or partial protection. On the upside they seek
traded like stocks or a fund and usually become available as soon
market-linked returns or high target levels of income. Structured
as the product terms are hedged. With retail products the issuer,
products are usually subject to a certain level of participation
distributor or plan manager will produce literature at the time
or a maximum return which means, in certain cases, they may
of launch of each new investment into the market. The brochure
underperform against direct investments in strong market
identifies the terms and key features of the product. The investor
conditions. However, this is balanced by reduction of risk to the
should be fully aware of the features of each investment how the
investor. Thus investors give up some upside in good market
product fits into their portfolio.
conditions, in return for some protection against losses in a
bearish market.
Structured products also offer the investor an opportunity to
invest in a range of mainstream and alternative asset classes which This handbook aims to educate by breaking down the key
include the world’s major equity indices, commodities, commercial components that go into a structured product through
and residential property, currencies and particular industrial sector clear explanations and illustrated examples.
indices. It is often difficult to gain access to these markets directly,
therefore structured products act as an investment vehicle to them.

2 History and the Current Market
The UK structured products market has been active in the retail and institutional
arena since the early 1990s. Many market developments have been seen
in that time.
During the 1990s, volatility levels were relatively low and interest Simple capital protected products have generally been rarer with
rates were also quite high. This scenario led to the growth of other constructions such as digitals becoming more popular.
guaranteed equity bonds as such products were then known,
Since 2007 the investment world has been dominated by credit
many issued under a life insurance wrapper. Such products were
worries. Major bank failures and bailouts have caused funding
simple capital protected investments and they continued to be
levels to rocket and this has impacted product terms and their
popular during most of the 1990s.
associated risk. Everyone now accepts that it is vital to assess credit
The next major change in UK structured products was dictated by risk as well as market risk. There has in general been a flight to
the continued stock market volatility that started in 1997 following quality in the use of issuers with those with stronger credit ratings
crises in Asia and Russia. Volatility stayed at high levels and the as well as increased usage of deposit wrappers which may benefit
dot-com boom ensured rising equity markets in the period 1998- from compensation schemes. There has also been an increase in
2000. This was combined with falling interest rates and so many the use of collateralisation and other credit mitigating techniques.
investors sought alternative income bearing products. Necessarily Since 2010 government stability particularly in the Eurozone has
these involved risk to capital and consequently reverse convertible also had an impact.
income products grew in popularity.
In 2009 the FSA published a number of regulatory directives for UK
The peak of issuance in these products was between 1999 structured product business. It looked at the quality and balance
and 2001 which coincided with the peak in equity markets. of product brochures but also focused squarely on the quality of
Unfortunately the ensuing bear market in the FTSE-100 Index and advice given to investors particularly with regards to risk. The aim
other major equity indices meant that the vast majority of these of these directives was to ensure that issuers and advisors alike
investments lost significant amounts of capital, leading them to adopt sound selling practices.
be dubbed “precipice bonds” by the press.
As RDR continues to draw nearer the FSA further acted in 2011-
Between 2003 and 2007 structured products changed again 2012 to undertake an important review of practice of distributors.
with the popularity of the “super-tracker” type accelerated This includes making sure that products are properly assessed and
return product and the growth of auto-calls. This was due to scrutinized before being brought to market. The new requirements
a combination of market parameters and attitudes to risk as detailed in RDR apply to product providers and retail investment
investors sought to recoup losses in a risk controlled manner. advisers as part of the FSAs consumer protection strategy.
They were happy to accept maximum returns capped at a sensible
level to either boost the chance of achieving this or to control risk.

3 Common Features in Structured Products
The three most fundamental components of a structured product are
the underlying asset, the issuing entity and the maturity horizon.
If an investor is uncomfortable with any of these aspects of the
investment, it is highly unlikely to be suitable.
Capital Protection exposure to the growth of an asset comes at the cost of reduced
downside protection because it is impossible to provide both.
Some structured products focus on capital protection while
Growth products with longer terms tend to offer higher market
others offer greater potential returns by taking capital risk.
participation rates. This is because the cost of protection can be
Capital protected products achieve their protection by sacrificing
spread over a longer period of time thereby allowing more upside
some market upside and/or the dividends associated with
exposure to be retained.
the underlying.
While a provider will seek to offer high participation rates,
Barriers sometimes products have a cap so that no underlying growth
Capital-at-risk products usually offer features to reduce exposure beyond a certain level will be passed on to the investor.
to decline in the underlying asset, for example by use of a “barrier”.
The two main types of barriers used in the UK market are the final Averaging
day (European) barrier, which is only observed on the final day of Averaging refers to the method of calculating the reference
the investment and the daily closing or intra-day (American) barrier underlying’s final level. The simplest products are termed point-
type, which are both observed throughout the life of the product. to- point, i.e. they depend on the relative levels on the first and last
The intra-day barrier is more likely to be breached than the daily day of the investment term. The most common use of averaging
closing barrier because there are more opportunities to fall below. is to define the final level of the underlying for calculating the
Conversely, the European barrier is the least likely to be breached product return as the average value over a certain period of time.
because there is only once chance to be breached. Final index averaging can be useful as it may soften the impact of
sudden falls in the last stages of the investment term. However, it
If the barrier is breached because the asset falls below the barrier
can also constrain growth in a rising market.
level then capital will be directly at risk in some way. In the UK
barriers for index linked products are often set at a level of 50%
of the initial level of the underlying asset. It is often the case that Autocalls
a lower (deeper) barrier is present for a product linked to a more An autocallable product is one that can be redeemed prior to
volatile asset such as an emerging market or single stock. maturity if the underlying asset(s) reach the required level on a
pre-defined date during the product term. Products that include
Market Participation and Capping an autocall feature are commonly referred to as “kick-out” products
and usually pay the investor a fixed return plus their initial capital if
Participation or gearing is commonly used to describe the
the auto call feature is triggered.
level of upside exposure to the underlying asset. Leveraged
4 How a Structured Product is Offered
Structured products can be bought in three ways: through a plan
manager, as a securitised/ listed instrument or through a private bank.
The plan manager and securitised routes are similar in that products reach 100% or some other target value of the amount invested.
are designed for large investor bases and mostly of small to medium The amount of money available to purchase call options or an
case sizes. Private banking distributed products tend to be more income stream is dependent on the interest rate and length of
bespoke aimed at more wealthy or sophisticated investors. the investment term. Higher interest rates and longer investment
terms lower the cost of capital protection which results in a higher
Whoever is responsible for product design will need to carry out
participation rate or higher potential returns.
extensive research in order to match investors’ requirements and
then try to assess which features can be realistically achieved in An alternative is to produce a capital-at-risk product in order to offer
current market conditions. potential higher returns. In this instance, put options are sold to
generate value which is used to buy more call options to increase
In the case of a private bank or plan manager once a potential
the participation level of the product. However, capital is at risk if
product design is reached one or more investment banks are
the market falls below some pre-defined level. The same strategy
contacted to request indicative prices for the intended product.
is used by high-income structured products where put options are
The price of the assets will depend on market conditions, the cost
sold to enhance the level of the income stream.
of hedging and (in the case of fixed terms offered for a significant
period) the uncertainty of the provider meeting the expected
sales volume. Competition
Another feature of the structured products markets is that more
Securitised and listed instruments are brought to market by an
issuers will seek to compete for simpler more liquid products but a
issuing bank directly which will issue products it believes are
significantly fewer number of banks are willing to engage in more
competitive and appropriate for the target market.
complex products, those of exceptional long maturity or linked to
unusual underlying assets.
Structuring
Capital protected and capital at risk products are constructed quite Managing the Sales Process
differently from each other. Capital protected products include
The case of plan managers is the only one of the three to have
features to provide the return of capital at maturity, while giving
significant “volume risk” because of the need to offer the product
the investor the opportunity to benefit from market growth. Capital
at fixed terms to the investors of the plan manager. Both parties
protection is typically ensured through the purchase of a zero-
will agree the amount or range of product volume to be purchased
coupon bond with the rest being spent on options or an income
based on expected sales figures. The bank takes on the risk of
stream which cannot return less than zero. This requires the bulk
under or over selling and may incur further costs if prices move
of the investment being put into a deposit which at maturity will
significantly from the time of the quote to the time the product is Counterparty Selection
hedged. Product providers opt for variable hedging if they do not
The capital return element of a structured product is generally
want to commit to a pre-defined level of volume of sales. Variable
provided by the investment bank that delivers the derivative-linked
hedging is, however, more expensive, often making the terms of the
payoff as well, but this is not always the case for larger investments.
product less competitive.
Typically the product structurer would identify a bank whose credit
Listed or securitised products do not carry this risk as terms are set risk profile is suitable for the investor. For example, if the structured
on the day of pricing and future trading occurs at the banks bid- investment forms less than 5% of a portfolio and the investor is
offer prices. Private banking trades are agreed generally with the seeking aggressive growth, a less secure institution may be suitable,
client base already approached and demand established. but for a cautious investor allocating a large portion of their wealth,
it may be more suitable to spread the risk among a number of
In order to manage its risk the investment bank may purchase an
stronger financial institutions. Alternatively, a collateralised solution
amount of the underlying asset or options traded on an exchange
may be sought where the bank puts up government bonds, or other
to hedge its principal exposures to the market, volatility and interest
paper of very strong credit-worthiness as collateral, on a daily basis
rates.
which are available to the investor if the bank fails.
The volatility of an underlying asset is a key factor in
determining the price of call options, which are sensitive to Payoff Selection
the volatility of an asset because the option benefits from The investment return (payoff ) can deliver virtually anything the
market appreciation but does not suffer from losses. Call investor needs and the product structurer would normally source
options for product linked to volatile underlying assets this from the most suitable of a number of counterparty institutions.
are more costly which results in lower participation rates. In order to win the business, the ability of a bank to provide suitable
Higher volatility also makes put options more expensive. secondary market pricing, regular valuations and other services
would be taken into account in addition to a competitive price for
The level of complexity in product design can be considerable for the derivative assets. The underlying assets to which the product
wealthier or institutional investors, but generally would be broken is linked can range from a portfolio of funds chosen for the client,
down into two core parts: through to commodities, individual stocks, equity indices or any
combination of these.

