Effective Use of Structured Products In an Uncertain World February 2009 Erick Goralski Director Structured Investments Deutsche Bank Securities, Inc. | ![]() |
Evolution of the U.S. Structured Products Marketplace Pre-2005 2006 2007 2008 - -------- ---- ---- ---- U.S Business is Industry The vision of what predominantly participants begin the market could the domain of to place become, shows wire-house significant focus the first signs of firms with large on the "Third coming to fruition: broker networks Party" client (Merrill Lynch, space. o Wire-house firms Citi, UBS, Morgan move to "open Stanley, Goldman Independent architecture" Sachs, etc). brokerage firms, model. asset managers, o Independent Market participants private banks and firms begin broad lacking distribution Registered adoption (Lehman, DB, Bear, etc) Investment o Investment had marginal Advisors are Advisors enter businesses, at best. targeted. space in a meaningful way Modest results are o Large portion of achieved, largely the business focused on a migrates to "fee narrow range of based" (non- products. commission) | ![]() |
2008: The "Tipping Point" o The year began with tremendous momentum carried over from late 2007 oUncertainty in the market, coupled with an enhanced awareness of how structured products could be used in client portfolios led to steep increases in product issuance. o Clients began to utilize "synthetic asset management" as a surrogate for actively managed strategies. o Comparable/superior performance, with superior fees, transparency and liquidity o Client demand for commodity exposure with degrees of capital protection was high in the first half of the year. o On many levels, the defining event of 2008 was Lehman Brothers o At the time, it was uncertain as to the impact the Lehman bankruptcy would have on the structured products industry. o September, October and November were the strongest months of the year o Counterparty scrutiny was incredibly high | ![]() |
Industry Forensics o Who is participating in the market? o Traditional Structured Products investors (commission driven brokerage networks) remain strong participants. o Since September 08, bank issued market linked CDs with FDIC insurance are in strong demand. o By far the fastest growing market segment are Registered Investment Advisors and Independent Advisory networks. o Traditional long only stock, bond and mutual fund buyers. o Non-Commission driven: Investing based on the merits of the products, not based on the amount of commission that the product pays them. o Why are they choosing to utilize these investments? o In some cases, they have determined that the structures/underlying instruments are the best way to gain exposure to a given asset class. o Cash is not a long-term solution: "I can't continue to be a negatively yielding savings account that lacks FDIC insurance". o They recognize that for a portion of a clients portfolio, it is important to maintain market exposure, but reduce the uncertainty of the outcome over a given period of time. | ![]() |
Reduction Of Uncertainty For any given period, being long the market presents the following risk profile: Investment Return Underlying Return The investor owns the market all the way up and all the way down For a given period, structured products define a more narrow range of outcomes Leveraged/Buffered Notes Absolute Return Notes Buffered Barrier Rebate Notes Note Return Note Return Note Return Underlying Underlying Underlying Return Return Return All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP All Structured Products payoffs can be constructed by some combination of call(s) and/or puts, which can range from vanilla options to more exotic varieties such as "barrier" options, "Look Back" options, "Rainbow" options.to name a few. | ![]() |
Structured Products From the Ground UP It is understood that investors are exposed to credit risk against the issuer of the product. Structured products are often described as having an underlying Zero Coupon Bond 5% Bond 5% Plus any Profit Accretes premium Initial To generated from Option $ Bond Par selling options Based Floor Over the tells us how Return 95% Term of much we have the to "Spend" "Bond" Structure 3 Year 3 Year "Bond" Structured Product The "Bond Floor" is determined by two things: o 3 Month Libor (Which is currently very low) o The issuer's "Spread"- Credit strength and issuer spread have an inverse relationship (i.e. the less credit worthy, the more interest they have to pay when given cash.) All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP There are many different types of options that are currently used in Structured Products, but the most common are "Vanilla" options and "Barrier" Options Vanilla Option: An option that has two meaningful dates; the day that the option is initially set (the Strike date) and the