What Is an Embedded Derivative?

Financial forward contracts, financial futures, financial options, and financial swaps are four common financial derivatives that are also commonly referred to as "building block tools". They are the simplest and most basic financial derivatives, and use their structure Characteristics, through combination with each other or with basic financial instruments, can develop and design more financial derivative products with complex characteristics. The latter is often called structured financial derivative products.

Structured financial derivatives

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structural derivative financial products

Currently, the most popular structured financial derivatives are various types of structured products developed by commercial banks.

Structured products are an important development direction for the wealth management business of banks and securities companies. With the large number of foreign banks entering the domestic market, the issuance of domestic structured products has also grown rapidly. At present, structured products are mainly targeted at foreign currencies, and issuers use overseas investment tools. The advantages of multiple, perfect risk hedging mechanisms, the introduction of a variety of structured products, has been favored by the market. In terms of product structure, principal-protected products are mainly sold to investors. In addition to the traditional interest rate and exchange rate, the underlying index is also a stock index. In the past, the RMB wealth management business of domestic banks had a narrow investment range, mainly bonds, central bank bills, deposits, etc., with low yields, and was not attractive to investors. Recently, domestic banks have gradually adopted the design model of structured products in foreign currencies for RMB wealth management. Various banks have launched a number of RMB wealth management services. For example, the RMB wealth management A plan recently launched by China Everbright Bank includes products linked to crude oil futures.

Structured products have broad development prospects in China. As of the end of February 2006, there were a total of RMB 15.12 trillion in household savings deposits in China, with a deposit balance of approximately RMB 9 trillion. The outstanding problem in the financial market is that there are too few investment types available for residents, the size of the direct financing market is small, and the circulating market value of the stock market is only about 1.16 trillion yuan. Although the residential savings deposit interest rate is very low, there is no better choice. In the case, they can only choose to deposit. If it is assumed that most investors in the market are risk-averse, then the more risky the investment products, the smaller the market demand. Structured products can construct multiple types of investment products with risks between stocks and time deposits. Its market size should theoretically be larger than the stock market and smaller than the balance of bank deposits, which means that the potential size of this market will be between 1.16 trillion and 15.12 trillion yuan. From the booming sales of structured foreign currency products in China, we can see that there is considerable demand for structured products in China.

China should accelerate the pace of development of structured products. The development of structured products can first increase the variety of investment, activate the market, broaden the investment channels of domestic residents, and alleviate the problem of residents' excessive investment in bank deposits. Second, they can expand the business scope of securities companies and banks and strengthen competition between banks and securities companies. Ability and profitability; thirdly, it can familiarize domestic investors with various financial innovation products, and lay the foundation for the extensive development of derivative products business in China.

However, structured products are still relatively unfamiliar to most people in China. Relevant domestic institutions still have a low level of awareness of the product, and lack of research on the design principles, pricing methods and risk hedging of structured products. In the face of competition from foreign banks, it is necessary for domestic securities firms, banks and other relevant financial institutions to strengthen their research and practical operations on structured products. When the structured products of domestic banks are developing rapidly, the competent authorities should actively guide innovative securities companies to pilot the issuance of structured products, expand the participation base of the securities market, and meet the needs of investors in more aspects. For the stock exchange, it can learn from the Hong Kong Stock Exchange's stock-linked notes and launch some listed and traded structured products.