Key Takeaways

  • Structured products combine securities with derivatives to create specific risk/return profiles.
  • ETNs are unsecured debt obligations linked to an index - have CREDIT RISK of issuer.
  • Principal-protected notes guarantee return of principal but cap upside.
  • Leveraged ETFs deliver DAILY multiples (2x, 3x) and reset daily.
  • Inverse ETFs profit when the underlying index DECLINES.
  • Leveraged/inverse ETFs are NOT suitable for long-term buy-and-hold due to daily compounding decay.
  • Viatical settlements involve purchasing life insurance from terminally ill individuals.
  • Complex products require enhanced suitability analysis and disclosure.
Last updated: December 2025

Structured Products and Complex Investments

These complex products combine traditional securities with derivatives to create specific risk/return profiles. They require enhanced understanding and suitability analysis.

Exchange-Traded Notes (ETNs)

ETNs are unsecured debt obligations issued by financial institutions.

ETN Characteristics

FeatureDescription
StructureSenior unsecured debt
ReturnsLinked to index performance
Credit RiskIssuer default risk (unlike ETFs)
TrackingNo tracking error (unlike ETFs)
MaturityFixed maturity date
Tax TreatmentMay be more tax-efficient

ETN vs. ETF Comparison

FactorETNETF
StructureDebt obligationTrust holding assets
Credit RiskYes (issuer)No (owns assets)
Tracking ErrorNoYes (possible)
Asset OwnershipNo underlying assetsHolds underlying assets
Counterparty RiskYesMinimal

ETN Risks

RiskDescription
Credit/Default RiskIssuer may default
Call RiskMay be called before maturity
Liquidity RiskMay be difficult to sell
Market RiskLinked index may decline

Exam Tip: ETNs have CREDIT RISK of the issuing bank because they are unsecured debt. If the bank fails, ETN holders may lose their investment. ETFs do NOT have this risk.

Principal-Protected Notes

Principal-protected notes (PPNs) guarantee return of principal at maturity while linking returns to market performance.

PPN Characteristics

FeatureDescription
PrincipalGuaranteed at maturity
UpsideLinked to index/asset performance
CapMaximum return often limited
ParticipationMay receive only portion of gains
MaturityMust hold to maturity for protection
Credit RiskGuarantee only as good as issuer

PPN Components

ComponentSource
Zero-Coupon BondProvides principal protection
Call OptionProvides upside participation

PPN Considerations

ProCon
Principal protectionCapped returns
Market participationCredit risk of issuer
Known worst-case outcomeIlliquid
No dividends received

Leveraged ETFs

Leveraged ETFs seek to deliver multiples of daily returns of an underlying index.

Types of Leveraged ETFs

TypeDaily Target Return
2x Long2 times index return
3x Long3 times index return
-1x (Inverse)Opposite of index
-2x2 times opposite
-3x3 times opposite

The Daily Reset Problem

Leveraged ETFs reset daily, creating compounding decay over time.

Math Example: Index Up 10%, Then Down 10%

InvestmentDay 1 (+10%)Day 2 (-10%)Total Return
Index100 → 110110 → 99-1%
2x Leveraged100 → 120120 → 96-4%
3x Leveraged100 → 130130 → 91-9%

Key Insight: Even though the index only lost 1%, the 2x ETF lost 4% and the 3x ETF lost 9% due to daily compounding.

Volatility Decay

In sideways, volatile markets:

  • Leveraged ETFs lose value over time even if index is flat
  • Called "volatility decay" or "beta slippage"
  • More pronounced with higher leverage

Leveraged ETF Suitability

Suitable ForNOT Suitable For
Short-term tradingLong-term buy-and-hold
Sophisticated tradersRetirement accounts
Daily hedgingConservative investors
Intraday speculationPassive investors

Exam Tip: Leveraged ETFs are for DAILY trading only. They should NEVER be recommended for long-term holding. Daily reset causes returns to differ significantly from expected multiples over time.

Inverse ETFs

Inverse ETFs are designed to profit when the underlying index declines.

Inverse ETF Uses

UseDescription
HedgingProtect against market decline
SpeculationBet on market downturn
Short ExposureWithout margin account

Same Daily Reset Issues

  • Reset daily like leveraged ETFs
  • Subject to volatility decay
  • NOT suitable for long-term hedging
  • Returns diverge from expected over time

Viatical and Life Settlements

These involve purchasing life insurance policies from policy owners.

Definitions

TypePolicy Owner
Viatical SettlementTerminally ill (life expectancy < 2 years)
Life SettlementElderly but not terminally ill

How They Work

  1. Policy owner sells policy for cash (more than surrender value)
  2. Buyer becomes new owner and beneficiary
  3. Buyer pays ongoing premiums
  4. Buyer receives death benefit when insured dies

Key Risks

RiskDescription
Longevity RiskInsured lives longer than expected
Premium RiskMust pay premiums until death
Fraud RiskMisrepresentation of health
Liquidity RiskDifficult to resell
Ethical ConcernsProfiting from death

Regulatory Considerations

  • Regulated by states as insurance products
  • May also be securities (SEC involvement)
  • Disclosure requirements vary by state
  • Suitability requirements apply

Complex Product Suitability

FINRA Guidance on Complex Products

RequirementDescription
Enhanced SuitabilityMust understand product complexity
Reasonable BasisFirm must understand product
Customer-SpecificMust be suitable for individual
QuantitativeNot excessive for customer
DocumentationMust document suitability analysis

Due Diligence Requirements

FactorConsideration
ComplexityCan customer understand it?
CostsAre fees reasonable?
LiquidityCan customer access funds?
RisksDoes customer understand all risks?
AlternativesAre simpler products available?

Exam Tip: Complex products require enhanced suitability analysis. Always consider whether a simpler product would meet the customer's needs.

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ETN vs. ETF: Key Differences
Test Your Knowledge

A leveraged 2x ETF is designed to:

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D
Test Your Knowledge

What is the primary risk unique to ETNs that ETFs do not have?

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B
C
D
Test Your Knowledge

Which statement about leveraged ETFs is TRUE?

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B
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D
Test Your Knowledge

A viatical settlement involves:

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B
C
D