Structured vs. Non-Structured Financial Products

On this page:

• Overview
• Non-Structured Financial Products (Plain-Vanilla)
  • Typical Examples
  • Payoff Intuition
• Structured Financial Products
  • Core Building Blocks
  • Typical Structured Products
  • Payoff Intuition
  • Key Modification Features
• Example 1: 5-Year Capital Protected Note
  • 1. Ingredients
  • 2. Possible Outcomes
  • 3. The "Fine Print"
• Example 2: 2-Year Autocallable Note
  • 1. Ingredients
  • 2. Possible Outcomes
    • Worst Case vs Best Case
    • Three Profit-Case Scenarios over Time
• Capital-Protected vs. Autocallable Notes
  • 5-Year Capital-Protected Note
  • 2-Year Autocallable Note
• Key Takeaway

Financial products can broadly be divided into non-structured (plain-vanilla) and structured instruments. The core distinction is not legal form, but how the payoff is engineered and which risks the investor ultimately bears.

Non-structured products offer direct, linear exposure to an asset or issuer, such as common stocks. Structured products, by contrast, embed derivatives and conditional logic to reshape risk and return into predefined payoff profiles.

This distinction is fundamental to understanding products such as MTNs, structured notes, warrants, certificates, buffers, and barriers.

Dimension	Non-Structured	Structured
Example	Common stock	Capital-protected note
Traded on exchanges	Mostly yes	Mostly no
Payoff shape	Linear	Non-linear
Embedded derivatives	No	Yes
Conditional logic	None	Yes
Pricing	Market-quoted	Model-based
Liquidity	Usually high	Often limited
Customization	Low	High

Non-structured products are securities with a transparent, linear payoff directly linked to ownership or lending, without embedded derivatives or payoff conditions.

• Common stock
• Preferred stock
• Corporate bonds
• Treasuries
• Plain ETFs and mutual funds
• Straight convertibles (borderline but largely linear)

• Stock: gains and losses move 1:1 with price changes
• Bond: fixed coupons plus principal repayment, subject to credit risk

Investor outcomes depend primarily on price movement, interest rates, or issuer creditworthiness, with minimal structural complexity.

Structured financial products are engineered investment securities whose payoff is determined by a pre-defined formula, typically involving embedded derivatives and non-linear or conditional outcomes.

Rather than providing direct exposure, they synthetically construct a desired payoff profile.

1. Fixed Income Component (Safe Leg)

   • This is typically the foundation of the product, making up the majority of the invested capital (often 80–95%).
   • Zero-Coupon Bond: The most common instrument used. The issuer buys a bond at a deep discount that matures at "par" ($100\mathrm{\%}$ of principal) at the end of the term.
   • This component is responsible for the capital protection feature. Even if the market side of the trade fails, the bond's growth back to its face value ensures the investor receives their invested capital back (subject to the issuer's credit risk).

2. Derivative Component (Kicker)

   • The money saved by buying the bond at a discount (the remaining 5–20%) is used to purchase derivatives.
   • Options: Usually options (call, put, or combinations) are employed to create the desired payoff structure.
     • Call Options: Provide "Upside Participation," allowing the investor to profit if an index or stock rises.
     • Put Options: Often sold by the investor (embedded in the structure) to generate "yield enhancement" (coupons), in exchange for taking the risk that the principal might not be protected if the market crashes below a certain level.
   • This part defines the payoff profile. It determines whether the product is for growth, income (coupons), or speculation. It defines how the investor participates in market movements, i.e. upside participation, neutral, or downside exposure.

3. Underlying Asset (Reference)

   • The performance of the structured product is linked to an underlying asset or index. Common underlyings include:
     • Equity indices (S&P 500, NASDAQ-100)
     • Single stocks
     • Commodities
     • FX rates

• Structured notes
• Equity-linked notes
• Autocallables
• Reverse convertibles
• Barrier notes
• Principal-protected notes
• Range accrual notes
• Buffered or capped notes

Examples of structured payoff logic:

• Pays 8% unless the index falls below 70% of its initial level
• Calls early if the index is at or above its start level on an observation date
• Caps upside in exchange for a downside buffer

These outcomes are implemented through embedded option positions.

Structured products are fine-tuned using modifiers such as:

• Caps: limit maximum return
• Barriers: activate or deactivate protection or losses
• Participation rates: scale exposure to the underlying’s performance

Critical note:Because the safe leg is a bond, investors are exposed to issuer credit risk. Even "capital-protected" products fail if the issuing bank defaults.

To understand how a structured product works in practice, we look at a classic example: a 5-Year Capital Protected Note linked to the S&P 500.

Imagine an investment of $10,000 into such a 5-Year Capital Protected Note.

The bank splits the $10,000 into two unequal pieces:

• The Shield ($8,500): They buy a 5-year zero-coupon bond. Because of the "time value of money," this $\mathrm{\$}8,500$ is guaranteed to grow back to exactly $\mathrm{\$}10,000$ in five years (provided the bank doesn't go bankrupt).
• The Engine ($1,500): They take the remaining cash and buy a call option on the S&P 500. This is a bet that the market will be higher in five years than it is today.

