Financial products

Financial Products—The Basics, Types and How New Financial Products are Created

Learn the basics about financial products and services offered by a bank or credit union before going there. You should not put all of your eggs in one basket. Diversify your investments over a wide range of financial instruments to secure your portfolio’s stability and growth.

Financial products are investments and securities designed to deliver long-term or short-term financial gain to purchasers and sellers. Financial products make it possible to diversify risks and move money throughout an economy.

So we will be looking at the basics and types of financial products and how new financial products are created. Let’s first begin with the meaning of financial products.

WHAT ARE FINANCIAL PRODUCTS?

Financial products are securities and investments designed to provide short- and long-term financial rewards to purchasers and sellers. These enable an economy’s liquidity to flow and risk to be distributed.

Many financial goods are available as contracts that can be negotiated on financial exchanges.

Cash movement is specified in the contracts, both now and in the future, depending on the conditions.

Financial products can assist us in increasing the amount of money we have in order to achieve various financial objectives, such as retirement, children’s education, marriage, and so on.

You should learn about any potential risks, limits, fees, and other product characteristics before investing in any financial instrument.

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Types of Financial Products

Checking Accounts

A financial institution account that facilitates withdrawals and deposits. It’s ideal for paying bills and keeping track of your expenses.

Savings Accounts

A deposit account is held at a bank or other financial institution that protects cash while also paying a modest interest rate. Excellent for accumulating emergency funds or setting aside funds for a short or medium-term goal.

Money Market Accounts

Low-transaction checking accounts with a higher minimum balance requirement in exchange for a higher interest rate. It’s a good way to save for an emergency or pay for occasional expenses.

Certificates of Deposit

Savings accounts that offer a higher interest rate in exchange for committing your money for a set period of time (six months, 12 months, etc.).

Mortgages

Loans to purchase a home where the collateral is the home itself.

Home Equity Loans

Loans offered to homeowners where the loan amount is capped at a percentage of the equity that the owner has on the home.

Auto Loans

Loans used to finance the purchase of an automobile.  It is usually unsecured and based on the borrower’s integrity and ability to pay. The collateral is the vehicle.

Personal Loans

Unsecured loans offered to bank customers.

Credit Cards

Unsecured, revolving loans that comes with a card and is primarily used for purchases, though some also provide cash advances. The credit card issuer sets a maximum limit that can be charged.  Borrowers make monthly payments on the amount charged to the account, as well as on the interest that is charged by the issuer. When payments are made, those funds become available for borrowing again. 

Debit Cards

Cards issued in association with checking or savings accounts that allow point-of-sale purchases that are then deducted from bank balances and ATM withdrawals.

Financial products

ATM Cards

Cards issued in association with checking or savings accounts that allow cash deposits and withdrawals at Automatic Teller Machines (ATM) but not point-of-sale purchases.

Cashier’s Checks

Checks written by banks that verify that the bank customer has sufficient funds to cover the check.  These checks are guaranteed by the bank or credit union. A cashier’s check may be required for closing costs in a home purchase, for example.

Money Orders

Documents written against other accounts or bought with cash, which provide a receipt and are converted to cash by the recipient.  Often used to pay bills when someone does not have a checking account.

Traveler’s Checks

Checks written against an account or bought with cash that are made valid when completed with the payee’s name and signed by the owner.  Less commonly used now.

Wire Transfers

A way to move money from one person to another.  Often used to send money internationally.

Foreign Currency Exchange

Converting one country’s currency to another’s.

Safe Deposit Boxes

A box located at a bank for use for personal possessions that can only be accessed with the assistance of bank personnel by lock and key.

Derivatives and options

Many financial products are derived from an existing asset or other financial product, and such products are called derivatives. Derivatives can be placed into one of two categories:

  1. Forwards, which are contracts to deliver something, usually a financial benefit, at some point in the future.
  2. Options, which are contracts that give one or both parties to a financial contract the right to gain a certain benefit in the future.

