Like any other investment product, structured products are risky instruments. It is important for the investor to realise the risks of every product.
- Issuer Risk: The issuer risk describes the risk of creditworthiness deterioration or failure of an issuer. Although the cash flows are derived from other sources, Structured Products themselves are legally considered to be the issuing financial institution's liabilities – and therefore the issuer is liable for the repayment. If an issuer’s creditworthiness is decreasing, the risk of him not being able to repay the product is increasing and the invested capital of the investor is at risk. Credit rating changes can therefore influence the secondary market price of structured products issued by the issuer that is being downgraded.
- Market Risk: Like other investment products, structured products are subject to price volatility and can incur substantial losses. The market risk of every product is known and described at issuance. The variety of structured products make them exposed to almost every possible market risk.
- Liquidity Risk: The market maker (issuer) is responsible for pricing. Unfortunately, even now none of the issuers guarantees to provide regulated secondary market, stating in termsheets that they "make their best effort" to do so. It is, therefore, possible that the market maker shows no prices or the bid-ask spread widens if the market toughens. This has happened sporadically during the financial crisis. However, not providing the prices is not in the issuer's best interest. Regulated secondary market is part of the client services and one of the basic conditions for work with issuers at Cat Financial Products. We provided bid prices also during the time of the crisis, although some of the issuers did not show prices for their products at that time
- Interest rate Risk: The interest rate risk describes the risk of a decreasing interest margin caused by market interest rate changes. Since Structured Products often reinvest the interest of bonds and other interest paying instruments for purchasing the needed derivative components for the product, the customer cannot participate in rising interest rates. Additionally, the market interest rates influences the secondary market prices of structured products.
- Maturity: The capital invested in Structured Products is bound and cannot be used otherwise during the maturity of the product. Therefore it’s mandatory to match the maturity of the Structured Product with its intended purpose.