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 products.
Most equity-linked notes are not actively 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.
A typical ELN is principal-protected, i.e. the investor is guaranteed to receive 100% of the original amount invested at maturity but receives no interest.
Usually, the final payout is the amount invested, times 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). Generally, the participation rate is better in longer maturity notes, since the total amount of interest given up by the investor is higher.
Usually, an equity-linked note can be thought of as a combination of a zero-coupon bond and an equity option with appropriate prices. Indeed, the issuer of the note usually covers the equity payout liability by purchasing an identical option. In some equity-linked notes, the payout structure is more complicated, resembling that of an exotic option.
- Equity-Linked Notes: An Introduction
- Are Structured Products Suitable for Retail Investors?
- Equity-Linked Note (ELN) on Amex.com
- Equity Linked Note Structures article on Financial-edu.com