In this chapter, we describe certain exotic or structured notes that have been introduced into the fixed-income market. The motivations behind the development and use of these products are varied, but include the desire for increased yield without additional credit risk, as well as the need to alter, transform, or transfer risk exposure and risk-return profiles. Certain structured notes were also developed as hedging instruments. The instruments themselves have been issued by banks, corporate institutions, and sovereign authorities. By using certain types of notes, investors can gain access to different markets, sometimes synthetically, that were previously not available to them. For instance, by purchasing a structured note an investor can take a position that reflects her views on a particular exchange rate and anticipated changes in yield curve but in a different market. The investment instrument can be tailored to suit the investor’s particular risk profile.
Note that this is only the tip of the iceberg, and many different types of bonds and structured notes are available. Indeed, if any particular investor or issuer requirement has not been met, it is often a relatively straightforward process whereby an investment bank will structure a note that meets specific requirements.
Floating-rate notes (FRNs) are not structured notes as such. However, we describe them here as a prelude to a discussion ...