Structured Products and Packaged Investments
Domain 6 - Structured Products and Packaged Investments
This domain tests products that wrap another asset in a legal structure, and whether the representative can explain payoff, fees, liquidity, and the layer of regulation that applies.
The main categories
- Structured notes are unsecured debt of the issuer with an embedded derivative: principal-protected notes, reverse convertibles, buffered and leveraged notes. "Principal protection" applies only at maturity and only if the issuer remains solvent.
- Exchange-traded funds are registered under the Investment Company Act and trade intraday; they may trade at a premium or discount to NAV. Exchange-traded notes are unsecured debt with issuer credit risk.
- Unit investment trusts hold a fixed portfolio, have a set termination date, and are sold at a public offering price that includes the sales charge.
- Closed-end funds issue a fixed number of shares, often use leverage, and frequently trade below NAV.
- Variable annuities invest through separate accounts, add mortality and expense charges and surrender schedules, and can be exchanged under Section 1035 without current tax.
- FINRA treats complex products - leveraged and inverse funds, structured notes, non-traded REITs - as requiring enhanced suitability review and clearer disclosure.
Worked example
A $1,000 reverse convertible pays 8% annually and delivers shares if the underlying falls below a 75% barrier. If the stock ends at 90% of its starting value, the investor receives par plus the coupon. If it ends at 60%, the investor receives shares worth $600 and loses $400 of principal despite the coupon.
Traps
- Reading "principal protected" as guaranteed regardless of issuer default.
- Overlooking that ETNs have no portfolio assets backing them.
- Ignoring the surrender charge period on a variable annuity when comparing costs.