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What are Structured Derivatives?

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  • Written By: Dana DeCecco
  • Edited By: A. Joseph
  • Last Modified Date: 26 November 2016
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Investing in structured derivatives provides the investor a means to participate in the performance of various underlying asset classes. Equities, commodities and indices are a few of the asset classes that can be considered underlying assets. Structured derivatives are financial contracts assembled to create a specific investment strategy. All structured derivatives are not available in all countries. Over-the-counter (OTC) derivatives are unregulated and not available in countries that require regulation.

Structured derivatives are normally prepackaged investments. The profit or loss on these investments is specifically tied to the performance of underlying assets. Investment banks and their affiliates package these derivatives for clients and charge fees for this service.

Structured products are very similar to options and might include types of options. The risk involved is similar to option trading. The investor who trades structured derivatives should be approved for option trading. These products are extremely complex and lack the liquidity to be considered a tradable product. The complexity of the product makes it difficult to predict the performance relative to simple ownership of the underlying assets or the trading of plain options on the assets.

The underlying theory of structured derivatives is the transfer of risk from the unwilling to the willing investor. This objective might be accomplished by the investment bank for a fee. The fees charged might affect the performance of the investment. These investments might incorporate certain tax advantages, enhanced returns and reduced volatility, depending on the type of structure.

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The term used for the creation of these products is "financial engineering." It is simply a combination of spot, option, futures or other financial positions. The goal of any financial position is to mitigate risk while providing an opportunity for profit. Structured derivatives are the complicated way to accomplish this goal. The savvy investor could actually construct an investment product to meet the necessary requirements.

Securitized derivatives are a form of structured derivatives. These are basically pooled receivables of contractual debt. Examples of this are mortgage-backed securities and asset-backed securities such as car loans. Investment banks package these individual assets into a form referred to as collateralized debt obligation.

National and international derivative associations have been organized in an effort to create standardized contracts and legal policies. These associations are located in many countries around the world. A wide array of rules and regulations have been scrutinized in an effort to improve and enhance derivatives markets.

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