2008 FIRMA National Conference

Why You Should Know AboutStructured Products

By : Eric MillerManaging Director

Date: April 7, 2008

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Contents

What Are Structured Products?

Industry Trends

Current Market for Structured Products

Looking Ahead: Emerging Themes for 2008

Challenges & Opportunities

Section 1

Section 2

Section 3

Section 4

Section 5

What Are Structured Products?

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Structured Products Overview

Tools for Shaping Client Portfolios

What Are Structured Investment Products?– Structured investment products are investment vehicles which allow investors convenient and tailored

exposure to a specified reference asset.

– Both upside and downside exposure to the reference asset can be modified to suit investors’ investment preferences.

– About half of all structured products issued in the U.S. provide full downside protection for the invested amount, but partially protected and unprotected structures are gaining popularity.

– Most structured products can be cleared and settled via DTC or Euroclear.

Properly applied, structured products can be used to:

Selectively take on desired risk exposures while shedding undesired risks

Customize investments according to specific market views

Conveniently gain access to alternative investment classes that may be difficult to invest in directly

Eliminate or hedge specific portfolio risks or business risks

– Currency risk of foreign investment assets

– Inflation linked notes to hedge rising cost of liabilities for defined benefit pension plans

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Structured Products Overview

Reference Assets – Many Choices

The return on a structured product investment can be linked to any major asset class. In addition to the most popular asset classes listed below, credit-linked and emerging market-linked products are gaining interest among more sophisticated investors.

EquitiesInterestRates

Foreign Exchange

HedgeFunds Commodities

S&P 500®

NASDAQ 100®

DJ Industrial Average®

Nikkei 225

DJ EuroStoxx 50

Hang Seng China Enterprises®

Stocks, ETFs & ADRs

3mo & 6mo LIBOR

10yr CMT

10yr – 2yr CMS

CPI

EUR (Euro)

JPY (Japan)

CNY (China)

GBP (UK)

BRL (Brazil)

Fund of Funds

Permal

MAN

Tremont

HFR Global Hedge Fund Index

Private Hedge Fund Portfolios

DJ-AIG Commodity Index®

GS Commodity Index®

Gold

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Structured Products Overview

Risk / Volatility

Cash Alternati

ve

Bond

AlternativeRet

urn

Cash Alternatives Short-term maturities (1 year or

less) principal protection Potential to exceed traditional

money market investment returns

Bond Alternatives Principal protection Potential to exceed current

fixed income yields

Equity Alternatives Structured equity solutions may

be customized to meet the specific market views and risk tolerance of investors

Potential to exceed equity market returns

Re-allocation exampleA principal protected equity linked note reduces the investment risk by incorporating principal protection, thus redefining the asset as a fixed-income alternative. By obtaining direct equity exposure in this manner it improves the risk adjusted performance of the overall portfolio.

Alternatives to Traditional Asset Allocation

Equity

Alternative

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Structured Products Overview

What are the building blocks of Structured Products?

The pricing components of an Index-linked Principal Protected Structured CD are:– A zero coupon bond

– An equity or index option

Zero Coupon Bond

Option

Principal Protected Structured

Product

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Structured Products Overview

Assume $100 is invested in a 5 year Principal Protected Structured Note, a 5-year interest rate of 5% and a face (or par) value of $100.

The current value of the zero coupon bond is $75. The zero coupon bond will accrete to a value of $100 in 5 year and guarantee the full repayment of principal. Thus, $75 is the current cost of providing the principal protection.

Difference of the $100 invested in the Structured Note and the $75 set aside for principal protection is $25. HSBC allocates $24 to an option linked to the underlying asset to provide the potential for an index linked return and if applicable, a minimum guaranteed return at maturity.

The remaining $1 is paid to Dealer. Investor’s return is based on the initial $100 investment, not $99.

$100

=

$75

+

$24

$1

+

What are the building blocks of Structured Products?

