What is a Principal-Protected Note?

A principal-protected note (PPN) is a type of security where the bondholder is guaranteed to receive the amount of capital originally invested at the minimum if the security is held to maturity. The performance of the underlying assets in a PPN does not deter the payment of the principal amount. Principal protected notes are otherwise called guaranteed linked notes. These are forms of investments that are most suitable for investors seeking to protect their principal amount (initial amount invested) while partaking in the market gains. However, in a principal-protected note, bondholders do not receive coupon payments on time, because the issuer doesn't pay them on time.

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How Does a Principal-Protected Note Work?

A principal-protected note offers a major benefit to investors in the sense that the return of the principal amount invested is guaranteed, as long as the investor holds the note to maturity. While the performance of the underlying assets does not impede the payment of the principal amount, the returns can be affected. Usually, Principal-protected notes have small fixed returns. As a structured finance product, PPN is a zero-coupon bond that offers no interest payment and payment of principal amount until the bond matures. However, the promise to make full payment of the principal amount after the bond matures is subject to the creditworthiness of the issuer who is also the guarantor. Despite that principal-protected notes feature a guaranteed payment of the principal amount, there are exceptions to the payment. For instance, if the issuer has poor creditworthiness or goes bankrupt, he may default on most of its payments. PPNs can have long-term maturity periods, hence not attractive to investors who do not seek to hold down their capital for a long time frame. Since investors must hold the bonds or notes until full maturity before they can receive full principal payment, early withdrawal can cause a reduction in the amount received.

Limitations on Principal-Protected Notes

A principal-protected note (PPN) is a type of security where the bondholder is guaranteed to receive the amount of capital originally invested at the minimum if the security is held to maturity. The performance of the underlying assets in a PPN does not deter the payment of the principal amount. Principal protected notes are otherwise called guaranteed linked notes. These are forms of investments that are most suitable for investors seeking to protect their principal amount (initial amount invested) while partaking in the market gains. However, in a principal-protected note, bondholders do not receive coupon payments on time, because the issuer doesn't pay them on time.

The major downsides to principal-protected notes include the following;

• The guarantee of principal amount payment is subject to the creditworthiness of the issuer.
• Ignorant investors who have no full knowledge about the notes are often talked into buying them by brokers.
• PPN offers no tax benefits as returns are taxed as ordinary income.
• Individual PPN securities are sometimes complicated.