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Principal protection

Many structured notes come with a promise that at maturity investors would at least get their initial investment back. But the credit crisis combined with a dramatic increase in equity market volatility has presented structured note sellers with a number of challenges when it comes to offering principal protection.

Wealthy seek to profit from unstable markets

There are two main ways a structured note seller can engineer a product in order to protect principal. The first is the traditional structured note format of taking the investor’s money, using some of it to buy a zero-coupon bond (which costs less than par and rises in value to par at maturity) and using what is left to buy options to give exposure to whichever asset class the investor is keen on. So a classic structured note, for example, would combine a zero-coupon bond plus a call option on an equity index.

The other method is constant proportion portfolio insurance (CPPI), or variants thereof.

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