SG launches range-defined income product

Société Générale has launched the second edition of its UK Range 7 Deposit Plan - a six-year deposit product linked to the FTSE 100 index. The plan offers potential annual interest of 7% provided the closing level of the index stays within a specified range on every trading day during the year. Capital is fully protected at maturity regardless of the performance of the underlying.

Range products are often symmetric and typically offer investors the opportunity to achieve returns regardless of the direction of movement in the underlying asset from its initial level. Such structured products are commonly used to generate income rather than to provide a growth payout.

Range products would appeal to investors looking to go short volatility - that is, to benefit from a lack of movement in the underlying. Should the underlying move outside the range, this will not have the effect of cancelling the possibility of future returns, but it will have an effect on the coupon for that period.

Investors will receive the annual interest payment if the closing value of the FTSE 100 is within the relevant annual range on every day during the observation year. If the closing level of the index is equal to or above the upper barrier level, or equal to or below the lower barrier level on any trading day during the year, no interest will be paid for that period.

The range in year one is set at plus or minus 12%, after which it increases by plus or minus 3% each year. This means the index can move in either direction, and as long as neither barrier is breached, investors will receive the interest payment for that year. In the first year, for instance, the index must remain below 112% and above 88% of its initial level for income to be paid. The ranges for years two, three, four, five and six are plus or minus 15%, 18%, 21%, 24% and 27%, respectively.

As capital is protected at maturity, the full amount of capital is returned to investors regardless of the performance of the FTSE 100. Despite this protection, investors should be aware that credit risk increases with a product's maturity, so longer-dated products have more exposure to the credit risk of the issuing institution.

This product would appeal to those looking for capital protection and potential income well above the risk-free rate. It is aimed at low-risk investors that want access to the FTSE 100 whilst reducing the risk profile of the underlying asset. All principal-protected products are positioned as lower-risk versions of a direct investment in the underlying, with the cost of the protection paid for by giving up dividends. As this is a deposit plan, potential returns will be subject to income tax.

Pricing and risk

The price of range products is sensitive to changes in volatility. Assuming all other factors remain the same, if the volatility of the underlying decreases throughout the life of the product, the value of the structure will increase, as the chances of it moving outside the range get smaller. If a range product is structured using a high-volatility underlying, investors would expect the range within which payments are accrued to be wider than if the underlying has a low volatility, or to be offered a larger potential coupon.

The first pricing component is a zero coupon bond, which provides the base payment of 100%. Unlike traditional range accrual products, where investors are paid a proportion of the coupon depending on whether the underlying is within a range, this is an all-or-nothing coupon that will only be paid if the underlying is within the range for the whole of the observation period. Whether or not the range has been breached is always referenced to the initial index level rather than the level at the beginning of the observation period. This means that if the index falls or increases by a significant amount outside the range within the early stages of the product term, it will have to recover in order for the next coupon to be paid.

A PDF of this article is available

The information in this analysis is taken from sources which Future Value Consultants Limited deems reliable but no guarantee is made that the information is complete or accurate and it should not be relied upon as such. Any opinions in the analyses represent those of Future Value Consultants Limited at the time of writing but are subject to change. All valuations and prices shown are indicative only and do not imply an offer or commitment of any kind. The analysis does not constitute advice or recommendations nor should it be relied upon for any purpose. No liability whatsoever is accepted by Future Value Consultants Limited or Structured Products magazine for any loss or expense incurred from using this analysis.