This thesis researches the pricing and back testing on structured products in the United Kingdom Market. We conclude that structured products do not give equity like returns.
The structured products performance is evaluated on the basis of pricing and back testing is performed on three different instruments issued in the United Kingdom market. Their returns are compared with the returns of the FTSE 100 index, UK Treasury Bond and the Synthetic Instruments. The Black and Scholes model for dividend payments is used in this study to calculate the option prices of the structured products.
Table of Contents
1. Introduction
1.1. Background
1.2 Purpose
2. Structured Product
2.1. Evolution of Structured Products
2.2. Developments in the market
2.3. Global Market Comparisons
3. Literature Review
4. Problem Description
5. Research question and Hypothesis
6. Theoretical Frame of Reference and Methodology
6.1. Valuation of Structured Products
6.2. Valuation of Bonds
6.3 Valuation of Options
6.3.1 The Black and Scholes Model
6.4 Advantages and Disadvantages of Black and Scholes Model
6.5 Barrier Options
6.6. Volatility
6.7. Estimation of Volatility from Historical Data
6.8. Price Index
6.9. Return Index
6.10. Dividend yield
6.11. Yield Curves
6.12. Continuous compounding formula
7. Data Set
7.1 Instruments
7.1.1 Types of instruments used in the empirical study
7.2 Valuation of Structured Products (Synthetic Instruments)
7.3 Formulas used to calculate the return of synthetic instruments
8. Descriptive Statistics and Results
8.1 Returns Vs Sharpe Ratio
9. Summary and Conclusions
9.1 Comparing and contrasting with the present academic literature
9.2 Limitations and future research
Research Objectives and Themes
This thesis aims to evaluate the pricing and performance of three hybrid structured products within the UK market by comparing their returns against the FTSE 100 index and government bonds. The core research question addresses whether structured products provide equity-like returns for investors.
- Pricing and back testing of structured financial products
- Application of the Black and Scholes option pricing model
- Comparative performance analysis against synthetic instruments
- Investigation of capital-protected versus non-protected retail products
- Evaluation of risk-adjusted returns using the Sharpe ratio
Excerpt from the Thesis
2. Structured Product
A structured product is a hybrid instrument that is comprised of at least two financial components. They are composed of building blocks that can be identified as equity and debt. The equity component of the product is equivalent to a long term option and the debt component is equivalent to a bond.
We can divide the structured products into capital guarantee products and products that offer no capital guarantee. The products with capital guarantee ensure repayment of the formerly agreed portion of the capital whilst at the same point in time make it possible for investors to have some form of participation in the underlying instrument trends.
The structured products that have no capital guarantee give the investors a prospect to attain an attractive maximum return, but have no guarantee that the capital would be paid back to them. Products that offer no capital guarantee can be further classified into products with coupon payments, products without coupon payments and products that have exotic characteristics. All structured products consist of an underlying. For example at the time of maturity the price of the underlying instrument is less than or equal to the strike price, the total sum that will be paid to the investors will equal the strike price; else they will get back the underlying instrument.
Summary of Chapters
1. Introduction: Outlines the background of the study and the research purpose, focusing on the lack of transparency in the UK structured products market.
2. Structured Product: Defines structured products as hybrid instruments composed of debt and equity components and categorizes them by capital protection features.
3. Literature Review: Surveys prior empirical research on the pricing of structured products in US and European markets, identifying a research gap for the UK.
4. Problem Description: Discusses the challenges faced by private investors due to high transaction costs and complex, non-transparent pricing by issuers.
5. Research question and Hypothesis: Formulates the main research question and defines the null and alternate hypotheses regarding equity-like returns.
6. Theoretical Frame of Reference and Methodology: Details the valuation frameworks, specifically the Black and Scholes model, and the statistical methods used for performance evaluation.
7. Data Set: Documents the data sources from 1984–2007 and the process of constructing synthetic instruments for comparison.
8. Descriptive Statistics and Results: Presents the findings of the empirical analysis and compares the risk-adjusted returns of the investigated instruments.
9. Summary and Conclusions: Concludes that most studied structured products do not yield equity-like returns and discusses limitations and future research directions.
Keywords
Structured Products, Accelerated Trackers, Bonus Trackers, Guaranteed Equity Bond, FTSE 100, Black and Scholes Model, Pricing, Back Testing, UK Market, Synthetic Instruments, Financial Derivatives, Capital Protection, Investment Returns, Sharpe Ratio, Quantitative Finance.
Frequently Asked Questions
What is the primary focus of this thesis?
The thesis focuses on the pricing and performance analysis of structured financial products within the United Kingdom market, specifically comparing their returns against the FTSE 100 index and government bonds.
What are the main categories of structured products discussed?
The research discusses products with capital guarantees and those without, further sub-classifying them into instruments with and without coupon payments, as well as those with exotic characteristics.
What is the central research question?
The core question is: "Do structured products give equity-like returns?"
Which pricing model is utilized in this study?
The study primarily utilizes the Black and Scholes pricing model, incorporating continuous dividend payments to calculate the option component of the structured products.
What is the methodology for assessing performance?
The author constructs synthetic instruments—portfolios consisting of bonds and options—to compare the actual returns offered by financial institutions against the theoretical potential of these components.
What are the key performance metrics mentioned?
The study uses mean returns, standard deviation, and the Sharpe ratio to evaluate the risk and reward profile of the selected instruments.
Why are synthetic instruments used in this analysis?
Synthetic instruments are used to decompose the structured products and evaluate whether the retail offerings provide a fair return compared to an investment strategy constructed by the investor themselves using basic market instruments.
What conclusion does the author reach regarding the null hypothesis?
For the G950 and G994 products, the author rejects the null hypothesis because the products fail to provide equity-like returns; however, for the NS&I guaranteed bond, the null hypothesis is not rejected.
- Quote paper
- Vishal Subandh (Author), 2007, Do Structured Products Give Equity Like Returns?, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/164138
