Equity-Linked Note (ELN) is a structured product that includes a fixed rate of the return and yield tied to the dynamics of shares - basic assets, which allows investors to obtain potentially higher income than traditional bonds. Usually ELNs provide complete protection of capital assets.
ELNs are usually floating rate products that are directly linked to the stock performance. ELNs can have different configurations, but most often they have a built-in call option on a specific asset such as stocks / stock basket / indices.
ELN instruments are also characterized by the participation rate for investors, which is initially fixed. It is assumed that with an increase in the underlying asset, for example, by 10%, payments to the investor will also grow by 10%. At the same time, the costs of structuring a product can reduce the participation rate, let’s say, to 8.75% for an investor with a 10% increase in the underlying asset.
There are also types of ELN instruments that use dynamic hedging instead of options, using leverage to increase the income from the underlying asset.
An example of instrument structuring: ELN with a value of $ 100 - $ 80 to buy a strip bond with a yield to maturity of 4.5%, the investor reinvests $ 20 in a call option on the index. In this case, even if the call option depreciates, the investor will still return the original $ 100. If the option rises in price, the investor will return the initial $ 100 and additional income from the option.
Equity-Linked Note Example