Structured Products

A structured product is an investment instrument embedded with derivatives under which it's return is determined by reference to changes in the price value and / or level of one or more reference underlying (e.g. securities, commodity, index, interest rate, currency exchange rate); and / or the occurrence or non-occurrence of an event.

 

Understanding Equity-Linked Notes (ELNs)

Equity-Linked Notes (ELNs) is a structured product that combines a debt instrument with an option. There is no guarantee that holders of the ELN will get a return. Return of an ELN is usually determined by the value of a single stock, a basket of stocks, or an equity Index at a future valuation date.

Investment Risks of ELNs

Investors are strongly advised to consult a qualified investment advise or before investing in ELNs.

An Equity-Linked Note is a risky yield-enhancing alternative investment product traded over-the-counter. It is a combination of a debt instrument and an option on an underlying that enables an investor to make a directional bet on the upside (Bull note), the downside (Bear note) or within a trading range (Strangle note) of the underlying. The underlying may be a single stock, a basket of stocks or an equity index. It is the performance of the underlying that usually determines the return on an ELN.

An investor who purchases a bull note is effectively writing a put option and hence expects the value of the underlying to be stable or rise in the medium term. The "enhanced yield" is the sum of the interest received from the note plus the premium from writing the put. A bull note is issued at a price below its par value at the beginning of the term, and the strike price of the embedded put is set below the value of the underlying (i.e. an out-of-money option). At expiry, if the value of the underlying remains above the strike price of the put, then the investor will earn the "enhanced yield" (i.e. redeem at par).

However, if the value of the underlying ends below that strike price (i.e. expired in-the-money), the investor will be under obligation to receive in lieu of a cash return a number of units of the underlying equivalent to the initial par value of the note divided by the strike price of the put.

The investor will break even if the value of the underlying is equal to the product of the percentage issue price of the bull note and the strike price of the put.

Below this point, the investor begins to lose money.

A bear note is the opposite to the bull note. An investor purchases a bear note writes a call option and hence expects the value of the underlying to be stable or fall in the medium term. Again, the "enhanced yield" is the sum of the interest received from the note plus the premium from writing the call option. A bear note is also issued at a discount to par value, however, the strike price of the embedded call is set above the value of the underlying (i.e. an out-of-money call). At expiry, if the value of the underlying remains below the strike price of the call, then the investor will earn the "enhanced yield" (i.e. redeem at par). However, if the value of the underlying ends above that strike price (i.e. expired in-the-money), the investor will begin to suffer a loss equivalent to:

Depending on the upside on the value of the underlying, it is possible for the ELN investor to lose his entire investment.

Before subscribing to this kind of products, investors should endeavour to understand the risk associated with such products and carefully assess the suitability of such products in relation to their personal risk and return objectives, investment constraints and other unique circumstances. Investors should be aware that:

  • Neither principal is protected nor return of the investor is guaranteed.
  • Should the value of the underlying move against the investors' directional bets, they could lose their entire principal in extreme cases.
  • Return on an ELN is predetermined. Investors will not gain more than the amount specified in the purchase terms.
  • Return payable on an ELN is set at a specific time on a predetermined valuation date; therefore, fluctuations in the value of the underlying before and after the specified time are irrelevant.

To obtain more details on ELNs, please visit the Investor Education Centre at www.hkiec.hk.