Yakob Peterseil of Risk.net recently noted that "[b]anks are boosting issuance of leveraged notes linked to US equity indexes and notes that pay out when yield curves steepen." According to the article, reverse convertibles and buffered notes are seeing a resurgence as investors begin to be more optimistic about stock market growth. In addition, principal-protected structures like structured certificates of deposit and principal-protected notesare falling out of favor as attractive terms are hard to come by and investors continue to hunt for yield.
The important thing investors need to remember is thateven if they're generally optimistic about the future growth of the stock market this growth expectation is already priced into the structure of the product: a reverse convertible might offer a slightly lower coupon rate or a buffered note might have a more stringent cap. In the end, structured products are high-cost/high-risk debt securities that amount to a complex combination of derivatives and corporate bonds.
An interesting case study of the risk embedded in reverse convertibles is contained in the notes linked to Apple common stock (AAPL). Yakob mentions that "[w]hen Apple at one point lost more than 20% of its value, the notes converted into Apple shares at depressed prices - to the surprise of some investors." We've discussed exactly this point when we wrote a paper discussing the decline in market value of Apple-linked structured products earlier this year (see also the updated blog post).
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