5 Analysing and Rating Structured Products
FVC has pioneered research methodologies for structured products since 1999 and
covers all UK structured products. FVC has developed objective and consistent
methodologies that generate ratings and statistics on all structured
products allowing easy comparisons of one product
with another.
The first part of an FVC report contains a product summary and Return Score
product description, outlining the key features and terms of
The return score is based on a different methodology. Five market
the product. This description provides a clear summary of the
scenarios are selected representing high and low market growth
product’s terms as well as a comprehensive review which details the
and high and low volatility as well as a central “neutral” assumption.
advantages and disadvantages of the product compared to others
The probability distribution of the product is calculated under
currently out in the market. Important product features such as the
each of these scenarios and a risk adjusted average return value
choice of underlying asset, the investment maturity and choice of
is calculated. The higher the best of these numbers compared to
investment wrappers are shown as well as the offer period and key
the distribution of market peers will lead to a higher assessment of
dates. The report usually includes the product literature and contact
returns. These numbers are also converted to a scale of 0 to 10 for
details supplied by the provider along with their contact details.
benchmarking purposes.
Many users look to the report service as an efficient way of keeping
up with the market. However the real differentiator lies in the Risk
quantitative analysis. The report contains scores examining key The risk score (riskmap) calculates the expected total shortfall of
properties of value, return and risk as well as charts to demonstrate the product below the risk-free rate taking into account both the
potential returns. effect of product market volatility and the effect of issuer credit.
The riskmap is also expressed on a scale of 0 to 10, and the risk
Value Score number is decomposed into the contribution from market risk and
The value score is obtained by an independent estimate of the credit risk.
market price of the assets calculated by FVC. It uses prevailing
market data which is used to estimate the offer price of the product Probability Charts
components. This includes effects of interest rates, volatility and The use of probability charts show how the product might be
credit spreads. Because the product is valued at a time shortly expected to perform under the same five market assumptions used
after it is hedged it is possible to estimate how good or poor value in the return score calculation. Charts of probabilities of various
the product represents. This score is updated weekly to show the absolute returns as well as performance compared to cash returns
effects of changing market conditions allowing the comparison are also shown as are the probabilities with and without the effect
of the product with those that are issued subsequently. The value of credit risk taken into account.
score assesses implied fees in the same way that a fund would look
at TER. The estimate of value is translated into a score ranging from
0 to 10 for easy comparison purposes.
6 Asset Classes and Underlying Assets
The most common types of underlying asset classes used in
the UK structured product market are equity indices, equity
baskets, commodities, mutual funds and commercial &
residential property indices. Less frequently used underlyings
include hedge funds, currencies, ETFs and custom indices.
Equity Indices Inflation

Most structured products in the UK market are linked to major Products linked to the performance of inflation can be used within
global equity indices. The FTSE 100 Index has always been the most a portfolio to provide real returns that preserve spending power.
popular choice of underlying asset used in structured products Whilst the standard equity linked growth and income products
in the UK market. Other regular choices include US market index issued in the UK offer a means to generate high headline returns
S&P-500, Eurostoxx-50 (representing Europe) and the Japanese there is no guarantee that they will keep pace with inflation.
Nikkei-225. Major indices are the most liquid of the asset classes
and therefore dealing in the underlying shares, futures and options Commercial and Residential Property
is cheaper and more easily achieved. Additionally equity indices
Investing in property is another way to diversify a portfolio. Like
are by definition more representative and less volatile than a small
commodities, the value of property does not necessarily correlate
basket of stocks, which is why they may be seen as a more sensible
with equities, so it can help to spread risk. Both types of property
investment option. They are also the most natural and recognisable
are generally less liquid than other asset classes and dealing costs
choice for investors.
can be higher for anyone trying to invest directly.
Baskets Funds
A basket usually incorporates several equity indices, stocks or
Funds are essentially a portfolio of stocks or other instruments.
other assets in one product. Each asset is allocated a specific initial
These are either actively managed by fund managers with a view to
weight in the basket. A basket is sometimes used as a bespoke
outperforming benchmarks or lower-cost tracker funds to simply
choice to achieve a certain positioning or allocation, for example,
mirror the performance of indices, regions or sectors.
using ten stocks in the same sector.
Proprietary Indices
Commodities
There has been a rise in the amount of structured products
Commodities and commodity index-linked products can be used
linked to proprietary indices. These types of indices are designed
to diversify an investor’s portfolio. Commodities also offer investors
to provide exposure to a particular underlying or asset class
an opportunity to invest in an asset class which has historically had
following a rules-based strategy to either control risk (such as
lower correlation to equities and bonds but have obvious rationale
volatility controlled strategies) or to generate outperformance (e.g.
particularly in times of demand led inflation.
momentum or relative value based strategies).

7 Credit Quality of Issuers
The credit quality of the issuer is an important aspect to be taken into
account when analysing the risk in a structured product. In today’s
turbulent investment world, it is widely accepted to be at least
as important as market risk.
The construction of a structured product involves the purchase of The CDS level represents the market level for institutions to insure
assets by the product provider from the issuing entity (an investment against credit events from the issuing entity. This may be used as an
bank). Credit quality is the ability of the counterparty to honour its estimate of the return investors should expect to earn over the risk-
obligations, that is remain solvent until the product’s maturity. free rate by investing with a particular issuer as a fair compensation
for the credit risk taken on.
Lehman Brothers Collapse For this reason, providers may choose issuers further down the credit
Prior to the financial crises of 2007 and 2008, relatively little risk curve to enable them to produce a product that has optically
attention was paid to the credit quality of issuers, (certainly those more attractive terms. It is important for advisers to be aware of the
of “A” rating or above) as it was assumed that all issuers were stable identity of the issuer and judge their credit quality to assess whether
institutions representing little risk. Funding levels were low the returns are in line with risk involved in investing in the product.
meaning that banks did not have to offer much higher than the risk-
free rate when seeking to raise funds. In the last few years that has
An issuer with a high credit spread may offer higher returns
changed and today credit considerations are critically important and
on product than an issuer with a low credit spread, as the
will likely remain so for the foreseeable future.
investor should get adequate compensation for the credit
Credit rating agencies such as Standard and Poor’s, Moody’s and risk taken on.
Fitch assign ratings which vary from AAA to D (definitions and
naming vary a little between agencies). These are used as a guide to
indicate the likelihood of default. These ratings have long been used Collateralisation
in assessing the financial stability of a company, Some investors place very high importance on capital protection
however agencies have come under criticism for the accuracy and therefore may be uncomfortable taking direct issuer credit risk.
and relevance of their ratings following the collapse of many Collateralisation has emerged as the process used to back products
financial institutions and other companies with reasonable ratings. for such investors. Assets held independently by a custodian are
used as collateral to pay out returns in the event of issuer default.
Credit Default Swaps There are different collateralisation mechanisms but generally
There has been an increasing trend towards using credit default because of the additional costs incurred with this process and the
swaps (CDS) levels to reflect the credit quality of the issuer. The CDS lower rate of interest earned collateralised products generally offer
of a company is expressed as a number which indicates the size less attractive terms.
of the credit risk involved in investing with a particular company.