Industry Trends

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Structured Products Issuance – US

The SPA reported a 78% increase in US structured

product issuance between 2006 & 2007

US Structured Products Volume – SPA Data

USD Billion

$28$32

$48

$64

$114

$0

$20

$40

$60

$80

$100

$120

2003 2004 2005 2006 2007

Source: Structured Products Association

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Structured Products Issuance – North America

Registered and unregistered notes, CDs and GICs

(excludes EIAs)

US/Canada Structured Products Volume – Arete Data

$5

$9

$17$19

$24

$34

$0

$5

$10

$15

$20

$25

$30

$35

$40

2005 2006 2007

Canada Issuance Volume US Issuance Volume

USD Billion*

Source: Arete Consulting*Canada issuance volumes converted to USD using respective end-year USD-CAD cross-rates

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Structured Products Issuance – Industry Comparison

Structured products issuance is now on par with other

forms of retail investment product

2007 New US Issuance Volume

$28$29

$34$36

$0

$5

$10

$15

$20

$25

$30

$35

$40

CEF EIA SP UIT

USD Billion

Sources: Arete Consulting, ICI (Investment Company Institute), First Trust Portfolios LP

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Industry Trends - Wrappers

The trend toward unlisted registered notes continues

CD issuance gained, despite a bull market in US and

international equities

US Structured Product Issuance Volume

Source: Arete Consulting

5%

22%

52%

21%

2005

2007

7%

16%

56%

21%CD

Registered Listed

Registered Unlisted

UnregisteredNote/MTN

$19 billion

$34 billion

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Market Trends - Underlyings

Non-equity products have gained market share

Interest rate and FX-linked structures have grown in

popularity over the past two years

US Structured Product Issuance Volume

Source: Arete Consulting

Equity

AlternativesCommodities

Real Estate

FX

Equity

Real Estate

FX

Commodities Alternatives

Interest rates

2005

2007

89%

80%

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Market Trends – Top Underlyings

US single index underlyings are consistently popular, but

a trend towards FX, commodities and global

index baskets is also evident

US Structured Products Issuance

Source: Arete Consulting

UnderlyingVolume

($M) UnderlyingVolume

($M) UnderlyingVolume

($M)

S&P500 BuyWrite 679 S&P500 3325 S&P500 3407

Sector Basket (ETF) 432 DJ Eurostoxx50, Nikkei225, S&P500 971 DJ Eurostoxx50, Nikkei225, S&P500 1381

Nikkei225 412 Nikkei225 746 Nikkei225 1004

S&P500 BuyWrite 354CNY, IDR, JPY, KRW, MYR, SGD, THB, TWD vs. USD

500 MSCI EAFE 905

DJ Industrial Average BuyWrite 212 Rogers Int'l Commodity Index 480 Apple 660

DJ Industrial Average 175 DJ Industrial Average 442 Constant Maturity Swap Rate 627

Nasdaq100 153 DJ Eurostoxx50 386 DJ Eurostoxx50 627

PHLX Housing Sector 127 Constant Maturity Swap Rate 385 Russell2000 523

DJ Eurostoxx50, Nikkei225, S&P500 118 DJ AIG Commodity 357 DJ Industrial Average 470

Russell2000 112 Apple 348 BRL, CNY, INR, RUB vs. USD 446

2005 2006 2007

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Market Trends – Principal Protection

Significant growth in reverse convertible volumes and a bull market in US equities

have driven down the market share of principal protected

structures

Distribution of US Deals by Capital Protection Level

Source: Arete Consulting

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2005 2006 2007

<100% 100% >100%

Current Market for Structured Products

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What a difference ayear makes

Current Market for Structured Products

Credit Crisis Challenges Investor Confidence– Investors initially enjoyed better structured product terms due to issuer funding difficulties

(Merrill Lynch, Lehman, Bear Stearns)

– Then, the unthinkable almost occurs: could one of the largest US commercial or investment banks fail?

– Bear Stearns bailed out by the Fed, JPM

Structured product investors now increasingly choosy about issuer credit quality

BankShare price YoY

% changeCDS

Mar 07CDS

Mar 08Citigroup -63% +16bps +237bpsUBS -57% +11bps +228bpsLehman Brothers -56% +45bps +443bpsMerrill Lynch -49% +38bps +326bpsBarclays -40% +9bps +174bpsJPMorgan -15% +22bps +167bpsHSBC -12% +10bps +155bpsSource: BloombergNB: CDS spreads and USD share prices from 15 March 07 and 17 March 08

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Current Market for Structured Products

Stock Market Volatility Up

VIX Index – 5 Years, Weekly Data

Stock Market Performance Down

S&P 500 – 1 Year, Daily Data

Investors are uncertain as to the direction of the stock

market in the short to intermediate term.

