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Financial institutions create investment products, known generically as structured products, that trade on a stock exchange and link the return on an investor's principal to the performance of an underlying security, such as a stock or basket of stocks, or to a derivative, such as a stock index.
For example, the return on debt securities known as structured notes is determined by the performance of a stock index such as the Standard & Poor's 500 (S&P 500) rather than the market interest rate. The objective is to provide the potential for higher returns than are available through a conventional investment.
Each product has a distinctive name, often expressed as an acronym, and its terms and conditions vary somewhat from those offered by its competitors.
For example, in some cases the principal is protected and in others it isn't. But some features are characteristic of these complex investments -- their value always involves an underlying financial instrument and they require investors to commit a minimum investment amount for a specific term, such as three years.