MathFinance: Structured Products in Wealth Management

Structured Products Examples
Structured Products Litigation in FX/IR Markets
Summary
Structured Products in Wealth Management
Uwe Wystup, MathFinance AG
uwe.wystup@mathﬁnance.com
Frankfurt, 22 August 2017
uwe.wystup@mathﬁnance.com Structured Products in Wealth Management c by MathFinance AG 1 / 37

Summary
Hands-on FX
How to Structure Products?
Performance Linked Investment (PLI)
Dual Currency Investment (DCI)
Hands-on FX

Summary
Hands-on FX
Hands-on FX
The Cable

Summary
Hands-on FX
Hands-on FX
The Cable in Porthcurno

Summary
Hands-on FX
1 Coupon lower than market plus participation, e.g. long an option

Summary
Hands-on FX
2 Coupon higher than market by selling an option

Summary
Hands-on FX
3 Zero-cost structures on a margined account

Summary
Hands-on FX
3 Zero-cost structures on a margined account
4 re-iterated carry trades

Summary
Hands-on FX
Participation with p% in an underlying market using coupon p · max[ST −S0,0]
S0
Notional 5,000,000 GBP
Number of days 91
Money market reference rate 4.00% p.a. act/365
EUR-GBP spot reference S0 0.7000
Minimum rate 2.00% p.a. act/365
Additional coupon 30% · 100 max[ST −0.7000,0]
0.7000
p.a. act/365
ST EUR-GBP ﬁxing on 31 August 2005

Summary
Hands-on FX
Performance Linked Investment (PLI) - Composition
From the money market we get 49,863.01 GBP.

Summary
Hands-on FX
The investor takes a position equivalent to buying a EUR call GBP put
with strike 0.7000 and with notional 1.5 M GBP.

Summary
Hands-on FX
The oﬀer price of the call is 20,815.24 GBP, assuming an oﬀer volatility of
6.0% and a EUR money market rate of 2.50%.

Summary
Hands-on FX
The investor receives a minimum payment of 24,931.51 GBP.

Summary
Hands-on FX
The investor receives a minimum payment of 24,931.51 GBP.
Subtracting the oﬀer price and the minimum payment from the money
market leaves a sales margin of 4,116.27 GBP (as of the delivery date).

Summary
Hands-on FX
Performance Linked Investment (PLI) - Pros and Cons
+ Possible higher yield than market
+ Liquid product, whence sales margins are comparatively small
+ Capital is guaranteed, possibly partially guaranteed
+ Worst case coupon and return are known up-front

Summary
Hands-on FX
Performance Linked Investment (PLI) - Pros and Cons
+ Possible higher yield than market
+ Liquid product, whence sales margins are comparatively small
+ Capital is guaranteed, possibly partially guaranteed
+ Worst case coupon and return are known up-front
- Possible lower coupon than market
- Investor has to pay tax on the best case coupon, but cannot tax-deduct
the risk on receiving the worst case coupon
- Participation formulas can often appear misleading to investors
- Construction does not work if the money market interest rate of the
investment currency is already low

Summary
Hands-on FX
Invest 5 M EUR for 1 month
Market rate is 3.00 % = 12,500 EUR interest payment
DCI coupon is 5.00% = 20,833 EUR (guaranteed)

Summary
Hands-on FX
Investor’s risk: At a EUR-CHF spot reference of 1.4662 she chooses a
pre-agreed conversion rate of 1.4700.

Summary
Hands-on FX
If at maturity the spot stays below 1.4700 (strong CHF), then the investor
is paid back the full notional in EUR.
Conversely, if the spot at maturity is above 1.4700 (weak CHF), then the
notional is converted into CHF 7.35 M.

Summary
Hands-on FX
Investor always receives the weaker currency.

Summary
Hands-on FX
Investor always receives the weaker currency.
Worst case?

Summary
Hands-on FX
Dual Currency Deposit
-450000
-400000
-350000
-300000
-250000
-200000
-150000
-100000
-50000
0
1.30
1.32
1.35
1.37
1.39
1.41
1.44
1.46
1.48
1.50
1.53
1.55
1.57
1.59
1.61
spot at maturity
interestpaid
Comparing the market interest rate (dotted line) with the enhanced interest
rate of a dual currency deposit.