The graph below displays the average five year CDS of six major issuers of structured
products in the UK.
400
400
Lehman Brothers collapse
350
350
Major losses for AIG Eurozone crisis
300
300
Greek bailout
250
250
200
200
150
Series1 Average CDS
150
100
100
50
50
Source: Reuters
00
Mar 08 Mar 09 Mar 10 Mar 11 Mar 12
8
3-‐ 8
3-‐ 08
3-‐ 08
Ja
3-‐ 09
3-‐ -‐09
3-‐ 9
Se
3-‐ 09
Ja
M 0
3-‐ 0
Se
3-‐ 10
3-‐ -‐11
3-‐ -‐11
3-‐ 1
Se
No
1
3-‐ 12
3-‐ -‐10
2
Ja
8
1
0
-‐0
-‐0
v-‐0
-‐0
l-‐0
v-‐0
-‐1
l-‐1
-‐1
l-‐1
1
v-‐1
-‐1
v-‐1
l-‐
p-‐
n-‐
p-‐
n-‐
p-‐
p-‐
n-‐
ar
ar
ar
ay
ay
ar
ay
ay
ar
n
Ju
Ju
Ju
Ju
No
No
No
Se
Ja
M
M
M
M
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
3-‐
The graph illustrates the effect global market events have had on In March 2009, AIG announced huge losses for the last quarter of
the financial stability of these major institutions which include: 2008. This caused major international indices, including the FTSE
• Barclays Bank Plc • Morgan Stanley 100, to fall sharply. There were signs of slow recovery beginning in
April 2009 which caused a fall in CDS levels and the FTSE 100
• HSBC Bank Plc • Royal Bank of Scotland Plc
began a recovery.
• Lloyds TSB Bank Plc • UBS AG
The rise in CDS levels and subsequent decline in the FTSE 100
The first spike in the graph was around the time that Bear Stearns from March 2010 can be attributed to the effect of the debt crisis
was sold to JP Morgan Chase in March 2008. The sale was as a result in Greece. During this period, Greece requested a bail out and S&P
of Bear Stearns’ over exposure to the sub-prime mortgage crisis. downgraded Greece to BB+ causing stock markets to plummet.
The next significant peak was in September 2008 after the collapse Global stock markets fell in August 2011 amid growing concerns
of Lehman Brothers. Unlike the Bear Stearns situation, the US over the European Sovereign debt crisis, in particular towards Spain
government let the bank file for bankruptcy which subsequently and Italy. Additionally United States treasuries lost their AAA credit
sent shockwaves throughout the financial system. The CDS levels of rating. This caused panic in stock markets which remained volatile
major banks rose significantly during this period. for the rest of the year.
September 2008 also saw AIG being bailed out by the US
government causing more market panic. CDS levels began to fall
but remained volatile during the last quarter of 2008.

8 Single and Multi-Asset Products
In the UK, the majority of structured products are linked to a single asset such as an
index, equity, or commodity. The popularity of these products comes from the
fact that they are easier for the provider to construct and generally easier
to understand from an investor’s perspective.
Products linked to multiple assets provide investors with the The most common examples of multi-asset products in the
opportunity to diversify the risk in their portfolio and can offer UK market are worst of auto-calls or reverse convertibles. The
more targeted strategies for return. We define single asset products downside risk taken on by the investor is linked to the worst
as those linked to a single index or strategy even though that performing of two or more indices over the investment period.
underlying may itself be quite bespoke. Multi-asset products can Although the indices may be major indices with which the investor
be divided into two fundamental types. is comfortable, clearly the downside risk is greater than that of any
of them individually. The product’s return cannot be expressed as a
Firstly we consider “baskets” of assets. A basket is a collection
simple basket combination of the indices.
of assets with given weightings. The payoff of the product is a
function of the basket value. For these types of products, the Another example of a multi-asset product is the “rainbow”. The
performance of individual elements in the basket does not have performance of each asset is calculated at maturity and the weights
any (direct) bearing on the product payoff, except through its are calculated by giving higher weights to the best performing
influence on the basket return. assets according to a pre-defined formula.
Secondly we consider what might be termed true multi-asset The correlation between assets affects the pricing and prospects
structured products. These refer to products which look at of all multi-asset products. For reverse convertibles or auto-calls
each asset’s performance individually in some way rather than a higher coupon or return is offered as compensation for taking a
calculating a payoff which is simply a function of the basket capital return linked to the worst performing index. The investor is
(average) performance. These types of products are generally more hoping for high correlation so that the lower or lowest asset is not
complicated than simple basket products both from an investor’s much worse than the average of all the assets.
point of view and also from a risk management perspective.
Conversely for rainbow products assets that have little or no
The returns of many multi-asset products are based upon either the correlation to one another make this product more attractive as the
best or worst performing asset. Examples of this type of product investor would need one asset to significantly outperform another
include rainbow products, worst of kick-out and worst of reverse in order to achieve a better return than would have been offered by
convertibles. The correlation between each asset plays a crucial role the conventional basket product.
in such products.

9 Dividends and the Cost of Protection
A very common feature of structured products in the UK market is capital protection.
Products offering full capital protection at maturity help neutralise market risk.
In this case investors receive full capital return at maturity regardless
of the performance of the underlying asset. However, these products
are still subject to credit risk from exposure to the issuing institution.
In bull markets, some commentators may argue that buying The Cost of Protection
capital protection is unnecessary as markets are rising. Conversely
To study the typical cost and implications of purchasing capital
these same commentators are likely to say that in a bear market
protection, we compare a capital protected FTSE-100 linked
either asset levels have bottomed out making further protection
structured product with a direct investment into the equity market
unnecessary or that capital protected products will “only” return full
of a FTSE-100 tracker fund or ETF. Apart from the fact that only the
capital at maturity even though this represents outperformance
structured product offers capital protection the two investments
over a direct investment.
differ in that dividends are received by the fund.
Both these arguments are illogical and misleading. There is no such
If the FTSE-100 shows a fall in capital terms over the investment
thing as markets going up or down, only that they have already
horizon, the structured product will still return full capital at
gone up or down. Therefore capital protection is likely to remain an
maturity. However a tracker fund would show a capital loss offset
important feature for many investors in any market environment.
in full or part by the dividend income. If the size of the market fall
However different pricing regimes (particularly high volatility
exceeded the value of the dividends then it is possible for a tracker
levels) can make the cost of protection very expensive hence
fund to show a significant loss in value. Over the last ten years there
making the structured product solution unattractive.
have been several cycles where the decline of the FTSE-100 would
If an investor is risk-averse for some reason, for example because easily justify the premium implicitly paid.
they are approaching retirement or feel that their current portfolio
Although the price paid for capital protection is a fair market value
is too risky, or they change their mind about market sentiment then
for what is being offered it does nonetheless represent a significant
they would be unlikely to consider investing directly into equities
cost. Therefore, if capital protection is not required by an investor it
or other risky assets. In such cases looking for a capital protected
makes no sense to seek a product which provides it. However, if the
investment is the number one priority.
client requires capital protection but also seeks the opportunity of
As long as investors are aware that all protection carries a cost equity linked returns rather than interest then a capital protected
but represents a decision they wish to make then they ought to structured product may be the best choice.
understand that there is some opportunity cost if markets perform
strongly and that the protection with hindsight
proves unnecessary.

10 Different Pricing Regimes
Structured products are a popular and an important investment class
in just about every set of market conditions. However, the different
points in the economic cycle affect individual structured product
constructions in different ways, just as they differ in their consequences
for equities, bonds, cash and any other investment sector.
There are two main factors of the economic environment which mean that the investor (who is effectively selling a put option)
affect the pricing and suitability of structured products at any generates a healthy extra coupon and so the product is a high
given time. The first are simple market conditions – whether equity yielding investment. However, although the income looks
markets can be said to be bull, bear, or range-bound. Also of key attractive, it should be remembered that the high levels of volatility
importance is the level of interest rates which has a bearing on the indicate the market’s pricing of a sizeable amount of risk and
relative attractiveness of equity and cash or bonds. The second therefore the income offered is far from risk-free.
factor is the level of the different pricing parameters which affect
If however interest rates are low this is usually the best situation
structured products. The most important of these are levels of
for auto-call products. In such situations the fixed return available
volatility, but dividend levels are also significant as well as the
in the case of product calling looks attractive, benefiting from the
shape of the interest rate yield curve over different maturities.
downside risk taken in the event of kick-out not occurring.
Issuer funding levels and credit risk has also significantly affected
pricing conditions since 2007.
Low Volatility Markets
We shall concentrate on the effects of the levels of interest rates
The case of low market volatility tends to favour other types of
and volatility. For any market environment there are usually two
structured products. If volatility levels are low and interest rates
opposing considerations. The first is the perceived attractiveness of
are high, capital protected products make the most sense. This
any product that can be constructed in terms of participation rates,
is because the high levels of interest rates allow for a favourable
income levels etc. The second is the likely future performance and
swap of interest payments for an option related return and the
prospects of the product in such an environment. There is a natural
low levels of volatility mean that options prices are relatively low.
conflict between these two which shall now be explained.
Participation rates are high and may even exceed 100%. When low
We will consider markets with high and low volatility levels. volatility is coupled with low interest rates this favours accelerated
products because they are in fact relatively invariant to changes in
High Volatility Markets both interest rates and volatility levels due to the combination of
options that they purchase and therefore look attractive compared
The case of high volatility combined with high interest rates
to cash or direct equities.
arguably favours reverse convertible products.
In such situations the fixed coupon looks attractive, benefiting
from both high interest rates and the downside risk taken which
increases in high volatility markets. The high levels of volatility