final day on which it is valued (the Final Valuation or Expiry date). Call Option Payoff Diagram Underlying Value Final Date Final Underlying Value = 125% Strike Date Strike Level = 100% Time When using Vanilla options, the Final Value of the option is not impacted by the path of the underlying throughout the life of the option. As long as the Final Level of the Underlying is greater/less than the Initial Level in the case of a Call/Put, the option will have value at maturity. All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP Barrier Option: Barrier Options introduce the concept of "Path Dependency" of the underlying. They function in a similar way to Vanilla Options (at maturity), unless the underlying has moved through a pre-defined point at some point during the life of the option. If the "barrier crossing" occurs, the option value is zero at maturity. Scenario 1 Scenario 2 Underlying Value Underlying Value Barrier =125% Scenario 1, the barrier Barrier =125% is never crossed. Barrier Strike option and Vanilla =100% option have equal value Barrier is at maturity. Broken Time Option Expires Scenario 2, the barrier is Worthless broken. At maturity, Vanilla option captures the upside of the market, Barrier option expires worthless. All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP Why would an investor use non-Vanilla Options (Barrier options, etc)? o Most obvious and fundamental they are often less expensive than vanilla options. o Added barrier risk/path dependency reduces cost o Investor "sells" volatility at the barrier and is paid well given highly elevated market volatility. o Significantly more flexibility in the payoff's that can be created o If barriers exceed the investors expectations for what the market will realize, barrier options are a more attractive choice Investor Profit Investor Profit If an investors They can capture expectation is the same return "X" what is the in a less value of upside expensive way, beyond this provided that the point? barriers exceed their expectation Investor for the Expectation underlying over the life of the Underlying Value product. Underlying Value All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP Components of several common Structured Products Example 1: Buffered "Return Enhanced Note" Tenor/Duration: 13 Months Underlying Asset: Equity Index Downside Protection: 10% Upside Participation: 200% (Client Gains 2:1 up to the cap) Upper Cap: 108% Option Breakdown Upper Cap Investor Sells 108% Two 108 Strike Calls Strike Level Investor Buys 100% Two At The Money Calls Buffer Level Investor Sells 90% One 90 Strike Put All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP Components of several common Structured Products Example 2: M-Note (Absolute Return Barrier Note) Tenor/Duration: 18 Months Underlying Asset: Equity Index Downside Protection: 100% at Maturity Barriers: +/- 25% Option Breakdown Upper Cap If Underlying closes 125% above upper barrier options "Knock Out" Strike Level Investor Buys 100% ATM Barrier Call And Buys ATM Barrier Put Buffer Level If Underlying closes 75% below lower barrier options "Knock Out" All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Structured Products From the Ground UP Components of several common Structured Products Example 3: Buffered Barrier Rebate Note Tenor/Duration: 15 Months Underlying Asset: Equity Index Downside Protection: 15% at Maturity Participation Factor: 150% of index upside Upper Barrier: 45% (max return is 67.5%) Rebate Amount: 7.5% Option Breakdown If Underlying closes above upper barrier Upper Barrier options "Knock Out" 145% and Investor receives 7.5% "Rebate" Rebate Level 7.5% Investor Buys Strike Level 1.5 Barrier/Rebate 100% call options Lower Level Investor Sells One 85 85% strike vanilla put All terms reflected above are purely hypothetical and may not be available at a given time based on current market variables. | ![]() |
Buffered Underlying Securities: CUSIP 2515A0AP8 Hindsight analysis of note pricing vs. Underlying performance BUyS linked to the Nikkei 225 Index Summary Terms CUSIP: 2515A0AP8 Trade Date: February 26, 2007 Tenor: 36 months Underlying: Nikkei 225 Index Buffer: 20% Participation Factor: 130% Payment at Maturity: If the final level is greater than or equal to the Initial Level, investor receives: Notional + (Notional * Index Return * Participation Rate) If the Final Index Level is less than the Initial Level, and the decline is less than or equal to the Buffer, investor receives Notional. If the Final Index Level is less than the Initial Level by an amount greater than the Buffer, investor receives: Notional + (Notional * (Index Return + Buffer)) The terms above reflect market conditions at the time of the offering and may not be available at a given time based on current market variables. Source: Bloomberg as of 1/21/09 | ![]() |
