An equity-linked note (ELN) is a debt instrument, usually a
bond, that differs from a standard fixed-income security in that the final payout is based on the return of the ''underlying equity'', which can be a single stock, basket of stocks, or an equity index. Equity-linked notes are a type of
structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and t ...
s.
Most equity-linked notes are not traded on the secondary market and are designed to be kept to maturity. However, the issuer or arranger of the notes may offer to buy back the notes. Unlike the maturity payout, the buy-back price before maturity may be below the amount invested in first place.
Equity-linked notes can be referred to one of the following:
Equity-linked put option
An equity-linked put option (ELPO) is a
structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and t ...
composed of a deposit, and a short
put option
In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a s ...
.
The underlying stock, exercise price and maturity date determine the principal and interest of the product. The face value of the product is the exercise price times the trading unit, for example, if the exercise price is $100 and the product is sold at 100 shares per lot, the face value of the product is $10000.
The product is sold at a discount, which is the option premium received by selling the put option. Using the example above, if the option premium is $2 (per share), the product is then sold at $9800.
On the expiry day, if the stock is trading at or above the exercise price, the option is not exercised and the investor receives the full face value of the product ($10000 in the example). However, if the stock is trading below the exercise price, the investor receives the stock instead.
Principal-guaranteed notes
A principal-guaranteed note (PGN) is a
structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and t ...
composed of a
zero-coupon bond
A zero coupon bond (also discount bond or deep discount bond) is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zer ...
and a long
option, which may be a
call option
In finance, a call option, often simply labeled a "call", is a contract between the buyer and the seller of the call option to exchange a security at a set price. The buyer of the call option has the right, but not the obligation, to buy an ...
or
put option
In finance, a put or put option is a derivative instrument in financial markets that gives the holder (i.e. the purchaser of the put option) the right to sell an asset (the ''underlying''), at a specified price (the ''strike''), by (or at) a s ...
. The product is principal-protected, i.e. the investor is guaranteed to receive at least 100% of the original amount.
The product is sold at the face value, where the discount on the
zero-coupon bond
A zero coupon bond (also discount bond or deep discount bond) is a bond in which the face value is repaid at the time of maturity. Unlike regular bonds, it does not make periodic interest payments or have so-called coupons, hence the term zer ...
is used to buy an option. If the underlying product goes in favour of the investor, the option is exercised to create additional return.
Usually, the final payout is the amount invested, plus the gain in the underlying stock or index times a note-specific ''participation rate'', which can be more or less than 100%. For example, if the underlying equity gains 50% during the investment period and the participation rate is 80%, the investor receives 1.40 dollars for each dollar invested. If the equity remains unchanged or declines, the investor still receives one dollar per dollar invested (as long as the issuer does not
default
Default may refer to:
Law
* Default (law), the failure to do something required by law
** Default (finance), failure to satisfy the terms of a loan obligation or failure to pay back a loan
** Default judgment, a binding judgment in favor of ei ...
). Generally, the participation rate is better in longer maturity notes, since the total amount of interest given up by the investor is higher.
See also
*
Convertible bond
In finance, a convertible bond or convertible note or convertible debt (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock i ...
*
Exchangeable bond
Exchangeable bond (or XB) is a type of hybrid security consisting of a straight bond and an embedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) a ...
*
Structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and t ...
*
Structured note A structured note is an over the counter derivative with hybrid security features which combine payoffs from multiple ordinary securities, typically a stock or bond plus a derivative.
When the product depends on a credit payoff, it is called a cr ...
**
Floating rate note
Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a quoted spread (also known as quoted margin). The spread is a rate that remains constant. Almost all ...
**
Inverse floating rate note
An inverse floating rate note, or simply an inverse floater, is a type of bond or other type of debt instrument used in finance whose coupon rate has an inverse relationship to short-term interest rates (or its reference rate). With an inverse flo ...
**
Credit-linked note A credit-linked note (CLN) is a form of funded credit derivative. It is structured as a security with an embedded credit default swap allowing the issuer to transfer a specific credit risk to credit investors. The issuer is not obligated to repay th ...
**
Market-linked note
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single security, a basket of securities, options, indices, commodities, debt issuance or foreign currencies, and to ...
References
External links
Equity-Linked Notes: An IntroductionEquity-Linked Note (ELN) on Amex.comEquity Linked Note Structures article on Financial-edu.com
{{derivatives market
Financial markets
Equity securities
Interest-bearing instruments