After five years, only two things can happen:

Scenario A: The Market Roars (Bull Market)

• The S&P 500 is up 40%.
• The Shield has matured to $10,000.
• The Engine (the option) is now very valuable. The bank pays out a portion of that 40% gain.
• Result: $\mathrm{\$}10,000$ paid back + profit on the option (= $\mathrm{\$}13,000$ total).

Scenario B: The Market Crashes (Bear Market)

• The S&P 500 is down 30%.
• The Engine (the option) expires worthless.
• However, the Shield has still matured to $10,000.
• Result: $10,000 paid back, no profit. The investor lost the opportunity to earn a return, but the original investment is intact.

While this sounds like a "no-lose" situation, there are three hidden factors:

1. Caps & Participation: The bank might say, "We will pay out the upside, but only up to a maximum of 25%." That's how they pay for the protection.
2. No Dividends: The investor usually only gets the price return of the index. The bank keeps the dividends to help pay for the structure.
3. Credit Risk: If the bank fails, the "Shield" disappears. The investor is an unsecured creditor of that bank.

An Autocallable Note is a common "yield enhancement" product. While a Capital Protected Note is a bet on growth, the Autocallable is a bet on stability.

Imagine an investment of $\mathrm{\$}10,000$ into a 2-Year Autocallable Note:

The bank splits the $\mathrm{\$}10,000$ into two parts:

• The Shield ($9,000): The bank buys a bond to ensure it has the cash to pay back the initial investment.
• The Generator ($1,000): The investor sells a Put Option on the S&P 500 to the bank, i.e. the bank buys a put option from the investor.

The Logic: The investor will take the risk that the S&P 500 crashes by more than 30%. In exchange for taking that risk, the investor receives "rent" payments (=coupon) of 10% (= $\mathrm{\$}1,000$) per year from the bank.

This note has "Observation Dates" (e.g., every 6 months). At each date, the bank looks at the S&P 500:

• Scenario A: The Early Exit (Market is Up/Flat)If the S&P 500 is at or above its starting level on an observation date, the note is "called" (it ends early).
  • Result: Get $\mathrm{\$}10,000$ back, plus $10\mathrm{\%}$ coupon. The trade is over.
• Scenario B: The Steady Pay (Market is Slightly Down)If the S&P 500 is down $10\mathrm{\%}$, it's not "called," so the trade continues. As long as it stays above a certain "Coupon Barrier" (e.g., $-20\mathrm{\%}$), the investor keeps receiving $10\mathrm{\%}$ (= $\mathrm{\$}1,000$) annual pay.
• Scenario C: The Crash (Market is Way Down)If the S&P 500 drops $40\mathrm{\%}$ and stays there until the end of the 2 years, the investor hits the "Knock-in Barrier."
  • Result: The protection "knocks out.". The principal is lost 1-for-1 with the market. If the index is down $40\mathrm{\%}$, the investor only gets back $\mathrm{\$}6,000$.

Feature	Best Case	"Early Call" Case	Worst Case (Crash)
Market Move	Stable / Sideways	Upward / Bullish	Sharp Crash / Bearish
Duration	Full Term (2 yrs)	Short (e.g., 6 months)	Full Term (2 yrs)
Principal Returned	$\mathrm{\$}10,000$ ($100\mathrm{\%}$)	$\mathrm{\$}10,000$ ($100\mathrm{\%}$)	$\mathrm{\$}6,000$ (market value)
Coupons Paid	$+\mathrm{\$}2,000$	e.g., $+\mathrm{\$}500$	$\mathrm{\$}0$ (usually skipped)
Net Profit / Loss	$+\mathrm{\$}2,000$	$+\mathrm{\$}500$	$-\mathrm{\$}4,000$ (index down 40%)
Outcome	Profit	Profit	Loss

Scenario	Duration	Total Coupons Paid	Total Cash Received
Called at 6 Months	0.5 Years	$500 (2 quarters)	$10,500 ($\mathrm{\$}10k$ back + $500)
Called at 1 Year	1.0 Year	$1,000 (4 quarters)	$11,000 ($\mathrm{\$}10k$ back + $1k)
Matures at 2 Years	2.0 Years	$2,000 (8 quarters)	$12,000 ($\mathrm{\$}10k$ back + $2k)

Feature	Capital-Protected	Autocallable
Primary goal	Growth	Income
Derivative exposure	Long call	Short put
Best case	Strong market rally	Flat / stable market
Worst case	Opportunity cost	Capital loss
Risk profile	Lower volatility	Higher tail risk

A capital-protected note linked to the S&P 500 illustrates the growth-oriented use of structuring.

• Majority invested in a zero-coupon bond to return principal at maturity
• Remainder used to buy a call option on the index

Outcomes

• Strong market: limited participation in upside
• Weak market: principal returned, no gain

Autocallables are yield-enhancement products designed for stable or sideways markets.

• Investor effectively sells downside risk via embedded put options
• Receives high coupons as compensation
• Early redemption possible if conditions are met

Outcomes

• Flat or rising market: early call with coupon income
• Mild decline: coupons continue
• Sharp crash: principal loss proportional to index decline

• Non-structured products provide direct, transparent exposure.
• Structured products reshape risk and return using derivatives embedded in a security.
• Structured products trade simplicity and liquidity for customization and conditional outcomes, while introducing model risk and issuer credit risk.

Understanding this distinction is essential before evaluating yield, protection, or headline features.