Source: Bloomberg

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Even Apple Inc. stocktakes a dive

Current Market for Structured Products

Reverse Convertibles Perform Poorly– More reverse convertibles are returning stock

– Sales volumes begin to plateau in 2nd half of 2007

– Apple Inc. falls 40% from peak to trough in past 3 months

Apple Inc. – 6 Months, Daily Stock Price

Source: Bloomberg

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Brokers and advisors are looking beyond Reverse

Convertibles

Current Market for Structured Products

Searching for Safety– Increased demand for principal protection especially via CDs as FDIC insurance comforts

credit fears

– Partial protection OK as long as protection is “firm”, not “contingent”

Performance Through Uncertain or “Sideways” Equity Markets– Absolute return notes for equity cash on the sidelines

– Accelerated return notes: more bang for the buck

Quest for Yield Continues– Autocallable notes gaining popularity beyond Latam and Private Banking marketplace

– Return of the LIBOR range accrual note

Looking Ahead:Emerging Themes for 2008

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The asset management industry continues to evolve

Emerging Themes for 2008 - Convergence

New Wrappers for Structured Investments– Mutual funds and Unit Investment Trusts (UITs) offering principal protection

– Closed-end funds offering buy/write yield enhancement strategies

Active Management Offered via ETFs– Recent regulatory approval for the first actively-managed ETFs

– Formerly the territory of mutual funds and SMAs

New “Strategy-based” Indices– Replicating active management techniques for structured notes

– S&P’s DTI and CTI indices (HSBC)

– SEVENS Index (UBS, MS)

– Citibank Country Selection Index (Citi)

– Adagio Index (Bear Stearns)

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As interest rates fall and the bull market in equities fades, investors look elsewhere for

returns – often in hard-to-access investment areas

Emerging Themes for 2008 – Access via Structured Products

Market Volatility Encourages Search for Uncorrelated Investments– Hedge funds still inaccessible to many retail investors

– Advisors more willing to consider other (non-equity) asset classes

Investors Round Out Equity Portfolios– Emerging markets: have these economies de-coupled from G7?

– Access to “Frontier” markets

Customized Indices Provide Access to Sectors & Themes– Increasing development of new indices by Issuers in conjunction with S&P and Dow Jones

– Daily pricing via Bloomberg/Reuters and independent calculation agent instill investor confidence

Asset Class 2007 YTD 2008 YTDInterest Rate $814 $1,822FX $567 $2,155Commodity $748 $3,001

Notional USD millions

Source: Prospect NewsNB: YTD data through March 24 of each year

Challenges & Opportunities

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Today’s challenges will lead to new opportunities and

encourage continued innovation

Today’s Challenges...

Credit Crisis– Avoid the taint of problems in the structured credit market (SIVs, CDOs, etc)

– Restore confidence in the credit-worthiness of Issuers

Taxation of ETNs– Aggressive marketing of ETNs has led to increased scrutiny

– Clearer guidance as to tax treatment of certain structured products may benefit industry

Poor Performance of Reverse Convertibles– Independent broker-dealer channel most vulnerable

Current Market Environment Unfriendly for New Equity-linked PPNs– Low interest rates, high equity volatility

– Opportunity for more interest-rate and FX linked principal protected notes/CDs

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Today’s challenges will lead to new opportunities and

encourage continued innovation

...and Tomorrow’s Opportunities

Get the Word Out!– Increased broker awareness of structured products through education

– Nearly ¾ of structured product volume in 2007 sold via Issuers with internal distribution channels1

Great Time for Structured Products to Shine– The current market environment highlights the many benefits of structured products:

1. Attractive combinations of risk and reward

2. Access to uncorrelated asset classes and hard-to-reach markets

3. Returns linked to customized and/or strategy-based indices

1Source: Structured Products Association