In Part two of our series on Structured Products, let’s learn about Constant Proportion Portfolio Insurance.
Hello and welcome back to my youtube channel it’s great to see all your smiling faces out there excited to learn all about financial derivatives so we’re in the middle of a series here on structured financial products and today we’re going to learn about si ppi which stands for constant proportion portfolio insurance we’re going to learn all about what that is how its
Structured how it works and why people invest in it okay so today we’re going to learn all about si ppi this is the second video i’ve done on structured products if you watched my earlier video the one where i looked like a floating head because i wore all white this white background you learned about what structured products are so si ppi is the first example of a
Principal protected structured product it was called constant proportion portfolio insurance and these products involved investments which stop-loss strategies in place to preserve principal if you don’t know what a stop loss is have a link to a video above where i explain different order types and that will explain what a stop-loss is hopefully you do understand
It because you’re kind of watching to advance the video otherwise so how does this work well instead of buying a zero coupon bond and some options exposure as you probably learned about in my last video on structured products which is linked to above a portion of the investors funds were placed in a risky asset which would be liquidated if prices fell through a
Targeted tolerance level at which point the money could be invested in a bond where it would grow back to the initially invested amount of money over the life of the product so as you can see there it works a little bit different to the products i explained last week because what we’re doing is we’re straight away just investing the money in a risky asset but if
Losses reach a certain level we then have to give up and just sell out of that product and put all of the money into a bond whoo so it’ll grow back to the initial amount of money that we can then return to our customers let me know in the comment section below what you think of this approach under how it compares to the approach we talked about last week so how
Does it work in practice cpp i caps an amount that the portfolio is capable of losing before which all assets must be liquidated and shifted to a bond in order to ensure that it earns back the amount lost before the maturity date the amount of acceptable loss will depend on market interest rate levels and the amount of time remaining to product maturity suppose
An investor begins with a portfolio of $100,000 and it’s determined that upon dropping to $90,000 the portfolio has to be converted 100% into bonds the acceptable loss level is known as the bond floor and in this example it’s ten thousand dollars so once we lose ten thousand dollars we just have to move everything into bonds when it is the amount beyond which the
C ppi portfolio should never fall in order to be able to ensure the notional guarantee at maturity the investor’s portfolio in a c ppi product begins by being invested in a risky asset in the amount of multiplier x bond floor a multiplier is calculated based on an assessment of an investor’s risk profile for a maximum one-day loss if it’s decided that the most
The risky asset is likely to lose is 25 percent then the multiplier used is 1 over 25 percent which gives us 4 in our example cpp i will begin with multiplier times bond floor which is 4 times 10,000 dollars being invested in the risky asset which equates to a 40 percent equity investment out of a $100,000 overall portfolio the remaining 60 percent is put in a
Zero coupon bond on day 1 cpp i at the outset allocates more of the investors cash to a risky asset as compared to a structured product or a bond and call option strategy which allocates the residual cash left over after fees and the cost of a zero coupon bond to a riskier a structured product might be structured as 90% investment in a zero-coupon bond and 10%
In a call option for our example the investor will make an initial investment in the risky asset equal to the multiplier times bond floor and will invest the remainder in this ero coupon bond as the portfolio value changes over time the investor will rebalance timeframes for this rebalancing will vary widely if the equity value grows over time more money can be
Allocated to the risky asset while maintaining the same dollar portfolio floor if the equity value falls over time allocations to the risky asset will drop to maintain the dollar portfolio floor the payoff of cpp i is somewhat similar to that of buying a call option but it does not involve the use of derivatives however it’s worth noting that trading in and out
Of the risky asset depending on its performance does bears a striking resemblance to dynamic hedging strategies if you don’t understand that concept you should watch my videos on dynamic hedging which i have linked to above so that’s it on cpp i if you found the video helpful make sure you hit the like and subscribe buttons tune in next week when we’ll learn about
Structured product fees and where structured products can go wrong see you then bye you
Transcribed from video
What are Structured Products? (Part 2) CPPI Constant Proportion Portfolio Insurance By Patrick Boyle