11 Bringing Products to Market
A structured product goes through a series of stages from its initial
concept and design to its strike date. Structured product providers
and structurers carry out extensive research and analysis to
enable them to design a product to meet the needs of their
target investors.
Once the structured product design has been decided the One of the great benefits of the fund route is the ease of dealing in
structurer or product provider will seek to confirm indicative or the secondary market, both selling and buying, allowing investors
final terms. Sometimes this is an open market process involving to take advantage of changing views on market expectations, as
several issuers, sometimes more than one for each offer. Typically well as being able to use the same product across a number of
a provider would then agree a deal for the product to be hedged client portfolios.
with a particular bank, either based on indicative terms or fixed
terms based on expected sales volumes. The product structurer Plans
would normally organise the trade directly with the bank or banks
In the case of plans that are to be distributed in the retail market,
selected, with no offering period needed.
the bank usually fixes the terms around six weeks before the strike
date. Once the product has been hedged, a brochure detailing the
Securities features of the product is produced. During this time, providers
Securitised products are either privately placed or publicly offered. attempt to promote the product to groups of advisers. The product
They can either be listed on an exchange or the issuing entity goes on sale during the offer period during which time the advisers
provides two way pricing. The terms for products that are to be research on products to fit their clients’ portfolios. The offer period
listed on an exchange platform are confirmed closer to the strike of a structured product refers to the time the product is offered
date. In this case the product can usually become available as soon for sale to the public. The sales period usually lasts between six to
as the product terms are hedged, and is listed on an exchange eight weeks.
where it can be traded like a stock or a fund. Unlike plan based
retail products, there is no offer period and the product can be
bought and sold daily throughout its life up to maturity.
Funds
Some structured products are now offered within UCITS funds
and are available both for direct investment (like a Plan) and via
platforms, insurance bonds and other arrangements. Although
the cost of delivering a product in this format can be high, the
additional flexibility they afford can be critical to some investors.

12 Secondary Markets
The intermediate value of a structured product at any time between its
launch and its maturity is known as its secondary market value, which is an
ongoing valuation of the options and other components of the investment.
At the start of any product the level of its market value is the issue Many investors view a structured product as primarily a buy and
price less declared fees and at maturity it will equal the product hold investment. For them the existence of a reasonable secondary
payoff. The secondary market value during the life of the product market acts as an exit strategy in case the funds are needed
is the sum of the value of the individual product components. The urgently. For all investors a meaningful secondary market allows
value of each component varies continuously during the lifetime accurate valuations to be made and used in product or portfolio
of the product and therefore so does the market value of the reporting statements during the investment’s life.
product. Each component of the product has a sensitivity to market
More sophisticated investors or active managers will seek to trade
parameters such as underlying spot levels, interest rates, credit
either in or out of a listed structured product. This enables them
spreads and volatility. Fixed income components such as capital
to choose an appropriate risk profile but potentially also benefit
repayment and coupons decrease in value when either interest
from timing the market in some way. For example an investor who
rates or credit spreads increase. Options generally increase in value
seeks high yield in return for controlled risk through a reverse
when volatility increases and “call” options increase in value when
convertible or auto-callable might sell the investment back before
the spot level goes up whereas “put” options decrease.
maturity if markets are sufficiently high since most of the yield will
A secondary market exists when a bank market quotes bid have been earned and the product will be trading like cash. They
and offer prices on its own product during its lifetime. In most can then re-invest into a longer dated product and seek that yield
situations we would expect the bank’s estimate of fair value enhancement again.
to lie between the bid and offer price but supply and demand
Products listed on a stock exchange such as the London Stock
sometimes mean that this is not the case.
Exchange are typically more liquid than most retail structured
Increasingly a secondary market with reasonable bid-offer spreads products and in most cases will have continuous trading. Issuers
has become commonplace in retail structured products. Currently, of listed products on an exchange have to adhere to the market
generally only the issuer makes a market in its own products, making terms of that exchange under normal market conditions.
however in principle structured products could become more
widely traded between third parties on the secondary market.

13 Use of Structured Products within a Portfolio
Structured products have a place in many investors’ portfolios.
The variety of asset classes and risk profiles on offer mean that
they provide solutions to many investors of different risk
profiles and investment aims.
Structured products can be considered to have three main of the associated risk yet consider them to offer interesting
uses in an investor’s portfolio. potential returns. A capital protected structured product linked to
an overseas stock market index for example gives a safer way to
allocate a few per cent of an investor’s portfolio.
Core Holdings
The first is as a core holding. As structured products are constructed Improving Risk Profile
using derivatives, many wealth managers and advisers feel that The third use we consider here is to fundamentally shape the risk
structured products rank alongside such niche or alternative profile of an investment to take account of market conditions as
investments as commodities, property, hedge funds and other well as the investor’s risk appetite. Products such as accelerated
complex or illiquid investments. However, one of the most growth products or kick-outs allow an investor to capture a good
important features of structured products is that they aim to return from equities in the event of modestly performing markets.
control risk. Therefore a structured product is a natural choice This allows them to keep or increase exposure to their target
for a lower risk investor who wishes to retain market exposure or markets or asset classes but also offers them the opportunity of
income generation opportunities while reducing or eliminating a greater return than a direct investment in the event of modest
market (and credit) risk as much as possible. For an investor to do market growth. Popular and appealing in recent years have been
this without structured products it would be necessary to convert a the auto-calls which seek to generate high fixed returns without
large part of the portfolio to cash or bonds and potentially miss out requiring any market growth and therefore are the perfect choice
on market returns. for expected range-bound markets. The use of such tactical
investments would mimic many active fund managers’ strategies
Access to New Underlyings of core holdings plus specific overlays in order to enhance return.
The second use of structured products is to allow an investment For securitised products the opportunity to buy and sell to take
into a new market or underlying asset with better transparency, account of changing market conditions or strong performances
diversification, lower costs and typically some risk reduction as in the underlying allows extra possibilities to shape risk and
well as currency protection. Many investors would not consider boost returns.
any direct holding into some markets or underlyings because

14 Regulation and Compensation Schemes
The regulatory landscape for structured products is undergoing significant
change as a result of the credit crises and the collapse of Lehman Brothers.
There is a renewed focus on compliance, especially in relation to the retail
structured products space. As a result, this is an area which must be considered
carefully for structured products.
FSA Involvement is the desire to create a level playing field for investment products
that take a variety of legal forms – investment funds, structured
The FSA conducted a review of the marketing and distribution of
securities, unit-linked life insurance products and structured
structured products following the collapse of Lehman Brothers.
term deposits – but provide broadly comparable functions for
The FSA has noted that it will take direct action to ensure that
investors. This will be achieved through a two-pronged European
investors in structured products are treated fairly. Specifically, the
level approach: rules as to the form and content of key investor
FSA has set out the standards that it expects firms to meet when
disclosures and associated marketing materials; and selling rules
providing advice on marketing and designing structured products
which would include the management and disclosure of conflicts
and has produced a “Good and poor practice guide” to assist firms
of interest.
in conforming the promotion of structured products to the
required standards.
Credit Rating Agencies
In November 2011, the FSA produced a guidance paper to
The 2009 EC Credit Rating Agencies Regulation introduced a
structured products providers highlighting their product design,
restriction on credit rating agencies providing consultancy/
development, approvals processes, distribution processes and
advisory services or making proposals or recommendations in
post sales responsibilities in particular. Its main focus was to ensure
relation to the design of structured finance instruments and
that firms were adopting suitable procedures in order to avoid the
a requirement that an extra symbol be used to differentiate
risk of poorly designed products which lead to mis-buying and
structured finance credit ratings from other credit ratings.
mis-selling. The regulator found a number of weaknesses in these
areas and has set guidelines into how firms should manufacture
and distribute structured products. The regulator produced the
Retail Distribution Review
finalised guidance paper in March 2012 making no amendments As part of its Retail Distribution Review, the FSA has published
other than to clarify points raised in the earlier paper. proposed rules that will diminish the bias towards the sales of
certain products. Amongst other things, the FSA intend to ban
Retail Structured Products independent financial advisors from accepting commissions in
return for recommending specific products. The FSA has also
Of particular relevance, on a Europe wide basis, is the proposed
stated that it intends, in future, to prevent platforms from receiving
European legislation on Packaged Retail Investment Products
payments from product providers and to ban cash rebates where
(PRIPs). The driving force behind the forthcoming PRIPs legislation

