Accelerated Return Note Details

A Return is a loss or gains made on security over a particular period, while an accelerated return is a short term to medium term period debt device. The notes offer a capped leverage return but not drawback protection. Based on its failure to protect investors regarding the decline in return rate, the term is unsecured.

When it comes to accelerated return notes, investors pitch in different tents; this is because it automatically benefits investors that believe in a higher return based on the fact that the reference index will appreciate.

Unfortunately, ARN does not provide any protection to investors in cases where the reference stock index depreciates. Since accelerated return notes offer a higher return in the market using a reference index's performance, the determinant of how a return would look is the reference index.

ARN is a form of structured investment products (SIPs); some products base their strategies on a basket of securities or single security in the investment market. Like their SIPs, an accelerated return note stimulates a higher return rate for investors using the market reference index. Even though ARNs offer higher returns, they are not reliable due to their insecurity, and they are highly risky.

An accelerated return note's suitability depends on the interest rate limit on a variable rate product credit. Those investors who seek capped returns often benefit from ARN's usefulness, while those seeking uncapped returns find ARNs unsuitable.

A cap sets the threshold on how much interest a creditor can earn and how much interest a borrower has to pay. The cap benefits borrowers because it limits the level of interest they must pay in a rising rate environment. Some other related terms include -

  • Structured Investment Products, or SIPs: a type of investment that meets specific investor needs with a customized asset mix. They have derivatives and are often created by investment banks for hedge funds, retails, or organizations.
  • Mutual Funds: An investment vehicle consisting of a portfolio of stocks, bonds, or other securities overseen by a professional money manager. Different investors usually collect from this pool of money.
  • Notes: A note is a financial security that generally has a shorter term than a bond but a longer-term than a bill.
  • Junk Bonds: Junk bonds are debt securities rated poorly by credit agencies, making them highly risky with a higher-yielding than investment-grade debt. Compared to other bonds issued by governments and corporations, junk bonds carry the highest risk of default.

Example of an Accelerated Return Note

Assume that a particular accelerated return note chooses the Standard & Poor (S&P) 705 as its reference index, the ARN was initiated when the index was 1,000 under a maturity period of two years, and $200 was its principal amount.

The positive performance of S&P 705 will benefit investors who use the ARN, and the return can double the positive performance. The greatest return on any ARN is 30%, with 100% exposure to the reference index's account and risk.

For example, suppose the S&P 500 is chosen as the index reaches 2,500 at the end of two years. In that case, the return investors will benefit from a 25% return. In the unlikely scenario that it is twice this amount, the return is 50%. However, because the maximum return on ARN is 30%, an investor is only entitled to $2300 ($200 principal amount plus $30 return).

On the other hand, if the S&P 500 is 2,200 in two years, the investor will earn two times the return of 10%, 20% providing a total of $220 at the maturity period. Achieving higher returns from an accelerated return note happens because of the leverage employed through derivatives.

If the reference index decreases, it amounts to a loss from the investment. For example, suppose the index is 1,500 in two years. In that case, the return will be a -25% deficit, leaving investors with $175 as the return against their principal amount of $200.

Accelerated return note (ARN) is a type of market-linked investment known as a structured investment product (SIP). Structured products are a packaged investment strategy based on a single security, a basket of indices, commodities, securities, options, foreign currencies, debt issuances, or derivatives.

Accelerated Return Note Vs. Leveraged Loan Index

An accelerated return note (ARN) is a type of structured investment product (SIP) offering a potentially higher return and is linked to the performance of a specific reference index or stock. A leveraged loan index is an index that is market-weighted and tracks the performance of leveraged institutional loans.

A leveraged loan is an obligated senior secured debt rated below investment grade, making it part of the junk bond market, traded in the secondary market. It keeps track of all the current loans' prices in the market and receives its structure through syndication.

Loan syndication is the process of combining a group of lenders to fund various loan portions for a single borrower, often to diversify the exposure of credit risk on any single lender. This version of a leveraged loan index is a standard benchmark that generally represents the 100 most extensive and most liquid issues of the institutional loan universe.

Standard & Poor's (S&P) and the Loan Syndications and Trading Association (LSTA) developed the most popular leveraged loan index (LLI). The indexes are rebalanced twice a year. The sub-index of the two (S&P and LSTA) operates as the leveraged loan 100 globally and on its own, to include significant issuers in Europe.

A Leveraged Loan Index serves as a benchmark for performance measurement of fund managers dedicated to leveraged loan investment strategies and as a basis for passive investment vehicles such as Exchange-Traded Funds (ETF).