Summary
Hands-on FX
Dual Currency Investment (DCI) - Composition
The investor deposits 5 M EUR for 1 month

Summary
Hands-on FX
The investor sells a EUR call CHF put with strike at the pre-agreed
conversion rate 1.4700

Summary
Hands-on FX
Spot reference 1.4662

Summary
Hands-on FX
Premium: 11,631 EUR (deferred to end of the deposit)

Summary
Hands-on FX
This yields 12,500 EUR + 11,631 EUR = 24,131 EUR

Summary
Hands-on FX
The bank pays only 20, 833 EUR

Summary
Hands-on FX
The bank pays only 20, 833 EUR
→ Margin: 3,298 EUR

Summary
Claim involving a Structured Interest Rate Products
Claim with FX Exotics and Structured Products
Claim with FX Ratio Spreads
Claim with FX Target Forwards
FX-Linked Swaps in City-Treasury Departments and Family Oﬃces
FX CFDs on Brokerage Platforms
Structured Products Litigation Topics
1 Price too high - even in a zero-cost strategy
2 Poor or missing risk advisory
3 Forced close-out of portfolios traded on margined accounts
4 Product authorization (ISDA)
5 Violation of regulation or code of conduct
6 Patents

Summary
Commercial Court vs Arbitration
Figure: Commercial Court London: public/press/appeal/typically single judge

Summary
Commercial Court vs Arbitration
Figure: Singapore International Arbitration Centre (SIAC):
closed-doors/no-appeal/tribunal

Summary
Example: Ille Paper sues Deutsche Bank
Ladder swap (bet on diﬀerence of long and short term interest rates)

Summary
Ille claims losses after losing money during the life time of the swap.

Summary
Deutsche lost and pays repercussions of EUR 541,074 plus interest.

Summary
Reasons include:
The defendant structured the swap intentionally with a negative
market value at inception of EUR 80,000 (400bp).
German Federal Court, Judgment 22 March 2011 (XI/ZR 33710), paras 35-39.

Summary
Reasons include:
The defendant structured the swap intentionally with a negative
market value at inception of EUR 80,000 (400bp).
German Federal Court, Judgment 22 March 2011 (XI/ZR 33710), paras 35-39.
Comment: any zero-cost product must have a negative market value at
time zero.

Summary
Example: Indonesian Billionaire sues US Investment Bank
Figure: Portfolio of ≈ 100 highly leveraged structured products/exotics in EQ/FX -
Forced close-out - Claimant seeks USD 80M compensation because of wrong advise.

Summary
Figure: Portfolio of ≈ 100 highly leveraged structured products/exotics in EQ/FX -
Forced close-out - Claimant seeks USD 80M compensation because of wrong advise.
“Personally I think this is a terrible trade and someone has ripped oﬀ
the customer’s face.”

Summary
Example : Indonesian Billionaire sues US Investment Bank
Figure: MathFinance developed its own VaR-based threshold model to predict margin
calls.

Summary
Example : Indonesian Billionaire sues US Investment Bank
Figure: MathFinance developed its own VaR-based threshold model to predict margin
calls.
Margin calls were not issued - “Let’s not oﬀend the billionaire client”

Summary
Figure: Account balance rising because MTM losses are not crystallized.

Summary
Worst case outcome for Claimant: No compensation and paying all
expenses

Summary
Worst case outcome for Claimant: No compensation and paying all
expenses
Reasons: unknown

Summary
Example: Turkish Trader sues Standard Chartered
Figure: Bet on rising and sharp landing of USD-TRY in 2008 using a ratio call spread
on a margined account

Summary
Figure: Bet on rising and sharp landing of USD-TRY in 2008 using a ratio call spread
on a margined account
Gamma/Vega exposure with rising spot underestimated =⇒ high VaR
Repeated margin calls not met
=⇒ position is force-closeduwe.wystup@mathﬁnance.com Structured Products in Wealth Management c by MathFinance AG 17 / 37

Summary
Figure: Smile eﬀect

Summary
Figure: Smile eﬀect
Claimant being an experienced SuperDerivatives
user alleged never have heard of smile

Summary
Claimant’s dodgy expert calculated loss amount by constructing a “zero
gamma - long theta” portfolio

Summary
Change of value of the option book V :
V (S + δS, t + δt) = V (S, t) + ∆ δS + 1
2
Γ δS2
+ Θ δt + o(δt, δS2
)

Summary
V (S + δS, t + δt) = V (S, t) + ∆ δS + 1
2
Γ δS2
)
Change of delta-hedged option portfolio P(S, t) := V (S, t) + h S
P(S + δS, t + δt) = P(S, t) + (h + ∆)δS + 1
2
Γ δS2
).

