Citigroups Guide to

Structured Product Terminology

Times are changing. Retail and high-net-worth investors are
increasingly seeking investments that offer interesting ways to
generate attractive yield. They are also willing to consider products that
offer alternatives to traditional equity investments and, therefore, are not
necessarily looking for full principal protection. And, as a result, yield-
enhancing products, such as the auto-callable structure, have been winning
fans across Europe. Here we examine how such products work.
The denition
An auto-callable (or auto-call) product is essentially a market-linked
investment, which can automatically mature prior to the scheduled maturity
date if certain predetermined market conditions are achieved.
The criterion for deciding whether the product is automatically matured
(auto-called) is whether the underlying reference index is above a
predetermined trigger level (the auto-call barrier). This auto-call test is
usually carried out on a set of predetermined dates (for example, annually,
quarterly, etc.) specic to that particular investment product, so that the
product can only mature on one of these auto-call dates. The underlying
reference index will typically be an equity index, but it can also be linked to
stocks, basket of stocks, funds, etc.
If a product is auto-called, the investor normally receives a predetermined
coupon along with the capital redemption on that auto-call date. That
coupon is typically proportional to the length of time from the start date to
the auto-call date.
Most auto-call products incorporate a protection feature so that, if the
auto-call trigger has not occurred before the scheduled maturity date,
capital is fully protected provided the underlying has not fallen below a
certain level (the protection level) during the term of the investment. Only
if the underlying has fallen below that protection level, and the product
has not been auto-called prior to maturity, will investors be exposed fully to
the downside of the underlying market at maturity.
Behind the scenes
Figure 1 demonstrates how a plain vanilla auto-callable product linked to
an index operates.
In this example of a ve-year auto-call investment, the auto-call barrier is
100%. Therefore the product will auto-call if the underlying index is above
its original start level on any of the ve annual auto-call dates.
The coupon payable is X% if the product is auto-called on the rst auto-
call date, two times X% if the product is auto-called on the second date and
so on up to and including the maturity date. Its important to note that the
auto-call barrier condition is also tested on the maturity date.
At maturity, if conditions for an auto-call have not already been met,
then the investor is long the underlying index but with the benet of full
capital protection, provided the underlying index has not fallen below the
protection level during the term of the investment.
If the underlying index ever traded below the protection level during
the term of the investment, then the capital protection no longer applies
and the redemption will be equal to the index performance over the life of
the investment.
Product rationale
Auto-call investment products offer investors the opportunity for a high
coupon linked to the performance of the underlying index. The coupon
is usually higher than the auto-call barrier, so that investors can achieve
Citigroup believes that product education is vital for the continued success of the
structured investment product market. Kicking off its new monthly column, which will
discuss a wide range of structures, Citigroup explores what are commonly referred to
as auto-callable investment products
1. Example of vanilla auto-callable structure
Example : coupon = X%
maturity(T) = 5 years
t=1 t=2 t=3 t=4 T=5 t=0
1
2
3
100% capital + 4
100% capital + 5 x coupon X%
Maturity
Auto-call
level
100%
Protection
level
P%
100% capital
+
no coupon
Long underlying
+
no coupon
100% capital
+
(n) x coupon
-

100% capital + x coupon X%
100% capital + x coupon X%
100% capital + x coupon X%
x coupon X%
the investment proceeds and the potential coupon are
accrued for the next auto-call date
call date (t), When underlying < auto-call level at each auto-
No early redemption, No coupon payment :
>
Corporate statement Citigroup
attractive returns for small movements in the underlying index.
If a coupon is not paid, because the auto-call barrier has not been
achieved by the underlying index on an auto-call date, then the investor gets
the opportunity to recoup the missed coupon on the next auto-call date.
In addition, the protection level ensures that the investment is
conditionally protected. If the underlying does not fall below the protection
level, investors will receive at least the full principal amount back at maturity.
Scenario simulations
With each structure we examine in this monthly column, we will also
provide some simulations designed to show how the product can behave
in certain assumed market conditions. The following simulations are based
on a Monte Carlo approach. The Monte Carlo simulation involves generating
thousands of possible price paths for the underlying index, based on preset
volatility and trend assumptions. The simulation calculates how the product
would have performed using each of those simulated price paths and then
summarises the results. We assume that returns on the underlying single
index follow a process with constant growth rate and volatility.
The example we use here is for a ve-year auto-call investment linked
to the Dow Jones EURO STOXX 50

with an auto-call barrier at 100%, a

potential coupon of 9% per annum and a protection level of 60%.
Three hypothetical scenarios are analysed below.
n Flat market: the growth rate is zero per annum, representing a scenario
with no trend.
n Moderate growth market: the underlying has a positive drift of 2.50%
per annum, the trend is positive but weak.
n Bullish market: the growth rate for this scenario is equal to 7.50% per
annum, a clear uptrend is assumed.
For each scenario we have assumed a volatility level of 18% per annum,
which is similar to the current implied volatility of the Dow Jones
EURO STOXX 50

.
Parameters of the simulation
In all scenarios, the most likely outcome is that it is auto-called in year one
with a coupon of 9% (the dark-blue segment). If it is not auto-called in
year one, then gure 2 demonstrates the likelihood of it being called in
subsequent years (the remaining lighter-blue segments). The likelihood of
the product lasting until maturity is equivalent to the size of the red and pink
sectors combined in each scenario, with the size of the red sector showing
the probability of losing some portion of capital and the size of the pink
sector representing the probability of the product redeeming 100% capital.
Variations
As with any popular structure, a number of variations on the original idea
exist. Some of the more commonly seen variations are:
Performance auto-call: The auto-call coupon is not xed at a specic level
but pays the greater of X% and the actual underlying performance in case
of an auto-call event.
Crescendo auto-call: The auto-call event depends on two underlyings
being above the auto-call barrier. The additional condition on the second
underlying provides additional nancing for higher auto-call coupons.
Escalator auto-call: The auto-call barrier decreases each year increasing
the likelihood of an auto-call event and reducing the probability of capital
at risk.
Bonus plus auto-call: Besides the auto-call coupon, investors receive a
bonus coupon if auto-called early in the life of the product. The effective
per annum coupon is high in early years compared with a standard auto-
call note and reduces towards maturity.
Premium express: The auto-call barrier is below 100% of the initial strike
level aiming to provide a high auto-call probability with full capital protection.
2. Distribution of the payoff
0
10
20
30
40
50
60
70
80
90
100
Flat market Moderate growth
market
Bullish market
Not auto-called with capital loss at
maturity
Not auto-called with capital protection
at maturity
Auto-called year 5 with 45% coupon
Auto-called year 4 with 36% coupon
Auto-called year 3 with 27% coupon
Auto-called year 2 with 18% coupon
Auto-called year 1 with 9% coupon
%
Contact details
Albert Plattner, managing director, head of European structured
sales, Citigroup
e: albert.plattner@citigroup.com
t: +44 (0)20 7500 5000
Financial terms of the hypothetical auto-callable structure
Underlying Dow Jones EURO STOXX 50

Tenor, currency Five years, EUR

Auto-call barrier 100%
Protection level 60%
Auto-call coupon 9%
Flat market Moderate market Bullish market
0% growth rate pa 2.5% growth rate pa 7.5% growth rate pa