Investmentbanking. Structured Products. Basics and Quantitative Analysis

Bachelor Thesis, 2019

30 Pages, Grade: 1.3


Table of Contents

List of Figures

List of Tables

1. Introduction

2. Basic Principles of Certificates
2.1 General Types and Characteristics of Certificates
2.2 Trading of Certificates
2.3 Valuation of Certificates using the Black-Scholes-Model
2.4 Costs of Certificates
2.5 Risks of Certificates and Possibilities to Lower Risk

3. Quantitative Analysis of Selected Types of Certificates
3.1 General Approach for the Presentation and Analysis of the Chosen Certificates
3.2 Guarantee Certificate
3.3 Discount Certificate
3.4 Outperformance Certificate
3.5 Bonus Certificate
3.6 Index Certificate
3.7 Strategic Use of Certificates in Different Market Situations

4. Conclusion

A. Call and Put Payout Profiles
B. Data on the Market Volume of Certificates

List of Figures

Figure 3.1: Payout profile Guarantee Certificate incl. replication portfolio

Figure 3.2: Profit diagram Discount Certificate

Figure 3.3: Payout profile Discount Certificate incl. replication portfolio

Figure 3.4: Payout profile Outperformance Certificate incl. replication portfolio

Figure 3.5: Payout profile Bonus Certificate incl. replication portfolio

Figure 3.6: Payout profile Index Certificate

Figure A.1: Payout profile call long

Figure A.2: Payout profile call short

Figure A.3: Payout profile put long

Figure A.4: Payout profile put short

List of Tables

Table 2.1: Classification of structured products

Table 2.2: Market volume by underlying as of February 2019

Table 2.3: Influences on option prices

Table 2.4: Absolute influence of the Black-Scholes parameter on option prices

Table 3.1: Data for the pricing of the selected certificates with the Black-Scholes Model

Table 3.2: Suitability of certificates depending on market expectations

Table B.1: Market volume of investment products classified by product category

1. Introduction

In times of low or even negative interest rates in the German market, traditional forms of saving and classical bonds are not very attractive. Under such market conditions, wealth creation is almost impossible without participation in the stock market. Financial instruments such as shares and funds, however, only provide the opportunity to benefit from rising stock prices (Mommsen & Walle 2017, p. 6). Certificates, on the other hand, are the right choice for investors who do not only want to profit from rising stock prices but who also aim to achieve positive returns when stock prices are stagnant or even declining (Götte 2009, p. 5). That is one of the reasons why certificates have experienced increasing popularity among private investors over the last years (Götte 2009, p. 13): In February 2019, the certificates market in Germany had a total volume of 72.6 billion euros, which represents an increase of 4.3% since February 2018 (Deutscher Derivate Verband 2019, p. 1)..

Is the key to success not the identification of the best stock, but the identification of stock market trends that can then be exploited with suitable certificates? As it is always the case for financial products, structured products do not offer attractive return opportunities without any risks. Certificates have come under severe criticism for their role in the financial crisis in 2008: Due to Lehmann's default, around 40,000 investors in Germany lost approximately 700 million euros as their certificates became worthless (Götte 2009, p. 19).

Since certificates are mainly sold in Germany, there is rarely any English literature on the basics of certificates. The purpose of this paper is to provide profound knowledge about the possibilities, opportunities, and risks of structured products for international investors since only one who has gained a deep understanding of certificates and their functionalities is able to make successful investment decisions while minimizing risks.

This paper is structured as follows. In a first step, an explanation of the general concept of structured products and their different trade forms is provided. Additionally, the Black- Scholes-Model is presented for the theoretical fair value determination of certificates. The following chapter on risk focuses on approaches to minimize issuer risk, which has caused great criticism of certificates during the financial crisis. For the quantitative analysis, selected certificates are presented in detail in order to show how tailor-made certificates can be used to build capital by exploiting anticipated stock market trends. Finally, the conclusion critically reflects the opportunities achieved by investments in structured products.

2. Basic Principles of Certificates

2.1 General Types and Characteristics of Certificates

The variety of market scenarios has led to a large product range of different certificates. Table 2.1 presents a classified overview of the most common types according to the DDV.

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Table 2.1: Classification of structured products (Deutscher Derivate Verband, 2019, p. 1)

Certificates can be defined as securitized financial instruments which are used to participate in the performance of an underlying (Albrecht & Maurer 2016, p. 47). In other words, certificates are derivatives and thus represent an alternative to direct investments in an underlying security. Whereas the underlying determines the performance of the certificate, the derivative component determines its structural characteristics. The underlying asset can range from traditional security over funds to exchange rates (Rudolph & Schäfer 2010, p. 79). The only requirement for the underlying of a certificate is the possibility to determine its price on a regular basis (Götte 2009, p. 27).