Summary
V (S + δS, t + δt) = V (S, t) + ∆ δS + 1
2
Γ δS2
)
P(S + δS, t + δt) = P(S, t) + (h + ∆)δS + 1
2
Γ δS2
).
P&L at time t + δt
P(S + δS, t + δt) − P(S, t)
=(ht + ∆)δS + 1
2
Γ δS2
)
(1)

Summary
V (S + δS, t + δt) = V (S, t) + ∆ δS + 1
2
Γ δS2
)
P(S + δS, t + δt) = P(S, t) + (h + ∆)δS + 1
2
Γ δS2
).
P&L at time t + δt
P(S + δS, t + δt) − P(S, t)
=(ht + ∆)δS + 1
2
Γ δS2
)
(1)
Standard delta hedge ht := −∆ yields
P&L at time (t + δt) = 1
2
Γ δS2
)

Summary
Using the dodgy expert’s “average hedge”
ht = −
∆t+δt + ∆t
2
= −
V (S + δS, t + δt) + V (S, t)
2

Summary
ht = −
∆t+δt + ∆t
2
= −
V (S + δS, t + δt) + V (S, t)
2
and Equation (1) we obtain the P&L at time t + δt
δS
−V (S + δS, t + δt) − V (S, t) + 2∆
2
+ 1
2
δS2
Γ + Θ δt + o(δt, δS2
),
= − δS
V (S + δS, t + δt) − V (S, t)
2
+ 1
2
δS2
),
= − δS 1
2
V (S, t)δS + 1
2
δS2
),
=Θ δt + o(δt, δS2
).

Summary
ht = −
∆t+δt + ∆t
2
= −
V (S + δS, t + δt) + V (S, t)
2
and Equation (1) we obtain the P&L at time t + δt
δS
−V (S + δS, t + δt) − V (S, t) + 2∆
2
+ 1
2
δS2
),
= − δS
V (S + δS, t + δt) − V (S, t)
2
+ 1
2
δS2
),
= − δS 1
2
V (S, t)δS + 1
2
δS2
),
=Θ δt + o(δt, δS2
).
Dodgy expert introduces a systematic error in the P&L by artiﬁcially
removing the entire gamma risk.
Claim was based on artiﬁcially generated money.
Commercial Court London Case No. 2009 Folio 1204

Summary
Example: Alexander Vik sues Deutsche Bank

Summary
Largest structured products claim ever: USD 8 Billion

Summary
How does an FX target forward ﬁt into ISDA?

Summary
Option or Forward?

Summary
Option or Forward?
or neither of them?
Commercial Court London Case No. 2009 Folio 83

Summary
FX Target Forwards
Investor sells EUR 5 big figures above current spot every day for one year.
Terminates as soon as 30 big figures of profit have accumulated.
Zero cost strategy.

Summary
FX Target Forwards
Zero cost strategy.
1 Client type Treasurer vs. HNWI

Summary
FX Target Forwards
Zero cost strategy.
2 Other names: Target Proﬁt Forward, Target Redemption Forward, Flip
Flop, Potential Disaster Forward...

Summary
FX Target Forwards
Zero cost strategy.
2 Other names: Target Proﬁt Forward, Target Redemption Forward, Flip
Flop, Potential Disaster Forward...
3 Variations: Knock-in-knock-out, leverage, pivot, counter

Summary
Bloomberg Screen Shot: Target Redemption Forward (TARF)

Summary
Bloomberg Screen Shot: OVML Pivot Target Forward

Summary
Pivot Target Forward P&L Scenarios
Figure: P&L Scenarios Pivot Target Forward

Summary
Pivot Target Forward Payoﬀ and Psychology
Figure: Pivot Target Forward Payoﬀ and Psychology

Summary
Currency Related Swap
6M-EURIBOR + spread
−→
bank semiannual payments treasurer
←−
6M-EURIBOR +
(Strike−EUR-CHF-Fixing)
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
Notional EUR 5M, 10Y swap

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
Strike 1.4350, spot 1.5960 on 5 Sept 2008, spread 2.09%

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
Trades at zero premium, with initial MTM ≈ EUR −280, 000 < 0, which
includes the sales margin of the bank;

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
The bank’s hedge is short EUR put CHF call options strip;

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
Vanilla if interest rate is in EUR;

Summary
6M-EURIBOR + spread
−→
←−
6M-EURIBOR +
+
EUR-CHF-Fixing
× 100%
EUR
or
CHF
Vanilla if interest rate is in EUR;
Self-quanto vanilla if interest rate is in CHF.