the provider credits the customer’s account with a portion of the “The Financial Services Compensation Scheme (FSCS)
product costs. The FSA has also published a template for assessing is the UK’s statutory fund of last resort for customers of
suitability. In the accompanying notes the FSA points out that whilst authorised financial services firms. Compensation is paid
disclosure is a very important element of structured product sales, it if the firm is unable, or likely to be unable, to pay claims
cannot ultimately make an unsuitable product suitable. against it. The FSCS protects deposits, insurance policies,
insurance broking, investment business and mortgage
advice and arranging.”
“In its business plan for 2012/13 published in March
2012, the FSA noted that it will intervene earlier in the
development of retail product where it considers this
appropriate as part of delivering consumer protection. Other Developments
The FSA states that the intervention in retail products Finally, it is worth noting that the FSA has raised the prospect
would occur where it sees unsuitable products that have of actual product regulation, although at the time of writing no
a high probability of being mis-sold, where the firms have concrete proposals had been issued in this regard.
inadequate product design and sales processes.”
Compensation
Deposit based structured deposits may be covered under the FSCS.
Previously, it was thought that deposit based structured products
would automatically fall under the FSCS guaranteeing the investor’s
capital up to the prevailing limit. However, since the events of 2008,
such as Lehman Brothers going into administration, regulatory
outcomes have become less certain. The compensation limit
for bank deposits is now £85,000 per eligible claimant per
authorised institution.

How to Trade RBS Structured Products
One of the key advantages of the RBS proposition is the breadth RBS quotes live bids and offers, in normal market conditions, on
and depth of our listed structured product business. RBS operates each exchange business day under the rules of the London Stock
across Europe, Asia, Australia and the Americas. The investor Exchange. These prices allow for investors to trade in and out as the
products and equity derivatives business lists and trades products market moves. Prices are also published on the RBS institutional
on multiple exchanges worldwide, providing liquidity and website (www.rbs.co.uk/markets) throughout the trading day.
transparency for investors. In total we have almost 40,000 listed
Investors should note that the value of investments can rise as well
products available. RBS exchange traded products can be listed in
as fall. Investors are subject to the credit risk of RBS. In the unlikely
London, Amsterdam, Frankfurt, Zurich, New York, Hong Kong
event that RBS were to default or go bankrupt, investors may lose
and Sydney.
some or all of their money.
In the UK and Ireland, many of these products are listed and also
market-made primarily on the London Stock Exchange. Exchange
market-making comes with some advantages including efficient
dealing through the exchange, electronically via Retail Service
Providers (RSP) or on the telephone via our dedicated client
execution team. Settlement, through CREST, is also very familiar
and operates in the same manner as trading shares.
For further information please contact the team

at investorproducts@rbs.com

Introduction to Product Types
This section of the handbook describes the most popular product types
in the current UK structured products market. It aims to provide an insight
into each product type through clear descriptions and examples detailing
the key elements of each product.
This section of the handbook describes the most popular The volatility level used is 20% which is broadly in line with index
product types in the current UK structured products market. volatility in moderate market conditions. Similarly the CDS is
It aims to provide an insight into each product type through assumed to be 200 basis points which is approximately the average
clear descriptions and examples detailing the key elements of of the major issuers in the UK market. The probability of default is
each product. derived from the CDS and the assumed recovery rate in the event
of default of 75%.
The product sections include a detailed description of each
structure as well as providing an example to illustrate the typical Each product analysed includes charts displaying probability
terms available for each product. Each example product has been of return outcomes over the investment term. These have been
analysed with FVC models and data at the time this handbook was calculated using a forward looking simulation with the same
produced. It includes a pricing breakdown illustrating the typical volatility assumption for the underlying asset (FTSE-100) as used
cost of the key components that go into a structured product. in the pricing analysis. The range of outcomes for the underlying
are fed through the risk profile of the product to project how it
Each example product is analysed on a like for like basis. All have
might perform.
the same market pricing parameters, length of product term,
underlying asset and the overall cost of the structure. All of our We show the range of possible returns with and without credit risk
example products are linked to an equity index assumed to have taken account. These are shown against an absolute scale with
similar properties to the FTSE 100 Index and analysed assuming the 5% intervals.
following parameters:
We also show a scatter chart of simulated values of index
• Term of five years performance and product performance. These give an indication of
• A flat implied volatility of 20% the range and frequency of possible outcomes. More description of
• Total fees of 2% FVC’s research methodology can be found on our website
www.futurevc.co.uk.
• C
ounterparty credit strength approximately equivalent
to S&Ps A rating
• Probability of default over five year term is 12.7%
• In the event of default, 75% of the investment will be lost
• Counterparty funding level of 200bps

Capital Protected
Capital protected products offer the investor an opportunity to participate in
the upside performance of the underlying asset whilst protecting their
initial investment against market risk.
A simple growth product offers the investor participation in the Capital protected products usually refer to those that aim to
growth of the underlying asset which is not subject to any cap return full capital regardless of the underlying asset performance.
(limit) on returns. A capped growth product will instead offer a However the FSA in 2009 made it clear that a product could not
higher participation in the growth of the asset but subject to a be called capital protected if it was backed by an issuer of low
maximum return. credit quality. Please note that all capital protected securities are
still subject to issuer credit risk.
Capital protected products are often subject to final level averaging
which can restrict growth in a rising market, however this helps
protect against late falls in the value of the underlying asset.
Example: This product has capital protection at maturity from both the risk free interest rate and also the credit spread of
and 135% participation in the rise of the index. There is no the issuer. The amount left to spend on the upside is then 14.7%
cap on returns. in this example. We calculate that 100% participation in the index
would cost 10.9%. Since the amount of funds available is higher
than this the most common solution is to simply purchase more of
Pricing the option resulting in a geared product. In this case the gearing
The pricing for this product is broken down into two components. is 1.35% of index growth. An alternative could be to structure the
The most significant component by price is the zero coupon bond product with a higher minimum return or higher gearing with a
to repay 100% at maturity. The pricing of this reflects discounting cap on returns.
Component No. Type Maturity (years) Price Unit Price Description
1 Zero-Coupon Bond Five 83.30% Payment of 100%

2 Call Option Five 14.70% 10.90% 135% Participation in Index Growth
Fees 2%
Total 100%

3 Exposure

to growth of the
asset with capital protection.
This type of product is likely to appeal to a
cautious investor who wants capital protection
7 The product can underperform

plus the opportunity to participate in some
of the growth of the index.
the index return. The product
does not pay dividends unlike
tracker funds.
Issuer default risk ignored Issuer default risk included
100 100
75 70.9 75
Probability (%)
Probability (%)
62
50 50
25 22.8 25 19.7
12.7
6 5.4
0 0 0.2 0 0.2
0 0
< -5 -5 to 0 0 to 5 5 to 10 10 to 15 > 15 < -5 -5 to 0 0 to 5 5 to 10 10 to 15 > 15
Return bucket (% p.a.) Return bucket (% p.a.)
250
Index returns and product payoffs (issuer default risk ignored)
The charts show that if issuer credit risk is ignored then the
200
200 product cannot lose capital. Once issuer credit risk is taken into
180 account there is a significant chance of losing capital.
160
The most likely return for the product is in the 0%-5% bracket
150
140
showing that this product is aiming to beat cash returns.
Product payoff
120
The scatter chart shows the range of product returns (ignoring
100
100 credit risk). This demonstrates the capital protection.
80
60
50
40
20
00
0 50 100 150 200
0 20 40 60 80 Index100 value
120 140 160 180

Accelerated Tracker
Accelerated tracker products offer the investor leveraged exposure to the
upside performance of the underlying asset.
An accelerated tracker product generally offers multiple times popular for many years as they offer enhanced returns and
index growth up to a cap level. Capital is at risk. Accelerated generally have some protection against capital loss. They are often
products are intended to capture magnified performance in touted as recovery investments to try to capture gains after a bear
the event of moderate index growth and in this scenario will market has occurred.
outperform both the index and cash. These products have been
Example: This product has five times index growth up to an Pricing

index limit of 16.5%. Thus the maximum return is 82.5%.
The pricing for this product is broken down into three components.
Capital is at risk and will be lost if the index closes below
The zero coupon bond is the “base” payment of 100%. Added to
the 50% barrier on any day throughout the life of the
this is the five times geared call spread which can provide the
product and finishes below the starting level.
return. For index growth up to 16.5% the product will pay five
times index growth up to a limit of 82.5% return. For index growth
above this level the product pays the maximum 82.5% return.
The geared return is funded by the sale of a knock-in put which
means that capital is at risk and therefore if the index falls (having
hit the barrier) the proceeds of the put are deducted from the
investor’s capital.

