The term structured notes or “structured note with principal protection” refers to any structured product that combines a bond with a derivative component and that offers a full or partial return of principal at maturity. Structured products in general do not represent ownership of any portfolio of assets but rather are promises to pay made by the product issuers. Structured notes with principal protection typically reflect the combination of a zero-coupon bond, which pays no interest until the bond matures, with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The investor is entitled to participate in a return that is linked to a specified change in the value of the underlying asset.
The retail market for structured notes with principal protection has been growing in recent years. While these products often have reassuring names that include some variant of “principal protection,” “capital guarantee,” “absolute return,” “minimum return” or similar terms, they are not risk-free. Any promise to repay some or all of the money invested will depend on the creditworthiness of the issuer of the note and investors could lose all of their money if the issuer of the Note goes bankrupt.
Many Structured Notes Offer Only Partial Protection
Moreover, many of these products are loaded upon with conditions as to the protection, or which only offer partial protection. In these cases, investors will lose their principal investment even if the issuer does not go bankrupt. Of those notes where investors will receive some principal protection from the issuer, investors are required to hold these investments until maturity.
Also, any guarantee that the principal will be protected, is only as good as the financial strength of the company that makes that promise.
In other words, the principal guarantee is subject to the creditworthiness of the guarantor, which is generally the securities firm that structures and issues the note. In the event the issuer goes bankrupt, investors who hold these notes are considered unsecured creditors and might recover little, if anything, of their original investment.
Investors needing cash before maturity, need to know that no secondary market often exists for them to sell these notes and there is no obligation for the issuer to repurchase them. Even where a secondary market exists, investors can only expect to receive pennies on the dollar.
The bottom line for investors is that structured notes with principal protection can lose their entire investment or depending on how the note is structured, could tie up their principal for upwards of a decade with the possibility of no profit on your initial investment.
Guiliano Law Group
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