Derivatives have been around for thousands of years, and until recently, they were only sold to private individuals. Individual and institutional investors have participated in complicated markets over the last 35 years. Trading has become more sophisticated, relying more heavily on technology. Following the publication of the Black-Scholes pricing model in 1973, options trading took off. Until then, it had been difficult for buyers and sellers to value options properly, but the Black-Scholes model, which relied on advanced mathematical modeling, allowed even unskilled traders to put a reasonably accurate value on the asset that the option was based on. Some analysts believe that an over-reliance on these pricing models contributed to the recent financial crisis.

Futures

Futures are contracts to buy or sell a real financial commodity at a future date, but at a price agreed upon at the time the contract is exchanged.

A coffee trader, for example, might buy a contract for 30,000 lbs of Columbian coffee at $1.20 for delivery in three months.

Over the next three months, this contract could be sold to another trader at any time.

If the market price climbs to $1.40 after one month, the contract owner can sell it for a profit of 20c per pound, or a total profit of $6,000.

Agricultural products, metals, transportation, and energy are the four main commodity futures.

Interest rates, currencies, and stock prices all have futures markets.

Bond markets

Corporate bonds are financial securities sold by private companies to raise funds in substantial amounts.

Government bonds, often known as gilts, are issued by the federal and state governments to raise huge sums of money.

Most bonds have a fixed rate, which guarantees the holder a fixed return over the bond’s life, which can be up to 30 years. Some bonds, however, are issued with a floating rate.

Corporate bonds are riskier than government bonds because private companies can fail, whereas governments can collect cash through taxes or fresh bond issues, ensuring that holders of government bonds receive a return.

The Treasury’s Debt Management Office oversees the issuance of government bonds in the United Kingdom (DMO).

Swaps

Swaps are derivatives that allow the user to exchange one type of bond for another, commonly a fixed-rate bond for a floating-rate bond.

Hedge funds

Hedge funds are investment funds for wealthy depositors who want to generate a solid return by utilizing the professional fund manager’s abilities and expertise.

Hedge funds, which primarily deal in derivatives, have grown in popularity as a viable investment alternative for individuals and institutions such as pension funds and insurance companies.

How New Financial Products are Created

The financial industry is skilled in developing new goods and effectively marketing them to the general public.

Many of these products have proven to be profitable for investors and financial institutions that sell them. Consider mutual funds and exchange-traded funds (ETFs).

Other products, on the other hand, have either been complete failures or, worse, have pushed the globe to the verge of financial collapse.

The prime—or should we say subprime—example of such toxic products would surely be U.S. mortgage-backed securities, whose collapse in the years 2007–09 triggered a global credit crisis and the Great Recession.

Here are the 10 steps involved in the creation of a new financial product.

Creating Something New

Clearly, developing a new financial product implies a higher level of risk than producing a widget. For example, the seller of a new financial product may be exposed to risks due to poor risk management or conflicts of interest.

Clients, on the other hand, bear the brunt of the risks associated with new financial products. Consider the number of Americans who experienced financial hardship as a result of dramatically higher mortgage financing expenses on their adjustable-rate mortgages when interest rates in the United States rose sharply from 2003 to 2006.

While new product failures may happen in the financial business from time to time, the reality is that these goods go through a lengthy development process that can take months.

1. Concept of New Financial Products 

Conceptualizing a new financial product is the initial step in the development process. A new product concept might come from a variety of places, including client demand, internal sales, or a third party. Exchange-traded funds (ETFs) were created to overcome the restrictions of traditional mutual funds by trading on a stock exchange, providing quick liquidity and transparency, both of which are highly appealing to investors.

Strip bonds, on the other hand, are thought to have originated when someone in a financial institution realized that “stripping” a 10-year bond of its 20 semi-annual coupons and selling each one separately would result in 21 separate commission-eligible transactions (20 coupon payments plus the bond principal), rather than a single bond transaction.

2. Product Development

It’s one thing to come up with a great concept; it’s another to bring it to life, because the devil is in the details. At this point, the product development team must turn the concept into a physical product that can be sold to the institution’s clients for a profit. The development team must tread a narrow line in creating a product that is neither overly sophisticated (a significant concern with financial products) nor so simple that the competition can easily copy it.