Summary
Example: City of Linz ./. BAWAG
In February 2007 Linz trades the 10Y CHF Swap 4175 containing a short
sale of 20 self-quanto EUR-Put-CHF-Call options

Summary
Is this currency related swap (CRS) a common “optimization” strategy?

Summary
Were price and risk advisory appropriate?

Summary
Were price and risk advisory appropriate?
Uwe Wystup and Thorsten Schmidt act as expert
advisers to Commercial court Vienna 48 Cg 218/11k - 308

Summary
EUR-CHF Carry Trades lead to the Linz-problem for many
treasurers/investors.

Summary
EUR-CHF Carry Trades lead to the Linz-problem for many
treasurers/investors.
CHF-loans done for the purpose of reducing
interest rate payments require active position management.

Summary
Example: FX CFDs on Brokerage Platforms
1 Contract For the Diﬀerence (CFD) - Futures contract for retail investors

Summary
2 Liquid underlyings such as FX, metals, commodities, major stock indices,
single stocks

Summary
single stocks
3 Initial margin (1 hour 6-sigma-event) can be as low as 0.25% of the
notional if e.g. EUR-CHF volatility is as low as 3%.

Summary
single stocks
4 Long EUR 1M requires EUR 2,500 margin and a drop in spot from 1.2100
to 0.9680 causes a loss of EUR 250,000.

Summary
single stocks
4 Long EUR 1M requires EUR 2,500 margin and a drop in spot from 1.2100
to 0.9680 causes a loss of EUR 250,000.
5 What happened to the stop loss order at 1.2000?

Summary
Solution to all Problems
Our Services for Banks
Our Services in Expert Reports and Conﬂict Resolution
Resources

Summary
Resources
FX Options
Structured
Products
and
SecondEdition
UWE WYSTUP

Summary
Resources
FX Options
Structured
Products
and
SecondEdition
UWE WYSTUP
Education

Summary
Resources
FX Options
Structured
Products
and
SecondEdition
UWE WYSTUP
Education Education

Summary
Resources
FX Options
Structured
Products
and
SecondEdition
UWE WYSTUP
Education Education Education

Summary
Resources
Our services:
Structured products business development
Independent valuation
Pricing libraries
Vetting of front-oﬃce models and systems
Model validation
Management consulting
Training of staﬀ
Seminars for clients

Summary
Resources
Expert Reports and Conflict Resolution
Our services:
Pool of experts
Portfolio analysis (also intra-day)
Market data sourcing and visualization
Product classification, ISDA, documentation of OTC derivatives
Identification of market standards: valuation, trading, product life-cycle,
risk advisory
Explain how trading and risk management systems work
Validation of patents in financial markets
Project management

Summary
Resources
Resources
Publications:
https://mathfinance.com/company/publications/
MathFinance Pricing Libraries:
https://mathfinance.com/products/
MathFinance Flow:
FX Volatility 101 Exam
November 2017 Singapore
18th Frankfurt MathFinance Conference:
16 - 17 April 2018
https://mathfinance.com/mathfinance-conference-2017/

Summary
Resources
Thank you for Coming and your Attention
Stay tuned to MathFinance

Summary
Resources
carry trade, 81, 82
CFD - contract for the diﬀerence, 83–87
currency related swap, 70–76
currency related swap (CRS), 77–80
dual currency investment (DCI), 17–21
gamma exposure, 45, 46
margin call, 40, 41, 45, 46
margined account, 45, 46
performance linked investment (PLI), 9
pivot target forward, 69
self-quanto, 70–80
SIAC, 32
stop loss, 83–87
target forward, 58–65
VaR-based threshold model, 40, 41
vega exposure, 45, 46

MathFinance: Structured Products in Wealth Management

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