As opposed to regular bonds, where the interest is fixed when they are issued, the interest on structured bonds is dependent on an external financial variable. This variable can be a stock index, an exchange rate, or just about anything else.
The relationship between the financial variable and the interest rate is declared when the bond is issued.
Below are a few examples of structured bond series.
Example 1
A Structured Bond Series with Variable Interest According to the Dollar-Euro Exchange Rate
Bond Information
- Total Issue: 1 Billion Dollars.
- Face Value of Every Bond: $100,000.
- Time to Maturity: 5 Years.
- Interest Rate:
- 6% annual interest, for every day that the euro is worth more than 1.1 dollars.
- 1% annually, for every day the euro is worth less.
Structured bonds, such as the one in the example above, with two possible interest rates are called Range Notes.
Why Buy This Bond?
Let’s assume that on the date this bond series was issued, the euro was trading at $1.08 and the available interest rate on 5-year dollar deposits was 2%. An investor that expects the Euro to get stronger would buy one of these bonds. If his predictions are fulfilled, he will make a 6% interest rate rather then the 2% he would have settled for by leaving the money in the bank. Also, even if he was wrong, his loss is limited to only 1%.
Example 2
A Structured Bond Series with Variable Interest According to the LIBOR
The LIBOR rate is an accepted base rate for loans across the world. A detailed explanation of the LIBOR rate appears at the continuation.
Bond Information
- Total Issue: 200 Million Dollars.
- Face Value of Every Bond: $500,000.
- Time to Maturity: 10 Years.
- Interest Rate:
The interest rate is adjusted every six months according to the following formula:
Interest = 14% – The LIBOR Rate
Below are a few examples of thr bond’s interest rate according to the LIBOR rate.
| LIBOR Rate | Bond Rate | |
| 1 | 10% | 4% |
| 2 | 7% | 7% |
| 3 | 4% | 10% |
The bond’s interest rate changes inversely to the LIBOR rate. In other words, it goes up when the LIBOR goes down, and goes down when the LIBOR goes up. Structured bonds, which carry an interest that moves inversely to any financial factor, are called: Inverse Floaters.
Why Buy This Bond?
Let’s assume that when the bond is issued, the LIBOR rate is 7% and the best rate available for a ten-year bank deposit is 6%. An investor who thinks that the LIBOR will go down will buy a bond like this. If the LIBOR doesn’t change, he will earn interest at 7%: 14% – 7%. However, if the LIBOR rate does fall, then the he will make even more money. In either case, the investor will receive a higher interest rate than what he could have gotten from the bank. Only if the LIBOR were to rise would the investor be hurt.
Differences between Structured Deposits and Structured Bonds
- As opposed to structured deposits, structured bonds are tradable, and can be sold at any time.
- On structured deposits, the bank that holds the deposit guarantees the principle, while it is the bond issuer that takes responsibility for structured bonds.
- Structured deposits are usually aimed at private investors, and they therefore have low minimal deposits. Conversely, structured bonds are generally geared toward institutional investors, and their par value can reach one hundred or even five hundred thousand dollars.
