What Is an Equity-Linked Note (ELN)?

An equity-linked note (ELN) is an investment product that combines a fixed-income investment with additional potential returns that are tied to the performance of equities. Equity-linked notes are usually structured to return the initial investment with a variable interest portion that depends on the performance of the linked equity. ELNs can be structured in many different ways, but the vanilla version works like a strip bond combined with a 澳洲幸运5官方开奖结果体彩网:call option on a specific security, a basket of securities or an index like the S&P 500 or DJIA. In the case of a note li🎃nked to an equity index, the security would typically 😼be called an equity index-linked note.

Understanding Equity-Linked Notes

Equity-linked notes provide a way for investors to protect their capital while also getting the potential for an above-average return compared to regular bonds. In theory, the upside potential for returns in an equity-linked note is unlimited, whereas the downside risk is capped. Even in the worst-case scenario, most equity-linked notes offer full principal protection. That is what makes this type of a structured product appealing to 澳洲幸运5官方开奖结果体彩网:risk-averse investors who nevertheless have a bullish outlook on the market. That said, equity-linked notes only pay on maturity, so there is an 澳洲幸运5官方开奖结果体彩网:opportunity cost for locking in🍃 that money if only the principal is returned in the end.

How ELN Work

In the simplest form, a $1,000 5-♎year equity-linked note could be structured to use $800 of the fund to buy a 5-year strip bond with a 4.5% yield-to-maturity and then invest and reinvest the other $200 in call options for the S&P 500 over the 5-year life of thꦚe note. There is a chance that the options will expire worthless, in which case the investor gets back the $1,000 initially put in. If, however, the options appreciate in value with the S&P 500, those returns are added to the $1,000 that will eventually be returned to the investor.

Equity ✱Linked Note Caps, Participation Rates, and Levꦏerage

In practice, an equity-linked note will have a 澳洲幸运5官方开奖结果体彩网:participation rate, which is the percentage amount that the investor in the note participates in the appreciation of the underlying equity. If the participation ra▨te is 100%, then a 5% increase in the underlying is a 5% increase for the eventual payout on the note. However, the cost of struc🍒turing the ELN and managing it can lower the participation rate. In the case of a 75% participation rate, for example, a 5% appreciation in the underlying is only worth 3.75% to the investor. 

Equity-linked notes can also use different structures and features. Some will use an averaging ✃formula to smooth out returns on the equity-linked porti💛on or a periodic cap that limits the ELN’s upside by realizing returns at a particular level on a regular basis. There are also types of equity-linked notes that use dynamic hedging instead of options, deploying leverage to increase returns from the underlying equity. Overall, equity-linked notes can be a powerful tool for investors who want to protect their principle while still having the potential upside of an equity investment.