A Study On The Pricing Of The Equity-linked Structured Financial Products

With China's economic and social development, personal wealth increases rapidly and shows a central tendency. People's attitude and disposition toward personal wealth have changed a lot. As a result of financial liberalization and market diversification in recent years, especially the tough competition among commercial banks in the domestic market, a large number of personal financial products come forth continuously. Personal financial services have become the major business of the commercial banks in the process of financial innovation and the scale is developing rapidly. At present, more and more financial products have been put into market by commercial banks. These products have become the core competitiveness of their retail business.Since 2003, structured products became the focus of the personal finance market. Domestic and foreign banks have been offering their own products, which are sought after by individual investors. The so-called structured products are the financial products which combine the fixed-income securities with financial derivative products. Certain financial derivatives (mainly various types of options) are embedded in the fixed-income products。Linked with the fluctuation of interest rates, exchange rates, indices, etc., the structured products entitled the investors to high yield on the basis of bearing some risk. Gearing effect has occurred between the ROI of structured products and the price volatility of the related assets linked to the object through the combination of fixed-income securities and options, which can get principal protection or higher ROI to some extent. However, because the type of structured products is various, and the terms of which is complex, it's hard for the investors to determine their actual earning. Besides, a number of Chinese-funded banks earn price difference simply as brokers, and they don't predominate in the field of product designing, pricing and risk management. Since the beginning of this year, due to the impact of international financial crisis, a number of structured products gain no earnings or even lose their principle at maturity. These products, with no exception, are implicated because of their participation in capital and commodity market. This phenomenon led to the concerns of the financial supervision and regulation department to the structural designing, pricing and risk management. In order to reduce the growing investment risks, the regulation is becoming more and more stringent.July 8.2009, the China Banking Regulatory Commission issued a notice about reinforcing the Investment Management of the Personal financial services of commercial banks. It explicitly requested that the area of financial capital investment should not contain the publicly traded shares in the secondary market, as well as the high-risk investment. It will lower the risk of future structured products, and the complex structured products might disappear.Different from other financial products, the structured products ensure investors to share the high-yield opportunities in financial markets under the premise of the safety of their principal. But at the same time, it also proposes higher requirement for the issuer's pricing capability, as well as the regulatory authority's risk management capability.This paper focuses on the pricing method of structured products, especially the equity-linked structured products of commercial banks. By analyzing specific products, we try to explore the structural designing and pricing principles of financial products. Using Monte-Carlo method to simulate the product pricing, we compare the simulation of the theoretical value with the actual price of the chosen product to make further analysis and explanation. By analyzing the fundamental principles of designing and pricing of structured products, we try to find ways to promote the development of structured products and its risk management level, referring to the current situations of China. The full text is structured as follows:In Chapter 1, as an introduction, the background, significance, framework and methods of this paper are described, as well as the literature review of structured pricing.Chapter 2 is an overview of the structured products, mainly to introduce the definition of structured products, as well as the classification. We define the properties of structured products, and organize them by different criterions. In Chapter 3, we focus on the pricing principle of equity-linked structured products. First of all, we divide the product into two parts:the fixed-income security and the option. Secondly, we price each part respectively. At last, we add up these two parts and the price of the structured products is acquired. The pricing of structured products is the core.Chapter 4 is the empirical study of the pricing method of equity-linked structured products. We choose the 15th product issued by Everbright Bank as an example. Comparing the theoretical value with the actual price of this product, we find that this product is issued at a premium and the investment risk is high for investors.Chapter 5 introduces the current situations of structured product's development, the risk faced by the issuing bank and the reasons for the existent problems. According to the Problems discovered, solutions were raised in the views of both the issuer and the market.