In purely legal terms, certificates are interest-free bearer bonds of the respective issuer (Götte 2009, p. 15). Looking at a transaction between an investor and the issuer, the bond character of certificates is well demonstrated (Röhl & Heussinger 2001, p. 23). The money that the investor pays for the purchase of the certificate can be used by the issuer to economize until a certain amount of money finally has to be repaid at maturity (Röhl & Heussinger 2001, p. 23). The variable repayment amount depends on the performance of the underlying and the construction of the certificate (Götte 2009, p. 16).

In short, certificates are derivatives with a bond component and differ in terms of underlying value, time of maturity and repayment structure (Albrecht & Maurer 2016, p. 48). Consequently, certificates can be classified as structured products as they are composed of various instruments and thus possess new, specifically generated characteristics. Therefore, in order to invest in the best suitable certificate, it is first essential to choose the most appropriate underlying asset of the certificate. Since certificates offer the possibility to profit from all price directions, investors should ideally choose an underlying for which they have a well-founded market expectation. In order to provide a benchmark for the popularity of different underlyings, Table 2.2 presents the market volume by underlying as of February 2019. The newly emerged possibility to invest in an index instead of just individual securities is one other important opportunity of certificates (Röhl & Heussinger 2001, p. 13).

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Table 2.2: Market volume by underlying as of February 2019 (Deutscher Derivate Verband 2019, p. 5)

Based on the market expectation of the investor for the underlying, the next step is to select a corresponding repayment structure for the certificate. A specific payout profile is always achieved by a combination of the underlying and one or more optionl components (Mommsen & Walle, 2017). The quantitative analysis in Chapter 3 focuses on the construction of different payout profiles in order to lead investors to the most suitable certificate.

2.2 Trading of Certificates

The selection of a suitable certificate is not only about choosing an underlying and a payout profile corresponding to individual risk and return preferences. Since profits are always only generated when a certificate is bought or sold, the form of trading and the pricing of certificates are also highly important.

For the purchase of certificates, the investor first needs a custody account with the house bank or a direct broker in order to execute an order in writing, by telephone or online (Mommsen & Walle 2017, p. 10). The custodian bank then executes trading either directly off-exchange via various banks or discount brokers or on an exchange (Mommsen & Walle 2017, p. 11). Both direct trading and exchange trading have their advantages and disadvantages. If one opts for direct trading, there is no brokerage fee and trading is also possible outside of exchange trading hours (Mommsen & Walle 2017, p. 12). In addition, the fact that the price is visible immediately after the conclusion of the transaction and immediate execution takes place speaks in favour of direct trading because an investor knows with certainty whether his transaction has been executed and under what conditions (Götte 2009, p. 50). All the advantages mentioned above are not provided by exchange trading (Mommsen & Walle 2017, p. 12). However, in contrast to direct trading, the latter is possible with any bank or direct broker (Götte 2009, p. 50). Moreover, more favourable prices may be achieved in individual cases, limit orders may be placed and trading is monitored by the exchange (Mommsen & Walle 2017, p. 12). The standard in the German market is that products can be traded both in Frankfurt and Stuttgart on the stock exchange and via direct trading (Löhndorf 2010, p. 20). In order to ensure market liquidity even if there is currently not enough supply or demand for certificates in the market, market makers assume the role of the counterparty and thus almost continuously ensure the tradability of securities (Löhndorf 2010, p. 20).

2.3 Valuation of Certificates using the Black-Scholes-Model

Since certificates are derivatives, their pricing is not based on supply and demand, but on the performance of the relevant underlying (Götte 2009, p. 15). Options, which are part of a certificate, enable the construction of various different payout profiles of certificates (Schaller & Sisani 2015, p. 13). The fair value of a certificate equals the sum of the prices of its single components. Therefore, option pricing can be used in order to theoretically determine the fair value of certificates. In the following, the Nobel prize awarded Black- Scholes-Merton formula is used to determine the prices for European options (Hull 2012, p. 299). The basic idea of the Black-Scholes model is the construction of a risk-free portfolio with the derivative and the underlying stock (Hull 2012, p. 299). In this context, the portfolio is risk-free, as the return for a short period of time is not influenced by the price fluctuations of the share (Hull 2012, p. 299). However, this formula relies on a number of assumptions and, therefore, has to be used with caution (Goldman Sachs 2011, p. 2). The analysis which led to the Black-Scholes model assumes the following: First of all, any derivative which has a non-dividend paying share as its underlying can be priced using this formula (Goldman Sachs 2011, p. 3). Moreover, the price of the underlying follows a geometric Brownian movement (Hull 2012, p. 294). Furthermore, the returns of the underlying stock show a lognormal distribution with constant expected return and volatility (Hull 2012, p. 309). Financial instruments can be traded continuously, and riskless arbitrage is not possible (Hull 2012, p. 309). In addition, efficient markets, the elimination of transaction costs and taxes, the possibility of short selling and the constancy and transparency of interest rates are assumed (Goldman Sachs 2011, p. 3). The Black-Scholes-Merton pricing formulas for European call and put options are:

Abbildung in dieser Leseprobe nicht enthalten

“The function N(x) is the cumulative probability distribution function for a standardized normal distribution. (..) The variables C and P are the European call and European put price, S 0 is the stock price at time zero, K is the strike price, r is the continuously compounded risk- free rate, σ is the stock price volatility, and T is the time of maturity of the option.” (Hull 2012, p. 313f). Due to the limited scope of this thesis, no detailed discussion and no derivation of the option pricing formula are provided. Table 2.3 summarizes the resulting changes in option prices when single parameters of the Black-Scholes-Formula change. Once investors have understood which option components build a certain certificate, this table can be used to evaluate the influence of the four price factors on individual certificates.