2 Call Option Five 29.40% 5.88% 5x Geared Call Spread 100%-116.5%
Short Put Option with 50%
3 American Knock-In Put Five -14.70%
Closing Day Barrier
Fees 2%
Total 100%

3 Outperforms

the underlying
under moderate index growth.
This type of product is aimed at an investor
who expects some moderate index growth
and is prepared to take capital risk.
7 Capital is at risk if the 50%
barrier is breached, and
returns are capped at 82.5%.
100 100
75 75
Probability (%)
Probability (%)
50 50
38.2
30.7 32.9 33.8
23.5 26.6
25 25
6.7 5.9
0.9 0 0.8 0
0 0
New Rtn
There is a good chance that the product will return at or near its
200
200 full amount as this only requires modest index growth.
180
180
There is also a significant chance that the product will lose some
160
160 capital, potentially a large amount.
140
140
Product payoff
120 The scatter chart shows the range of likely outcomes, with hardly
120
any showing small capital loss.
100
100
80
80 New Rtn
60
60
40
40
20
20
0 0 0 50 100 150 200
0 50 100 value
Index 150 200

Reverse Convertible
Reverse convertible or income generating products offer fixed income
above the risk free rate by taking on risk to capital.
A reverse convertible offers fixed income on generally an annual stream which is generally above the risk free rate plus full capital. If
or monthly basis. Capital is at risk and if the index falls (and hits volatility levels are high then the amount of extra income that can
any barrier present) then capital will be reduced in line with the be generated is higher but this comes with increased capital risk.
index fall. If the index rises then the investor does not receive any Given the amount of extra income offered an investor expects the
extra return. The maximum that can be received is the income risk to capital to be moderate.
Example: This product pays 6.5% income per annum. Pricing

Capital is at risk and will be lost if the index closes below
The pricing for this product is broken down into three components,
the 50% barrier on any day throughout the life of the
just as for the accelerated product. The zero coupon bond is the
product and finishes below the starting level.
“base” payment of 100%. Added to this is the coupon stream of
6.5% p.a.. This above risk-free rate income is funded by the sale of
a knock-in put which means that capital is at risk and therefore if
the index falls (having hit the barrier) the proceeds of the put are
deducted from the investor’s capital. Note that in our examples the
value of the coupon stream is same as the upside amount for the
accelerated product since the products are otherwise identical.

2 Coupon Stream Five 29.40% 4.52% per 1% p.a. 6.5% Income p.a.
Closing Day Barrier
Fees 2%
Total 100%

3 Income

above the risk free
rate is paid.
This type of product is aimed at an investor who
wants fixed income in excess of the risk-free rate
and is prepared to take on capital risk
7 Capital is usually at risk which
can significantly reduce the
overall return.
100 100
76
75 75
66.5
Probability (%)
Probability (%)
50 50
25.5
25 25
14.9
6.2 2.9 5.5
0 0 2.5 0 0
0 0

There is a chance that the product will return at or near its full
200 amount of capital plus income as this does not require any index
180 growth. As for the accelerated product, risk
160
160 to capital comes from market risk and credit risk.
140
140
Product payoff
120
120
100
100
80
80
60 Series1
60
40
40
20
20
0
0 0 50 100 150 200
0 20 40 60 Index100
80 value
120 140 160 180

Autocall
Autocall products offer the investor a pre-determined rate of return if the
underlying asset performs sufficiently well on one of a given series of dates.
An autocall product has a series of dates and a target index level for an autocall product may be capital protected but offer a fixed
each of those dates. For the first date that the index has finished at return part-way through the investment term if the index
or above its target level, the product matures with a given return. rises sufficiently.
These tests are applied for each date in succession. If the product
Autocall products can also be linked to more than one index or
is not called on any date then it runs to its full term and pays
asset. In such cases generally all relevant indices have to be above
according to the formula at maturity. The most common type of
the target level for the product to successfully be called. Because
autocall pays a return proportional to the length of time it takes for
this is less likely to occur the corresponding return is higher.
the product to be called and usually does not require index growth.
However if the product is not called, capital is at risk. Alternatively
Example: The product can be called annually from the first Pricing
anniversary that the index is at or above its initial level.
Because of the nature of autocall products with multiple maturities,
This product offers a return of 12.75% times the number
it is not possible to split the pricing into components as for the
of years elapsed when the autocall occurs. If the product is
other products in this section. The value of the autocall product
not called then capital is at risk and will be lost if the index
depends on the fixed returns, their likelihood and the downside
closes below the 50% barrier on any day throughout the
risk if autocall does not occur.
life of the product and finishes below the starting level.
1 Full Product Payoff One to Five 98% 98% Autocall Product

Fees 2%
Total 100%

3 Opportunity

to make an early
return above the risk-free rate if
who wants to achieve a pre-determined return
product requirements are met. in the event that the index performs to target.
7 Umaturity
ncertainty of product
and re-investment
opportunities.
100 100
78.9 75.6
75 75
Probability (%)
Probability (%)
50 50
25 25 19.2
15
2.4 3.6 2.1 3.1
0 0 0 0
0 0

The charts show there is a risk to capital but that there is a
200 decent chance of the product being called on one of the
180
180 observation dates. The scatter chart shows the range of product
160
160 returns (ignoring credit risk). The index level refers to the index
140
140 level at the time the product is called or at maturity if the
Product payoff
120
120 product is not called throughout the five year term. This helps
100
100
convey the multi-maturity nature of such products.
80
80 The values above 100 are in a series of horizontal lines
60
60 representing the returns at different maturities. There are
40
40
increasingly fewer higher up as reaching the trigger level on an
20 observation date late in the product term is generally less likely.
20
00 Note that the effect of including credit in the return charts is less
00 20 40
50 60 100
80 100 120
150 160
140
200 than in the other example products as the expected duration of
Index value
this product is less than 5 years.
Defensive Autocall
Defensive autocall products offer the investor a pre-determined rate of return
in a similar way to standard autocall products. The significant difference
between the product types is that the trigger level of the defensive
version is below the strike level, increasing the likelihood of early maturity.
The defensive autocall is a lower risk, lower return version of the

autocall product. The trigger levels which need to be met for the 1 2 3 4 5 Total
product to be called and pay the fixed return are set below the Standard Autocall 54.1% 13.9% 5.8% 3.1% 2% 78.9%
strike level which makes it more likely that the product will mature
early and therefore pay the outlined return. As the chance of return
Defensive Autocall 54.1% 21.7% 8.4% 4% 2.4% 90.6%
is higher, these products offer a lower fixed payment in exchange
for the reduced risk. The table shows the probability of the example defensive autocall
product being called at each anniversary. It also shows the same
Defensive autocall products can be structured with decreasing
probabilities for the example standard autocall product (shown on
trigger levels which can make it more likely that the product will
the previous page). The overall probability of the product being
be called in the later stages of the term.
called is 91% for the defensive and 79% for the standard autocall.
As with standard autocall products these can be linked to more The potential return for the standard autocall is 5.25% higher
than one index or asset. In general all of the underlying assets for each year that the product has been live. The higher return is
are required to be at or above the required trigger level which possible due to the smaller probability of the product being called.
decreases the probability that the product will be called but
would consequently increase the potential returns.
Example: The product can be called annually from the first anniversary that the index is at or above the trigger level compared
to the initial index level. The trigger levels for years 1,2,3,4 and 5 are 100%, 90%, 80%, 70% and 60% respectively. This product
offers a return of 7.5% times the number of years elapsed when the product is called. If the product is not called then capital is
at risk and will be lost if the index finishes below the European barrier of 50% of the starting level.
1 Full Product Payoff One to Five 98% 98% Defensive Autocall Product
Fees 2%
Total 100%

3 Defensive

trigger levels mean
that returns can be made
who wants a pre-determined return even
even in index decline. during some market decline.
7 Ifthethefixed

index performs well only
return will be paid.
100 100
90.6
86.8
75 75
Probability (%)
Probability (%)
50 50
25 25
12.5
8.5
0 0.9 0 0 0 0.7 0 0
0 0