Absolute Return Barrier Note: CUSIP 25152C643 M-Note linked to the S&P 500 Index Summary Terms CUSIP: 25152C643 Trade Date: March 26, 2007 Tenor : 18 months Underlying: S&P 500 Index Barrier: +/- 21% Payment at If Underlying ever trades outside Barriers, Maturity: 00% If Underlying never trades outside Barriers, 100% + Absolute Return Payment Made: 117.34% @ maturity The terms above reflect market conditions at the time of the offering and may not be available at a given time based on current market variables. Source: Bloomberg as of 09/23/08 | ![]() |
Absolute Return Barrier Note: CUSIP 2515A0FR9 M-Note linked to the MSCI EAFE Index Summary Terms CUSIP: 2515A0FR9 Trade Date: November 26, 2007 Tenor: 18 months Underlying: MSCI EAFE Index Barrier: +/- 23% Payment at If Underlying ever trades outside Barriers, Maturity: 100% If Underlying never trades outside Barriers, 100% + Absolute Return Status: Knocked out on 09/04/08 The terms above reflect market conditions at the time of the offering and may not be available at a given time based on current market variables. Source: Bloomberg as of 01/21/09 | ![]() |
Indicative Performance Calculations o Indicative Pricing for all Deutsche Bank Structured Equity Notes are based off of bid levels posted by Deutsche Bank on Bloomberg that reflect indicative unwind levels for a limited notional amount of a given note (generally up to $1,000,000). The indicative bid levels posted on Bloomberg include accrued interest, if any, for a given security. o Actual unwind levels may vary from the indicative bid levels posted on Bloomberg depending on many factors that include actual unwind notional amount, current volatility of the underlier, liquidity in the market, Deutsche Bank's creditworthiness, and Deutsche Bank's profit and loss amortization assumptions. o Deutsche Bank's upfront fees (if any) are amortized over a portion of the life of the trade. Indicative bid levels posted on Bloomberg may not reflect the true fair value of a given security. o Indicative Note Performance is calculated using the underlying stock performance and accrued interest (if any) during the given time frame o Stock total return is calculated using stock price and dividends (if any) paid out to investors during the given timeframe | ![]() |
Risk Factors oAn investment in the securities described herein may result in a loss, and any payment is subject to our creditworthiness o Certain built-in costs are likely to adversely affect the value of the securities prior to maturity o You have no periodic coupon or dividend payments or voting rights o The securities will not be listed and there will likely be limited liquidity o Our research, opinions or recommendations could affect the level of the underlyings or the market value of the securities o Our actions as calculation agent of the securities and our hedging activity may adversely affect the value of the securities o Many economic and market factors will affect the value of the securities | ![]() |
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Unlike an actual performance record based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of a backtested model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of performance also differs from actual account performance because an actual investment strategy may be adjusted any time, for any reason, including a response to material, economic or market factors. The backtested performance includes hypothetical results that do not reflect the reinvestment of dividends and other earnings or the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid. No representation is made that any trading strategy or account will or is likely to achieve profits or losses similar to those shown. Alternative modeling techniques or assumptions might produce significantly different results and prove to be more appropriate. Past hypothetical backtest results are neither an indicator nor guarantee of future returns. Actual results will vary, perhaps materially, from the analysis. Results represent the performance of each basket on a back tested basis, tied to a structure whose economics are determined by current economic factors such as current volatilities and interest rates. There is no guarantee that a similar structure would have been available at any point in the past and that such results could have been achieved. Options, structured securities and illiquid investments, such as private investments, are complex instruments and are not be suitable for all investors. Prior to buying or selling an option investors must review the Characteristics and Risks of Standardized Options: http://onn.theocc.com/publications/risks/riskstoc.pdf If you are unable to access the website please contact Deutsche Bank AG at +1 (212) 250-6248 for a copy of this important document. 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