Is There a Need for an Industry Standard for Capital Guaranteed Products?

Abstract

The focus of this paper is on capital guaranteed products. In general, it can be difficult for investors to understand the complex features of such guaranteed products, and even harder to value them. The product “GuaranteeBonus III,” sold in the Norwegian market during fall 2003, illustrates these problems. By analyzing and valuing the product, the authors find that exotic features embedded in the contract significantly reduce the probability of obtaining a high return, and that the product may well be overpriced. Closely related to these findings is thus the marketing of such products. When GuaranteeBonus III was sold, the product brochure advertised a possible return as high as 45% over a two-year period. However, by adapting correlated geometric Brownian motions to the underlying assets and performing simulations, the authors find that the probability of obtaining such high returns is extremely low. Based on one million simulations, the highest realized return is less than 17%, indicating that returns close to 45% are highly improbable. Another related aspect is that the investors fail to gain from dividends paid on the stocks during the lifetime of the product. To mend the problems related to these products, they offer a discussion of selected suggestions for an industry standard.