The price of structured notes is constantly fluctuating
Pricing for structured notes can be a confusing and challenging concept for many people to understand. However, certain factors influence its valuation and determine its market price.
This article will explore three key things you need to know to understand how structured note pricing works.
What are structured notes?
First, it is essential to know what structured notes are, which under certain criterial could be considered similar to ETPs.
In simple words, they are hybrid financial instruments that combine characteristics of fixed-income and variable-income products to adjust to different investor profiles and offer higher returns than conventional ones.
According to the United States Securities and Exchange Commission (SEC), structured notes issued by financial institutions, and subsequently marketed by intermediaries are structured as securities with a fixed term, generally of at least one year.
Factors that influence the price
Since each structured note is dependent on an underlying asset or series of assets, there are a few factors that will impact its price:
Type of underlying asset
The price of a structured note will be influenced mainly by the type of underlying asset. A note linked to a US Treasury bond is not the same as one linked to the behavior of a stock index or the evolution of a specific real estate asset.
If the underlying asset is very volatile, that is, its price can fluctuate violently in short periods, then its corresponding structured note will behave in the same way. On the other hand, if the asset is stable, its price will also remain without sudden changes.
Fortunately, the family of ETPs is generally very versatile since it allows different underlying assets to be combined according to the investor’s needs and objectives, generating an adequate risk-return ratio.
In turn, the underlying assets, and therefore their related structured notes, will change in price depending on the macroeconomic context, where variables such as economic growth and central bank monetary policies, among others, come into play.
In times of expansion, interest rates remain reasonable, companies successfully sell their products and services, hire people, and the financial system thrives. As a result, for example, shares appreciate.
However, when the situation is unfavorable, the economy is not growing, or there is a recession, inflation is starting to get out of control, and interest rates must rise fiercely to contain it, equities are punished, giving way to bonds.
In the case of raw materials, climatic factors also play a leading role since rains, droughts, and other weather conditions will boost supply or demand, impacting their linked note.
Finally, it is essential to consider that generally, the economy and financial assets behave similarly in the long term, but in the short term, there may be discrepancies.
The reason is the “market sentiment,” which is nothing more than the sum of the fears and expectations of each investor.
As recounted in The Economic Times, “high expectations that are already reflected in stock prices before they have any effect on the economy are another factor that can cause a discrepancy in the markets and economy. As a result, when the overall economy grows, the markets don’t soar because stock prices already consider investor sentiment.”
Over time, the economy and markets tend to follow the same general direction (bullish, bearish, or lateral trends). Still, the markets tend to overreact to news and political reports that may have nothing to do with the macroeconomic fundamentals of a country.
Due to these three factors, the prices of structured notes or ETPs can fluctuate constantly, and those in charge of developing the notes must consider said prices when putting together strategies.