Structured products in times of interest rate volatility

Structured products are primarily zero-coupon bonds with embedded market-linked derivatives component, making their valuation and risk management more challenging in an evolving financial landscape.

Worries around elevated inflation, economic stability and growth are compelling central banks to adjust their monetary policies. Such moves have stoked volatility in interest rates that, in turn, is having a material impact on structured products already in the market as well as new offerings.

This paper examines how interest rate fluctuations affect the construction and performance of structured products, with focus on capital protection, yield enhancement and participation configurations.

We highlight the challenges and opportunities that issuers and investors face in navigating the changing environment and provide strategic recommendations to enhance resilience and align product structuring with the interest rate cycle.

Our findings include:

• Rising interest rates compress valuations of capital-protected structures, but may enhance coupon offerings in yieldoriented products
• Interest rate volatility increases hedging complexity and model sensitivity, particularly for path-dependent and longdated instruments
• Investor demand is shifting towards shorter-dated, hybrid and inflation-linked products, prompting issuers to innovate in terms of product design and risk transfer

The prevailing interest rate has the biggest influence on the valuation and performance of structured products. It affects not only the discounting of future cash flows but also the pricing of embedded derivatives, particularly options and swaps. As a result, interest rate fluctuations can significantly alter the attractiveness, risk profile and performance outcomes of structured products.