The charts show there is a risk to capital but there is a
200 decent chance of the product being called on one of the
180 observation dates.
160
160
The scatter chart shows the range of product returns (ignoring
140
140
credit risk). The index level refers to the index level at the time
Product payoff
120
120 the product is called or at maturity if the product is not called
100
100 throughout the five year term. This helps convey the multi-
80
80 maturity nature of such products.
60
60 The values above 90 are in a series of horizontal lines
40
40 representing the returns at different maturities. There are
20
20 increasingly fewer higher up as reaching the trigger level on an
00 observation date late in the product term is generally less likely.
0
0 20 40
50 60 80
100
100 120 140
150 200
Index value

Bull Bear
A typical bull bear product offers the investor an opportunity to make returns
regardless of the direction of movement of the underlying asset from its
initial level. Products generally offer a fixed participation rate of the
absolute performance of the underlying. Capital is at risk and usually
subject to barrier conditions.
A bull bear product allows an investor to profit from moderate up chance for any return is lost and capital is placed at risk. If a cap is
or downward movement in the underlying asset. This is achieved included investors do not participate in underlying growth above
by the purchase of both a call option (to provide upside if markets the maximum level. The investor therefore needs the asset to move
rise) and a put option (if markets fall). In order to achieve decent as far as possible from the initial level but not past either barrier
rates of participation it is common to put a barrier and/or a cap in or a cap.
place. If a barrier is used, if the underlying falls severely, then the
Example: This product pays two times growth in the index Pricing
up to a maximum 100% return. It also pays returns of 1.5
The pricing of this product is broken down into four components.
times index decline up to a maximum of 45% which is paid
The first is a zero coupon bond, the “base” payment of 100%.
if the index falls by 30% or more. If the final level of the
Returns are then provided by a geared call spread and a geared
index is less than 55% of its initial level 1% of capital will
put spread. The dual directional returns are paid for by the sale of a
be lost for every 1% fall from the initial index level.
knock-in European put with a 55% barrier. The barrier is observed
at maturity only.

2 Call Spread Five 21.20% 10.6% 2x Geared Call Spread 100%-150%
3 Put Spread Five 13.50% 9% 1.5x Geared Put Spread 100%-70%
Knock-In European Put with
4 European Barrier -20%
a Barrier at 55%
Fees 2%
Total 100%

This type of product is designed for investors
3 Dual

directional returns.
who have no particular market view but are
happy to assume that any movement
7 Capital is at risk and returns in the underlying will be rather steady
are capped in both directions. than dramatic.
100 100
75 75
Probability (%)
Probability (%)
50 50
29.9 32.9
28.2 26.3 29.1
25 18.7 18.6 25
16.4
0 0 0 0
0 0
250
The payoff chart shows the huge shift in returns between the
200 index finishing at or below 55% of its initial level and above this
200
180 level. The asymmetrical gearing of the call spread and the put
160 spread can be seen through the different gradients of the graph
150
140 either side of index starting level of 100.
Product payoff
120 The probability tables show that there is a reasonable chance of

100
100 earning high annualised returns, there is also considerable risk
80 to capital.
60
50
40
20
00
0 50 100 150 200
0 20 40 60 80
Index100
value120 140 160 180

Range Accrual
A range accrual product offers the potential to receive periodic coupons of which
the amount depends on how many trading days during the measurement
period the underlying finishes within the specified range.
A typical range accrual product pays a fixed return multiplied the observation period. Capital is at risk if the barrier is breached
by the number of days that the underlying asset closed within a and will be reduced in line with the fall of the underlying.
certain range and divided by the number of days occurring during
Example: This product pays a fixed semi-annual return Pricing

of 3.69% multiplied by the number of trading days the
The pricing of this product is calculated using the expected
index closes above the range accrual barrier of 60% and
proportion of the daily observations that the underlying closes
divided by all days during the six month period. Capital
within the range. The structure can be broken down into a zero
is at risk and will be lost if the closing level barrier of 50%
coupon bond, a series of digital options with a strike at 60%
is breached on any day throughout the product term and
to calculated the value of each accrual based coupon and an
finishes below its starting level.
American put option with a knock-in barrier of 50% and gearing
of -100%.
Component No. Type Maturity (years) Price Description

2 Income Stream Five 29.40% Accrual Based Coupon Stream
Put Option with 50% Closing Day Barrier
and the Gearing of -100%
Fees 2%
Total 100%

3 Ifmeasurement
the index finishes within the range on every
day, investors receive the maximum
This product is suitable for
an investor who wants to
periodic coupon above the risk free rate. receive income in excess
of the risk free rate and
7 Ctheapital
is at risk if the 50% barrier is breached and
underlying asset finishes below its initial level.
is prepared to take on
capital risk.
100 100
75 75
Probability (%)
Probability (%)
61
52.8
50 50
24.2
25 25
16.8 14.9
13
9.2 8.1
0 0 0 0
0 0

The probability of return charts show the maximum return for
200 this product falls into the 5 to 10 per cent per annum category.
180 The actual maximum return is achieved if the index remains
160
160 above 60% of its initial level throughout the life of the product.
140
140
The maximum coupon is more likely to be paid at the end of
Product payoff
120
120 the periods closer to the start of the product than in the final
100
100 periods as the chance of the underlying being below 60% of its
80
80 initial level increases over time.
60
60
40
40
20
20
00
00 50
100
100 150
200
200 250
300
300 350
400
400 450
500
Index value

Synthetic Zero/Growth Certificate
Synthetic zero and growth certificates offer a fixed return on the investment
providing the particular product’s requirements are met. This product type
typically pays a fixed return if the final level of the underlying asset is above
a specific level on a pre-determined observation date. Capital is usually at
risk subject to barrier conditions.
These types of products usually have one of two possible ways to level on the relevant observation dates. Capital is at risk and
generate upside returns. The first way is that the product will return repayment of capital is sometimes treated independently to the
full capital plus a fixed bonus amount if the index has reached the payment of the fixed returns on the upside.
required level at maturity. Capital may or may not be at risk.
The product provides a reasonable return even on moderate
The second is that fixed returns are locked-in throughout the market growth. However, investors do not benefit from any further
product term and paid at maturity if the index reaches the required index growth and cannot receive more than the fixed amount.
Example: This product pays a fixed return of 43% if the Pricing

index finishes above 60% of its initial level. Capital is at
The pricing for this product is broken down into three components.
risk and will be lost if the final level of the index is below
These are the zero coupon bond component for capital protection,
60% of its initial level. In this case 1% of capital will be lost
digital option and the European knock-in put. The cost of the zero
for every 1% fall in the index.
is 83.3% which is calculated using the current risk free rate and the
funding rate of the issuer. The price of the digital option is 0.66 per
unit or 28.4% to pay a 43% return if the final level of the index is
above 60% of the initial level. The European knock-in put option
with a barrier of 60% is worth 13.7%.

Payment of 43% if Index
2 Digital Option Five 28.40% 0.66%
Finished Above 60%
3 European Knock-In Put Five -13.70%
Closing Day Barrier
Fees 2%
Total 100%

3 Receive

a fixed return unless
the index falls by 40% or more.
This type of product is likely to appeal to an
investor looking for a fixed return even given
moderate market decline.
7 Namount
o return beyond the fixed
even if the index has
performed strongly.
100 100
79.3
75 75 69.2
Probability (%)
Probability (%)
50 50
30.8
25 20.7 25
0 0 0 0 0 0 0 0
0 0

The charts show that the most likely outcome is for the product
200 to return capital plus the fixed return of 43% which falls in the 5
180 to 10% per annum bracket.
160
160
If capital is lost the investor will lose at least 40% of capital due
140
140
to the final day barrier. There is no chance of small losses.
Product payoff
120
120
100
100
80
80
60
60
40
40
20
20
00
00 20 40 50 60 80 100
100 120 150 160
140 180 200
Index value

product comparisons
The table below displays the key aspects found in the major product types explained
earlier in this handbook.
Participation/
Product Protected/At Risk Growth/Income Barrier
Gearing
Capital Protected Protected Growth

3 7
Reverse Convertible At Risk Income
7 3
Leveraged Tracker At Risk Growth
3 3
Autocall At Risk Growth
7 3
Defensive Autocall At Risk Growth
7 3
Bull Bear At Risk Growth
3 3
Range Accrual At Risk Income
7 3
Synthetic Zero/Certificate At Risk Growth
7 3

Five reasons
to recommend structured products
1 Risk Control and Capital Protection
Investors are able to select a product that meets their risk-return requirements. Because a wide variety of structured
products exist at all points in the risk spectrum, there will be suitable choices for any type of investor.
2 Clearly Defined Return Profiles

