SHOULD ONE INVEST in stocks or in bonds? Stocks have upside potential, generating higher returns if markets go up. But they can generate losses if markets go down. Bonds offer downside protection, providing interest and principal repayment if held to maturity (absent default). But in good market environments, bonds generally underperform stocks. Wouldn't it be splendid if an investment offered both upside potential and downside protection? There are such investments and we will have much to say about them in this chapter. We will call them protected investment products, or PIPs.
Of course, in an efficient capital market one never gets something for nothing. PIPs are no exception. But they are created by financial services firms and purchased by investors (mostly individuals). The relevant questions for us concern their suitability for specific investors. We will see that these products may be appropriate for investors with particular kinds of preferences. This said, there is reason to believe that many of the investors who currently purchase protected products may be motivated more by predictions that differ from those reflected in market prices than by preferences that differ from those of the average investor.
Minimum Return Trust Certificates
There are many protected investment products in the United States and in other countries. They are usually sold directly to investors by banks and brokerage firms. Such instruments are intended to be held to maturity, although transactions prior to that time may be made on an exchange or directly with the initiating bank or brokerage.
In the United States, many PIPs are listed on the American Stock Exchange under the rubric structured products. For example, in April 2003, the exchange listed more than 100 issues offering downside protection and upside potential, with maturity dates ranging from the years 2003 to 2011.
A prototypical example is provided by a series of instruments created for U.S. investors in the first years of the twenty-first century by Citigroup Global Markets, Inc. A typical prospectus for instruments in the series (e.g., Citigroup