Financial Derivatives and Structuring
Termsheets
Definition
A comprehensive document outlining key features, risks, and payoffs associated with a structured product before it
is issued.
Key Components
Underlying Assets: Details about the assets linked to the product (e.g., equities, indices).
Payoff Structure: Explanation of how returns are calculated based on performance metrics (e.g., fixed income,
equity-linked).
Schedule & Settlement Terms: Specifies when payments are due and how they will be executed.
Barrier Details: Explanation of all the barriers present in the product.
It serves as a primary reference for investors, ensuring they understand their investment's structure and risks fully
before committing capital.
Post Trade Life Cycle
Definition
The post-trade life cycle encompasses all processes that occur after a trade is executed, ensuring that the
transaction is completed efficiently and accurately.
Stages:
Confirmation: Verification of trade details (price, quantity, counterparties) between the buyer and seller.
Reduces discrepancies and ensures both parties agree on the terms.
Clearing: The process of calculating net obligations between parties, including the determination of amounts due
for settlement.
Clearing Houses: Entities that facilitate this process to mitigate counterparty risk.
Settlement: The actual exchange of securities for cash. This can occur on a gross or net basis.
Settlement Types: T+1 (Next Day), T+2 (Two Days):
Reconciliation: The process of comparing records from different systems to ensure consistency.
Automated reconciliation systems to enhance accuracy.
Post Trade Life Cycle
Definition
Reporting: Regulatory and internal requirements to report trades to authorities and stakeholders.
Importance: Ensures compliance with various regulations as mandated by government.
PTDC (Post Trade Documentation Control)
Definition
PTDC refers to the process of ensuring that all trade documents are completed, accurate, and aligned with
agreements after the trade has been executed.
Importance:
1. Ensure smooth settlements and compliance.
2. Reduces operational risk by ensuring accurate records are maintained post-trade.
3. Essential for regulatory compliance, particularly under frameworks like EMIR (European Market Infrastructure
Regulation).
Process:
1. Confirmation messages sent via electronic platforms or trade repositories.
2. Discrepancies resolved through communication between counterparties.
3. Final confirmations documented for audit purposes.
Amendment
Definition
The process of changing existing terms in a structured product contract after it has been executed.
Reasons for Amendment:
1. Changes in regulatory requirements necessitating updates to terms.
2. Market volatility affecting the feasibility of original terms.
3. Client requests for modifications based on changing investment strategies.
Process:
1. Agreement between all parties involved in the contract.
2. Documentation of changes in an amendment letter or updated termsheet.
3. Distribution of revised documents to all stakeholders.
Rollovers
Definition
The act of extending the maturity date of a structured product or reinvesting proceeds into a new investment upon
maturity in a similar product.
Key Points:
1. Market conditions at the time of rollover can impact new terms and pricing.
2. Potential changes in risk profile based on new underlying assets or structures
Benefits:
1. Allows investors to maintain exposure to desired asset classes without liquidating positions.
2. Can provide an opportunity to adjust investment strategies based on current market outlooks.
Restate
Definition
The process of revising and reissuing a termsheet due to errors or changes in market conditions affecting the
original document.
Purpose:
1. To correct or clarify inaccuracies or original terms that could mislead investors regarding risks or payoffs.
2. To ensure compliance with evolving regulatory standards and market practices.
Process:
1. Identification of what needs correction (e.g., pricing errors).
2. Communication with stakeholders about changes.
3. Issuing an updated termsheet with clear indications of modifications made.
Mark to Market (MTM)
Definition
An accounting method where assets are valued at their current market price rather than historical cost, reflecting
real-time value fluctuations.
Purpose & Benefits:
1. Structured products often involve derivatives or embedded options, which need regular MTM updates.
2. Provides an accurate representation of an investment's value for financial reporting and risk management
purposes.
3. Helps investors understand potential gains or losses at any given time.
Example:
1. If a structured product was purchased at $100 but its current market value is $90, it would be marked down by
$10 as an unrealized loss on financial statements.
MTM Accounting
Definition
MTM accounting involves updating the book value of structured products based on their fair market value for
reporting purposes
Key Points:
1. Fair Value Estimates: Using market data, pricing models, or proxies for assets.
2. Unrealized Gains/Losses: Changes in MTM lead to recorded gains or losses.
3. Volatile markets can lead to significant fluctuations in MTM values, impacting balance sheets and potentially
triggering margin calls or liquidity issues.
Advantages:
1. Enhances transparency in financial statements by reflecting true asset values.
2. Assists in better risk assessment by providing real-time insights into portfolio performance.
MTM Losses During Crises
Definition
During financial crises (e.g., 2008 Global Financial Crisis), MTM losses can escalate rapidly as asset prices plummet
due to panic selling and reduced liquidity in markets.
Factors:
1. Volatility: Increased price fluctuations impact structured products.
2. Liquidity Crunch: Valuation models may become less reliable due to a lack of market data.
3. Counterparty Risk: Rising credit risk leads to widening spreads and loss in value.
Impact Analysis:
1. Significant declines in asset values lead to increased MTM losses across portfolios containing structured
products tied to volatile assets.
2. Investors may face margin calls if collateral values drop significantly below required thresholds, leading to
forced liquidations at unfavorable prices.
Lombarding (Margin Call)
Definition
The practice of using structured products as collateral against loans or margin accounts during trading activities,
allowing investors to leverage their positions while managing liquidity risks.
Key Points:
1. Margin Calls Occur When Collateral Value Drops Below Required Levels:
• Investors must either deposit additional collateral or liquidate positions to meet margin requirements.
2. Lombarding Process Steps:
• Initial assessment of collateral value against loan amounts.
• Monitoring ongoing valuations; if collateral falls below thresholds, a margin call is issued requiring
immediate action from investors.
3. Importance in Risk Management:
• Helps institutions manage credit exposure while providing clients with flexible financing options against
their investments in structured products.
