Downside buffer - Financial definition
Concise definition of the term downside buffer
A downside buffer is a feature in structured financial products that provides partial protection against losses by absorbing a specified amount of downside risk. It allows investors to limit their exposure to negative market movements up to a predetermined level.
Comprehensive definition of the term downside buffer
The downside buffer is commonly used in structured products to attract risk-averse investors by offering a degree of capital protection. For example, if a structured note has a 10% downside buffer, the investor will not incur any losses unless the underlying asset declines by more than 10%. This feature is particularly appealing in volatile markets, as it mitigates some risk while still allowing participation in potential upside gains.
However, it is important to note that the buffer does not offer complete protection; losses beyond the buffer threshold are fully borne by the investor. This mechanism can be found in various structured financial instruments, such as equity-linked notes, principal-protected notes, and some types of annuities, which are designed to balance the trade-off between risk and return.