Structured investment presentation

One of the most insightful notes/ materials from the bank thus far. I now know exactly how banks try to squeeze their customers and package it up with marketing fluff like a 'high-interest FD'. It ties back to what I learned earlier from the BoE quarterly bulletins about how banks constantly need funding. And what banks love the most is sticky funding. It's best to understand this product in 3 layers, namely: i) What the bank claims the product is ii) The downsides and risks of this shit product, using only the information that the bank provides iii) Understanding this product for what it really is, including what the bank doesn't tell you. So, i) This is a callable fixed rate negotiable instrument of deposit (CFR NID). It is a super FD! i.e. it pays an interest that's higher from other FDs that you can find on the market, and MGS. Other FDs rn, and MGS, are paying around 3.5%, this super FD offers you 4% indicatively for 5 years! It has a quarterly payout, so, 4 times a year, boom! You get money in your pocket. AND, it's principal GUARANTEED! You have a 100% chance of getting all your money back and the interest you accrue. Every quarter, you will get this amount: Principal * Coupon rate * 90/ 365 But remember that you cannot withdraw your money. If you keep your money in this super-FD for the full 5 years, then you get your principal back for sure, and all the accrued interest. But if you withdraw early, you forfeit the interest and incur some penalties. But no biggie! Just don't withdraw. And yea also, the bank has a right to 'call' this product, meaning we return your principal + interest to you any time we want. But it's principal guaranteed! If we return your money, you get your money back in full. The first year is non-callable. But the non-callable period is negotiable. And also, this product isn't protected by PIDM. But no biggie, bro! Trust me - *bank* is such a big bank! Ain't no way *bank* will default on your deposits right?! ii) As mentioned, you cannot withdraw your money for 5 years. Your money is locked up with us. If you have an emergency, too bad - you will incur a penalty. iii) The bank is buying a valuable call option from the saver/ customer for pennies on the dollar - just 0.5%. Call options are incredibly valuable to hedge all sorts of risk, and financial institutions regularly buy them on the open market for much more than 0.5%. This product isn't a scam, but it's engineered by the bank's quants to save money for the bank on funding and short-change their customers. The bank is long Vol, the customer is short Vol. If rates rise, the bank will not call the product. They will gleefully pay you 4% while rates markets are at, say, 5%. So you cannot take advantage of higher rates on the market by letting your existing FDs mature and buying a higher-rate FD or MGS. If rates fall, the bank calls the product immediately to take advantage of lower funding costs. And now you're stuck with low-rate FDs. So, logically, the only person this product could be well-suited for is a guy who: i) Knows this product for what it really is, ii) Has lots of spare cash lying around, iii) Has a genuine macroeconomic call that rates will stay stable for the next 5 years. But even then, and even if your macro call proves correct, it's still a bad deal! There are plenty of other options to express that macro view, like building a bond or FD ladder, instead of selling your option for a steep discount for nothing. Furthermore, market rates are not the only variable. You are further exposed to a massive uncontrollable - the bank's internal treasury models. The bank doesn't just look at market rates, they look at their COF, yield curves, FTP, liquidity coverage, etc. The bank would call the product any time they can get internal funding cheaper than 4%. And then, this FD doesn't even compound geometrically! The FD shovels out your interest into your current account, leaving you with a cash drag every month. The maxim to take away from this: Whenever a bank tries to sell you something callable, RUN. In institutional funding markets, callable securities are discounted accordingly, since sophisticated market participants price these markets efficiently. But the retail market is an uninformed one that retains much inefficiency.