Unlike some other investment vehicles and even mainstream investments such as actively managed funds, structured
products provide the investor with a clear view of how well their product will perform given performance in the
underlying asset(s) on which they depend.
3 Access to a Variety of Markets and Underlyings

Structured products allow the investor access to various underlying assets and markets from all over the world which
may otherwise be difficult to access.
4 Low Cost
Structured products generally involve lower costs in comparison to other investment products in the market. They
typically have a total embedded fee structure between 1% and 1.5% per annum. This compares favourably with hedge
funds, venture capital trusts and active unit trusts which can all charge much in excess of these levels. Additionally the
majority of structured products specify the product’s return net of all charges, unlike bond funds for example, which
quote a gross yield which is not achieved once charges are deducted.
5 Tax and Wrappers

Tax efficiency is important to investors. Structured products allow individuals to benefit from lower tax costs by
providing investors with various tax wrappers from which to choose from. In particular, returns on some products are
subject to capital gains tax as opposed to income tax. Products can also be sold as ISAs for which returns are tax-free.
Other investors prefer the deposit wrapper that is also available for structured products.

key risks
The following list of risk factors does not purport to be a complete enumeration or explanation
of all the risks associated with structured products. All persons should seek such advice as they
consider necessary from their professional advisors, legal, tax or otherwise, in connection with
any investment in structured products.
• Where products are not capital protected, investors’ initial investment amount shall be at risk.
This means that investors could lose some or all of their investment.
• If the issuing entity defaults or goes bankrupt, investors may lose some or all of their
investment.
• During the life of an investment, the market value at which the investment trades and can be
sold may be significantly less than the price at which it was bought.
• The value of investments can go down as well as up and investors may not get back the full
amount invested.
• Prospective investors should understand that investments in products relating to equity

markets may be negatively affected by global economic, financial and political developments

Glossary
American Barrier – Observed on every trading day throughout Funding – The funding level of an issuing institution is the
the product term. This barrier is observed either at the close of amount above the risk-free rate that it offers to bond-holders and
trading (closing day barrier), or throughout the day (intra-day other investors in its paper to compensate for the credit risk of
barrier). If breached, the investor’s capital is at risk and will be lost the issuer.
unless the underlying asset recovers to at least 100% of its initial
level at maturity. Lock-in – Typically refers to a fixed amount that is recorded and
paid at maturity if the underlying reaches a pre-defined level at a
Autocall – A feature within a product that allows it to mature specific time during the product term.
early, often with a fixed return on offer, if the asset(s) reaches a
specified level on a pre-defined date. Return Cap – The maximum return achievable in the best
case scenario.
Averaging – Refers to the underlying’s performance being
averaged over a period of time and is usually used to determine the Participation/Gearing – Term used to describe the level of
starting or final level of the underlying. upside exposure to the underlying asset.
Basket – Refers to a collection of underlying assets which are Strike Level – Usually refers to the initial level of the underlying
grouped together and given specific weightings. assets(s) and is used as a base measure for the performance of the
underlying throughout its life.
Coupons – Often refers to the level of income on offer in
a product. Worst Of – Refers to a feature in a multi-asset product where
the performance of the product is dependent on the lowest
Credit Default Swaps (CDS) – A number which indicates performing underlying.
the size of the credit risk involved in investing with a particular
company taken from the annual cost of insuring against a credit Zero Coupon Bond – A bond which is bought at a lower
event for a specified time period, for example 5 years. price than its face value and is redeemed at its face value at
maturity. These bonds can be used to provide capital protection in
European Barrier – Observed on the final day of the structured products.
investment. If breached, the investor will lose a significant amount
of capital depending on the barrier level.

Notes

Contact us:
Investor Product Sales, UK & Ireland
RBS Markets & International Banking
0800 121 6286
investorproducts@rbs.com
www.rbs.co.uk/markets

This handbook has been prepared for information purposes only. It shall not be construed as, and does not form part
of an offer, nor invitation to offer, nor a solicitation or recommendation to enter into any transaction or an offer to sell
or a solicitation to buy any security or other financial instrument. No representation, warranty or assurance of any
kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and
each of its affiliates disclaim all liability for any use you or any other party may make of the contents of this handbook.
The contents of this handbook are subject to change without notice and RBS does not accept any obligation to any
recipient to update or correct any such information. Views expressed herein are not intended to be and should not
be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax,
legal or accounting matters in any applicable jurisdiction. This handbook is not intended for distribution to, or use by
any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or
regulation. The information contained herein is being provided to selected recipients and may not be given (in whole
or in part) or otherwise distributed to any other third party without the prior written consent of RBS.
RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the
type described in this handbook and/or in related financial instruments. Such interest may include dealing in, trading,
holding or acting as market-makers in such instruments and may include providing banking, credit and other financial
services to any company or issuer of securities or financial instruments referred to herein.
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh
EH2 2YB. The Royal Bank of Scotland plc is authorised and regulated in the U.K. by the Financial Services Authority.
© 2012 The Royal Bank of Scotland plc. All rights reserved. The DAISY Device logo, RBS, BUILDING TOMORROW and THE
ROYAL BANK OF SCOTLAND are trade marks of The Royal Bank of Scotland Group plc. This handbook is for the use of
intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any
purpose without The Royal Bank of Scotland plc.’s prior express consent.

Future Value Consultants
151 Sheen Lane
London SW14 8LR
T: +44 (0)20 3384 1450
E: fvc@futurevc.co.uk
W: www.futurevc.co.uk
Regulated by the FSA
Specialists in structured product research, analysis and valuations
This handbook is intended for financial professionals only and should not be distributed to private investors. The information in this handbook
has been compiled in good faith but no guarantee is made that the information is complete or accurate and it should not be relied upon
as such. Any statements of market practice, regulatory or tax positions and all product illustrations are believed to be correct at the date of
publication but are subject to change. No liability whatsoever is accepted for any loss or expense incurred from using this handbook. All
material in this handbook remains copyright Future Value Consultants Limited.

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Structured Products Handbook

Welcome 3 How to Trade RBS Structured Products 22

Introduction to FVC 4 Major Product Types

Bringing Products to Market 17 Key Risks 42

Regulation and Compensation Schemes 20

2 | FVC Structured Products Handbook

Dear Financial Professional,

FVC Structured Products Handbook | 3

4 | FVC Structured Products Handbook

FVC Structured Products Handbook | 5

6 | FVC Structured Products Handbook

FVC Structured Products Handbook | 9

Equity Indices Inflation

FVC Structured Products Handbook | 11

12 | FVC Structured Products Handbook

FVC Structured Products Handbook | 13

14 | FVC Structured Products Handbook

FVC Structured Products Handbook | 15

16 | FVC Structured Products Handbook

FVC Structured Products Handbook | 17

18 | FVC Structured Products Handbook

FVC Structured Products Handbook | 19

20 | FVC Structured Products Handbook

FVC Structured Products Handbook | 21

For further information please contact the team

22 | FVC Structured Products Handbook

FVC Structured Products Handbook | 23

Component No. Type Maturity (years) Price Unit Price Description

1 Zero-Coupon Bond Five 83.30% Payment of 100%

24 | FVC Structured Products Handbook

7 The product can underperform

Issuer default risk ignored Issuer default risk included

FVC Structured Products Handbook | 25

Example: This product has five times index growth up to an Pricing

Component No. Type Maturity (years) Price Unit Price Description

1 Zero-Coupon Bond Five 83.30% Payment of 100%

26 | FVC Structured Products Handbook

Issuer default risk ignored Issuer default risk included

FVC Structured Products Handbook | 27

Example: This product pays 6.5% income per annum. Pricing

Component No. Type Maturity (years) Price Unit Price Description

1 Zero-Coupon Bond Five 83.30% Payment of 100%

28 | FVC Structured Products Handbook

Issuer default risk ignored Issuer default risk included

Index returns and product payoffs (issuer default risk ignored)

FVC Structured Products Handbook | 29

Component No. Type Maturity (years) Price Unit Price Description

1 Full Product Payoff One to Five 98% 98% Autocall Product

30 | FVC Structured Products Handbook

Issuer default risk ignored Issuer default risk included

Index returns and product payoffs (issuer default risk ignored)

The defensive autocall is a lower risk, lower return version of the

Component No. Type Maturity (years) Price Unit Price Description

32 | FVC Structured Products Handbook

Issuer default risk ignored Issuer default risk included

Index returns and product payoffs (issuer default risk ignored)

FVC Structured Products Handbook | 33

Component No. Type Maturity (years) Price Unit Price Description

1 Zero-Coupon Bond Five 83.30% Payment of 100%

34 | FVC Structured Products Handbook

Issuer default risk ignored Issuer default risk included

120 The probability tables show that there is a reasonable chance of

FVC Structured Products Handbook | 35

7 The product can underperform