Accelerated Return Note - Explained
What is an Accelerated Return Note?
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Table of ContentsWhat is an Accelerated Return Note?How does an Accelerated Return Note Work?Example of an Accelerated Return NoteAcademics Research on Accelerated Return Note (ARN)
What is an Accelerated Return Note?
An accelerated return note (ARN) refers to a debt instrument that offers a leverage return, that is a higher return to investors based on the performance of the market index. ARN is a type of debt instrument is unsecured, this is because it fails to protect investors with regard to a decline in the rate of return. Investors are pitched in different tents when it comes to accelerated return note, this is because it typically benefits investors that believe in a higher return based on the fact that the reference index would appreciate. However, in cases where the reference stock depreciates, ARN does not give any protection to investors.
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How does an Accelerated Return Note Work?
Accelerated return notes are able to offer higher return in the market using the performance of a reference index, this means the performance of this index determines how the return would look like. ARN is a form of structures investment products (SIPS), there are products that base their strategies on a basket of securities or a single security in the investment market. Just like their SIPS, an accelerated return note stimulate a high return rate for investors using the reference index in the market. Despite that ARNs offer higher returns, they are not reliable due to their insecurity, they are risky. Investors seeking capped return often benefit from ARNs while those seeking uncapped returns find ARNs unsuitable.
Example of an Accelerated Return Note
Below is an example of accelerated return note; Assuming a particular ARN selects the S&P 500 as its reference index and the aren was initiated when the index was 2,000 with a maturity period of two years and $100 as its principal amount. A positive performance of S%P 500 will be profitable to investors who use the ARN, the return can be double the positive performance. The maximum return on ARN is 30% with a 100% exposure to the performance and risk of the reference index. For instance, if the S&P 5pp selected as the index reaches 2,500 at the end of two years, that means the return investors will benefit is 25% return. If it is however twice this amount, the return is 50% but because the maximum return on ARM is 30%, an investor is only entitled to $130 ($100 principal amount plus $30 return). On the other hand, if the S&P 500 is 2,200 in two years, the investor would earn two time of the return of 10% which is 20% giving a total of $120 at the maturity period. If the reference index decreases, it amounts to loss for the investor. For example, if the index is 1, 500 in two years then the return will be a -25% deficit, leaving the investor with $75 as against his principal amount of $100.