The saying “time is money” is based on the the interest rate earning potential of money, which grows with time. However, interest rates cut both ways: time works for me if I earn interest rates on my invested money, but time works against me when I owe money to someone, and I have to pay interest rates on my debt! In the latter scenario, time isn’t money—it’s losing me money!
What is the time-value of a structured product?
Similar principles apply to structured products—albeit it’s a bit more complicated. Generally speaking, in structured product investing we distinguish between
The time value denotes the difference between a product’s present value and its intrinsic value. The time value consists of two components:
- The financing time value, which (assuming positive interest rates) is positive for products earning interest rates and negative for products paying interest rates.
- The opportunity time value, which is positive for convex payoffs, negative for concave payoffs, and zero for linear payoffs as explained in the follow exhibit:
Concave or convex payoffs – why does it matter?
Illustration of convex and concave payoffs compared to the linear payoff of the underlying asset. A convex payoff is an advantage compared to a linear payoff (i.e. it has a positive opportunity value and therefore typically makes the product more expensive), while a concave payoff is a disadvantage compared to the linear payoff (i.e. it has a negative opportunity value, which is why concave products are typically coming at a price discount to compensate you for the relative disadvantage).
The likelihood for profiting from a convex payoff increases with the volatility of the underlying asset price and the time to maturity.
How does the market influence the time value of your investment?
The opportunity value typically increases with the volatility of the underlying and the time to maturity, since both factors increase the likelihood that the convex payoff turns into an advantage over the lifetime of the product. Similarly, the financing value increases with the level of interest rates and time to maturity.
Both types of time value can interact in a structured product, making it complicated to understand how the value of a structured products evolves over time. This is where our structured products factory can be really useful – please have a look at the video below.
Straight up!
- The so-called time-value of a structuredproduct tells you how its value changes over time – all other parameters beingequal.
- Concave payoffs and payoffs that earn interest rates typically have negative time value, which means time works for you (since the negative time value shrinks towards maturity).
- By contrast, convex payoffs typically have positive time-value, which means time works against you (since the positive time value shrinks towards maturity).
