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Capital protected


Capital protected products allow investors to gain some exposure to financial assets whilst protecting the capital invested, in return for surrendering any income related to the underlying asset.

The degree to which there is participation in the performance of the financial asset and protection over capital invested vary from product to product. This will largely depend on the maturity profile, forward interest rates plus the yield and volatility of the underling asset (ignoring any FX considerations).

Capital Protection

 

Issuer:

ABC Bank

Issue date:

March  2005

Expiry date:

March  2008

Participation:

100%

Protection level:

100%

Underlying Asset:

FTSE 100

Underlying price:

5000

Conversion ratio:

1000:1

Instrument price:

500p

As can be seen from the above chart, the investor faces no downside risk over the three year lifetime of the product but takes part in 100% of any upside performance.


This achieved by purchasing a zero coupon bond and using the discount from nominal value to invest in a call option. The zero coupon bond matures at par, thereby guaranteeing the investor’s capital, whilst the call option maintains the upside exposure required

At maturity

On expiry, the holder of the capital protected instrument has the right to:


1.  If the final underlying asset price is greater than or equal to the initial underlying asset price:


      Initial price + (change in underlying / conversion ratio x participation)  


2. Otherwise:


      The higher of
      a) Initial price / conversion ratio x protection level
      b) Final price / conversion ratio


In this case, regardless of whether the index falls to zero by the time the product expires, the investor is guaranteed to receive the initial price of the product when launched. So a fall of -100% equates to a 0% movement in the product.


Should the index rise over four years, then the investor fully partakes in any capital appreciation. A 15% rise in the FTSE100 will result in a 15% rise in the value of the product. However, it should be remembered that the income attributable to the underlying asset has been given up in order to achieve this payout profile.



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