Since most of the remaining processes are dictated by whether the product is meant for a retail audience or should only be targeted at institutional clients, the clientele for the product is also identified at this stage.

Related: 9 Major Types of Financial Institutions

The new product must adhere to the competent authority’s securities legislation. The Financial Industry Regulatory Authority’s (FINRA) Regulatory Notice 12-03, for example, gives guidance to financial firms on additional supervision needs for complex products. A complex product, according to FINRA, is one that has multiple features that affect investment returns differently depending on the scenario, such as asset-backed securities or structured notes.

Because regulation is primarily intended to protect ordinary investors from dubious products or services offered by unscrupulous businesses, ensuring that the new product complies with all existing regulations is critical to its success (not to mention avoiding potential embarrassment later). On the legal side, the firm’s legal experts will make sure that the intellectual capital invested in the product is safeguarded by filing the relevant documents. The legal team will also make sure that all regulatory criteria, such as product appropriateness and conflicts of interest, have been met. 

4. Operations

The nitty-gritty of a new product’s development is hammered out at this stage. Because it contains all of the crucial aspects involved with offering the product, this is probably the most important step in the entire new product development process. This includes creating client-facing documents and paperwork, ensuring the transaction will go smoothly on the firm’s platform and determining the procedures necessary in completing the trade in the back office. It also involves client reporting, employee training (front office and back office), and supervision, as well as risk management and controls to ensure that risks to the firm emerging from the new product are mitigated. 

5. Registration of Products

The new product may need to be registered with the appropriate body, such as the Securities Exchange Commission in the United States or the Provincial Securities Commissions in Canada, via a prospectus or offering documents. 56 Note that these organizations do not offer an opinion on the new product’s merits or investment appeal. Rather, they ensure that the prospectus has all of the “I’s” crossed and all of the “t’s” crossed, as well as full disclosure of all of the factors that an investor needs to make an informed investment decision.

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6. Marketing New Financial Products

It is critical to market a new product to ensure its success. If the product is quite complex, this phase also includes educating the client. In general, marketing cannot begin—or can only be done in a limited way—until the prospectus or offering document has obtained approval from the organization with which it was registered. Creating marketing materials like brochures and presentations that effectively describe a product’s features and benefits, as well as putting together a cohesive media plan, are time-consuming tasks that can take weeks to execute.

7. Distribution of the New Product

This is an important phase because without a competent sales team to sell or distribute the goods, it would fail. At this point, the company or institution must make a number of critical decisions, including who will sell the product, how they will be compensated, and how much compensation they will receive. The characteristics of the product are critical in determining the appropriate target audience for it.

A high-risk, high-reward product or one that is extremely sophisticated, for example, maybe more suited for institutional investors, whereas a product that is relatively basic may be more appealing to individual investors. Following the identification of the target market, the appropriate distribution channels can be implemented.

8. Product Launch

Finally, the big day arrives the launch of the financial product, the culmination of months of work. New financial products are frequently introduced with great fanfare, either following or concurrent with a marketing blitz to enhance product awareness. Some new products may sell out immediately after they are released, while others may take longer to gain traction. It all relies on which investor need the new product is meeting—income, growth, hedge, or other needs—as well as the risk profile of the product.

9. Compliance

The firm’s compliance department will keep an eye on sales of the new product to ensure that it is only being sold to clients who are eligible for it. In the financial industry, client appropriateness is a major concern. A compliance officer may soon visit an advisor who sells a sophisticated structured note to an 80-year-old with limited means of income, and the advisor may be asked to leave. Compliance would also be on the alert for unlawful actions such as front-running or manipulative trading, depending on the specifications of the (new) product being offered.

10. Product, Profitability Review

At the end of the development cycle for a new product, it will be examined at predetermined intervals to assess several metrics such as product sales vs projections, unforeseen obstacles, risk management, and the product’s contribution to profit, among others. The new product may have a brief shelf life or become a winner, expanding the firm’s portfolio of successful product offerings, depending on the results of such frequent reviews.

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