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Accelerated Return Note (ARN) Definition
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.
A Little More on What is Accelerated Return Note (ARN)
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.
Reference for “Accelerated Return Note (ARN)”
Academics research on “Accelerated Return Note (ARN)”
Open to disclosure, Becker, L. (2014). Open to disclosure. Risk, 52.
New evidence on the financialization of commodity markets, Henderson, B. J., Pearson, N. D., & Wang, L. (2014). New evidence on the financialization of commodity markets. The Review of Financial Studies, 28(5), 1285-1311. The research looks into Commodity linked notes and the influence it has on financial investments. It makes use of unique data of the commodity linked notes to explore the influence of the flows of the financial investors on future prices. The movements are not based on the data about future price drifts but however, results to either an increase or decrease in future pricing. This change is as a result of passing the CLNs through to and withdrawing them from the future markets. The flows into and out of CLNs from the future markets is through issuers’ trades to evade the liabilities arising from CLN. The results confirms that non-information based financial investments have significant effects on commodity prices.
Accelerated Capital Recovery, Debt, and Tax Arbitrage, Warren Jr, A. C. (1984). Accelerated Capital Recovery, Debt, and Tax Arbitrage. Tax Law., 38, 549. The article considers the policy in place that discusses on accelerated capital recovery, debt and tax arbitrage. It further looks into the new Treasury tax reforms proposals and its limitation to the recovery of capital costs. The major focus for the discussion is a combination of interest on both taxed and exempt income. However the Code limits the deductibility of the interests incurred in relationship with a number of exempt income. It is worth to note that accelerated capital recovery has not yet received the attention needed. Tax arbitrage may at times involve transactions with no effect on an investors net worth apart from the taxes therein.
Modeling autocallable structured products, Deng, G., Mallett, J., & McCann, C. (2011). Modeling autocallable structured products. Journal of Derivatives & Hedge Funds, 17(4), 326-340. Autocallable structured products have experienced continuous growth since 2003. Research on the same shows a sharp increase in 2007 and thereafter a steady growth of 40% annually. Its features causes the products to be highly redeemable as it reduces its duration and anticipated maturity. This is so because the product matures immediately it is called. The article presents a flexible Partial Differential Equation framework, which values products with distinct call dates using the finite difference method and continuous call dates using a closed-form solution. It further estimates the probability of an autocallable structured product being called on each call date and advise investors on the same.
Reducing barriers to microfinance investments: The role of structured finance, Glaubitt, K., Feist, J., & Beck, M. (2009). Reducing barriers to microfinance investments: The role of structured finance. In New partnerships for innovation in microfinance (pp. 335-364). Springer, Berlin, Heidelberg. Dynamic changes have been witnessed in the microfinance industry. With close to 100 million clients worldwide and continuously growing, Microfinance is playing a significant role in contributing to the UN Millennium Development Goals. However access has been limited to clients from low income households because of inadequate funding thus limiting its potential growth and vast outreach. It is key to note that microfinance institutions (MFIs) can finance their growth by systematic mobilization of local savings, commercial refinancing loans and retained earnings. Others include equity and long term funding and grants for technical assistance. It further suggests that MFIs can maximize their full potential by developing new and innovative ways to upscale sustainable microfinance and integrate the MFIs fully into local and international financial markets.