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Table 2.3: Influences on option prices (Goldman Sachs 2011, p. 3)

2.4 Costs of Certificates

The Black-Scholes Formula can be used to determine the fair value of certificates since in general, the structure and composition of the certificates determine the costs. However, due to the issuers’ intention to generate profits, issuers do not trade certificates at their fair value, but rather continuously quote bid and ask prices (Hull, 2012). By this process of market making, they ensure liquidity even if no purchase or sale contracts for a certain certificate have been concluded for days (Götte 2009, p. 45). The spread between the bid and ask price means costs for the investor and is particularly taken into account by short-term ones (Löhndorf 2010, p. 23). Annual fees such as exchange rate hedging costs, foregone dividends or management fees, on the other hand, are particularly relevant for medium to long-term investors (Löhndorf 2010, p. 23). If certificates have a limited maturity, the costs are usually included in the issue price instead of being charged annually by the issuer (Löhndorf 2010, p. 24). The amount of the actual cost of a certificate can therefore hardly be estimated by the investor (Götte 2009, p. 55). Since there are more suppliers in the market for longer existing and more standardized certificates with common underlyings, the fees for such products are usually lower than those for more innovative and exotic products, which are more complicated in their composition (Löhndorf 2010, p. 23).

2.5 Risks of Certificates and Possibilities to Lower Risk

Institutional and private actors operating within the financial industry are exposed to a variety of risks. After events like the financial crisis of 2008, which led to serious economic consequences for numerous banks and investors, it is of great importance to be able to adequately assess financial risks. First of all, like other financial products, certificates are exposed to price risks and thus the possibility of loss in the event of unfavourable price developments of the underlying instruments (Mommsen & Walle 2017, p. 8). In addition to price risks, however, investors dealing with certificates are also exposed to counterparty risk and the risks of the options which the certificate consists of.

Since certificates have the character of bonds, the total default may occur in the event of the issuer's insolvency (Mommsen & Walle 2017, p. 8). For this reason, the insolvency of Lehman Brothers during the financial crisis in 2008 caused serious damage to the image of certificates. Therefore, it is essential for investors to evaluate the creditworthiness of the considered issuers. Well-known agencies such as Standard & Poor's, Moody's or Fitch provide information about the creditworthiness of the issuer by giving ratings on a scale from AAA at best to D at worst (Löhndorf 2010, p. 22). Due to a possible delay in the adjustment of these ratings, investors are recommended to also consider other key figures such as the credit default swaps spread or specific balance sheet figures (Löhndorf 2010, p. 22).

A CDS is a derivative that is used to trade the default risks of loans (Hull 2012, p. 548). If there is a high issuer risk, a significant CDS spread is required, whereas a low CDS spread indicates a good credit rating (Mommsen & Walle 2017, p. 9). The core capital ratio reflects the proportion of risk positions in the balance sheet covered by own capital (Löhndorf 2010, p. 22). Consequently, a higher core capital ratio implies a lower default risk (Löhndorf 2010, p. 22).

Moreover, since certificates consist of one or more option components, holders of certificates also need to consider the risks resulting from the sensitivities influencing the value of the options (Hull 2012, p. 377). These sensitivities are measured by the “Greek letters”, which show how changes in the parameters of the previously introduced Black- Scholes-Formula affect option prices (Hull 2012, p. 377). In more concrete terms, the Greeks are obtained by partially deriving the option price according to the respective model parameters (Hull 2012, p. 380ff). Thus, the Greeks facilitate the analysis of the influence of particular risk factors. In order to hedge the individual risks of certificates, the single Greek letters can be hedged by an investor. Since the sensitivity analysis of option prices is not the focus of this thesis, the role of the Greeks for risk management is not further elaborated at this point. Table 2.4 presents an overview of the absolute influence of the Black-Scholes parameters on option prices.


1 Options entitle, but not oblige, the investor to buy or sell the underlying at a specific price at or before a specific date (Hull 2012, p. 7).

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Investmentbanking. Structured Products. Basics and Quantitative Analysis
University of Mannheim
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investmentbanking, structured, products, basics, quantitative, analysis
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Sabrina Breunig (Author), 2019, Investmentbanking. Structured Products. Basics and Quantitative Analysis, Munich, GRIN Verlag,


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