Inflation is the driving force for China’s Structured Product market

My wife and I recently visited Shanghai.  Walking through IFC Shanghai we can’t help but noticed that the prices has gone up dramatically when we were there not too long ago.

Inflation is one of the biggest problems people in China are facing, and with interest rate still relatively low, the need to fight off such high inflation is the driving China’s structured products market.

Structured deposits that linked to commodities, interest rates, exchanges, equity, with principal protection features are being promoted by banks and wealth managers as a weapon against high inflation. 

Commodities-linked products are especially popular.  According to “China Investment Online”, an online financial publication, eight banks have issued 26 different types of commodity-linked financial products in 2011. 

But experts are now cautioning investors that although these structured deposits may provide anti-inflationary effect, they must be clear as to the terms and conditions that come with these products, especially when such investments might lock their money in for a while. 

Of the 26 products, only two allow the investor to redeem their investment payoffs each month, and that’s after a three month holding period.

http://www.927953.com/cn/bulletins/bulletinlist_d.aspx?id=336&pid=19&nid=20328

Structured Products Valuation a Challenge for Regional Banks

Recently I've completed a partnership between a large regional bank in Hong Kong and my company, SuperDerivatives (SD), where we will be providng them with a system that can perform on-demand mark-to-market valuation of their structured products portfolio.


And from my experience working with regional banks, I've found that most are still very much relying on periodic counterparty valuation for their structured products mark-to-market.  This is a serious problem.


Given recent market volatility, relying on counterparty for periodic mark-to-market valuation can have a major impact on credit risk management and CVA analysis.  But unlike investment banks who spend tens of millions in systems, modelling and market data, regional banks do not process the resources, the technology, or the expertise needed to properly value their structured products portfolio, and this is a big challenge to many market risk managers in these banks.


Some would argue that the majority of them are conducting back-to-back trades so they're not really taking on that much risk and the volume is a fraction compared to that of an investment bank.


While it is true that by doing deals back-to-back, the market risks of these structured products trade are nullified, the counterparty credit risks or collateral risks still have to be properly maintained.  And when it come to risk management, the volume of deals is irelvant.  A proper risk management due diligence should be consistent regardless of volume or types.


Risk managers, managing various risks of the bank in today economic environment is like navigating a tank on an unstable mine field.  Banks that are still relying on counterparty valuation for mark-to-market should start seriously consider strengthening their procedures and systems, in case one accidently detonates.

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Ratio Par Forward (Participating Forward)

A Ratio Par Forward (aka Participating Forward) is a vanilla strategy. It is a synthetic forward where the call and put have the same strike and expiry date but different notionals.

Why buy a Ratio Par Forward?
Unlike a regular synthetic forward which guarantees an exchange rate on the expiry date, the different notionals in the call and put in the participating forward let you benefit from a favorable spot move, while insuring you are fully hedged in the event of an adverse spot move.

Because of the difference in notional, a Ratio Par Forward allows the customer get a better forward rate than they would normally get in a normal synthetic forward situation.  It can also be structured into a zero cost strategy where the buyer don't need to pay any premium up front.

A single Ratio Par Forward trade may have a single leg of two option, or it can be stripped into multiple legs with each legs expirying at different tenor. 

Example of a ratio par forward
A hedger needs to buy EUR 10 mio one year from now. The outright forward rate is 1.2000. He buys a participating forward with a strike of 1.21, made up of a buying a EUR call and selling a EUR put. However, the EUR call has a notional of 15 mio (i.e., 5 mio more than the EUR put).
If the EUR rises to say 1.31 the client can buy 10 mio at 1.21 and also benefit from the gain made of 10 bp on 5 mio on the excess EUR Call. His average cost of buying EUR overall will therefore be lower.

Pricing a Ratio Par Forward with SuperDerivatives SDX:

A participating forward (ppf) can be entered automatically in the Single Option page.

Ratio Par Forward a.k.a Participating Forward

The Premium (Market Value) of an in the money USDCNY ratio par forward

A portfolio of USDCNY ratio par forward, stripped for 1 year duration

A Ratio Par Forward is an extremely popular structured product which many regional banks offering it to both their corporate clients as well as their retail clients.

Register for your trial account and try pricing this for yourself: https://www.superderivatives.com/registration.aspx