Upside and fixed income don’t always go together, but in the case of equity-linked notes, they can fit together like two peas in a financial pod. An equity-linked note (ELN) is a hybrid financial instrument that combines a non-traditional fixed-income investment with exposure to an underlying stock or equity index. It offers investors a way to earn higher returns than traditional bonds, but still offers a level of downside protection. ELNs aren’t something shiny and new; they’ve been around for a while, and have gradually increased in popularity. Here’s how they work and whether they might make sense for you.
Understanding equity-linked notes
An equity-linked note is fundamentally a debt instrument, similar to a bond, that ties its return to the performance of a specific underlying stock. It’s issued by a bank or financial institution and has a set maturity date, like any traditional note. Unlike a normal run-of-the-mill bond, the payment out at maturity is variable, since the underlying equity price is also variable.
Most ELNs offer a fixed coupon or potential return, provided certain conditions are met. If the equity performs well (usually staying above a certain price level called the 'barrier'), the investor receives a premium or full repayment with interest. If the equity falls below a predetermined barrier or “knock-in” level, the investor may receive shares instead of cash, or in many cases, take a partial loss. ELNs are part bond, part stock option, and are designed for equity investors who want structured risk/reward payments.
Related investment topics
Terms | |
|---|---|
Investment | $100,000 |
Duration | 6 months |
Barrier level | 80% of Apple’s current price ($160 if Apple is at $200) |
Coupon: | 9% return if Apple stays above $160 |
Here’s how it works in basic terminology If Apple’s stock finishes above $160 when the investment ends, the investor just gets their money back plus a 9% return, so $109,000 on a $100,000 investment. But if Apple’s stock is below $160, the investor doesn’t get cash back; instead, they get 625 shares of Apple at that lower price. If the stock dropped a lot, those shares might be worth less than what they were originally invested. So the return revolves entirely around Apple’s price.
