Introduction
You may have a thin line of difference between analyzing which is the right investment platform for you to work on and which one isn’t. That being said, you cannot deter yourself from not getting into the investment domain because of the growing inflation rates across the US and other major economies surrounding the world.
You need a protection cover to secure future generations and getting into the right investing platform alone can help you do that. The knowledge know-how is the first prerequisite in getting started. Getting acquainted with how investment schemes work can help you with well-informed ideas on how to proceed further.
On this note, let us discover how reverse equity-linked note works:
Reverse Equity-Linked Note- Meaning And Conceptualization Explained
Reverse Equity-linked notes can also be called RELNs. The RELN or the reverse equity-linked note is another variant of equity-linked notes.
The RELNs are structured products investors use to enhance their yields in stocks over stable or mildly bearish market conditions. The stocks are usually sold when the bearish conditions are acute. And, the stocks are sold at the existing sale point values.
The RELNs are meant for investors who would want to invest while the market conditions are usually stable or indicate mildly bearish scenarios. The investment in RELNs usually happens wherein the stocks that are linked as underlying assets to the notes lie outside of the dividend payout term.
This is mainly because if they invest their stocks in reverse equity-linked notes at a time when dividend payouts are about to be disbursed, they would lose out on the same. This explains the out-of-the-box scenario wherein the stocks stand deposited with RELNs and investors lose the dividend earnings as in when they had invested in direct investments.
The RELNs are meant for sophisticated investors belonging to retail as well as institutional markets. However, these are investment options only meant for those who can handle a reasonable level of risk tolerance under their belt. In other words, this is an investment option that is not suitable for those of you who are against taking risks.
Know-How On The Process Mechanism
Let us discover how the process mechanism works with RELNs. Helping you through with suitable pointers:
- Strike Pricing Done At A Premium
For an RELN, the strike prices are usually done at a premium value. The strike price is greater than the original purchase price in this scenario. The purchase price can also be called the ‘spot market price’
This is the security linked to the structured note and therefore the RELN is a financial instrument whose initial price is lower as compared to the strike unit.
- Illustration Using The Concept
- Underlying asset- Stock A
- Spot Market price- $16.00
- Strike price- $16. 80
- Strike level= 105%
Therefore, the original market price here is 16 dollars while the achievable strike price is $16.80. When the underlying asset reaches $16.80 which is 105% of the original market price, then the strike price at 105% of the initial spot price is achieved. In other words, the spot price goes above 105 percent of what it was when it was purchased. The investment option is suitable for investors who want tangible income resources.
3. Graphical Chart Representing The Same
Here is a graphical representation of the same:
Image Courtesy: https://www.dbs.com
4. What Happens Next?
When the strike prices are achieved by the stock or the underlying asset of the RELN, then investors receive their principal amount in cash. The interest that accrues on the portfolio also gets paid out.
On the other hand, if the strike price is not achieved by the underlying stock, then the investor gets the deposited shares in lieu of the principal amount. The interest earned during that period is paid out as a cash settlement.
Therefore, this is a win-win situation for the product issuer and the investor.
5. Unveiling A Graphical Representation Of The Same
Here is a sample of the working mechanism in the form of a graphical infographic:
Image Courtesy: https://www.dbs.com
Here is how the payment scenario looks like:
Image Courtesy: https://www.dbs.com
Key Takeaways From The Process Know-How
The RELNs have a portfolio of stocks at the prevailing market prices and these are supposed to go above strike values during the tenor of the asset. Once this happens, investors get their initial principal and the agreed interest amount.
On the other hand, if the underlying financial instrument goes below “strike rates”, investors receive the stock’s market value in the form of shares.
What Are The Main Benefits That Are Associated With RELNs
These are the following benefits of RELNS:
- Yield Enhancement For Reverse Equity-Linked Note
Investors can use a reverse equity-linked note as a yield enhancer. RELNs can fetch you enhanced yields on stocks if your purview of how the underlying assets behave in bearish market conditions turns correct or precise.
- Customization Of Product Selection
These are investment products that can be customized or tailor-made based on the investor’s independent requirements and preferences. This is because you get to choose the underlying stocks, tenor, and strike prices. This way, you stand at an advantageous edge because you structure your product based on the risk profile you carry under your belt.
- Short-Term Investments
The RELNs are typically short-term investment products wherein the range of the investing period varies between 1 and 3 months. Therefore, investors need not cope with a hold-up time with respect to these. Therefore, these are close trade off products wherein price drops or default stock prices determine the capital and coupon rates for the investors on the whole.
What Are The Main Risk Factors That Are Connected With RELNs?
These are the main risk factors that are connected with RELNs. Let us see what they are:
- Credit Risk
Investors are at the risk of losing their principal investments if the credibility of the product issuing firm is at stake. For instance, if the issuer of RELNs signs up for bankruptcy, then you may lose the entire value of your investment.
- Potential Returns Cannot Be Determined That Easily
As the notes are linked to underlying equity or stocks, you never know how much returns you get at the end of the term asset. Sometimes, these stocks can be auto-called by product issuers if the market prices go up. Are relns suitable for you or not? Understanding the risks of relns will let you decide the same. Knowing about tax implications at a glance is also a requirement you must analyze beforehand.
The Bottom Line
Reverse equity-linked notes are mainly meant for investors who may want to hedge their stocks over a shorter duration of time. You may have a time-out period between receiving the dividend earnings and your investment redemption. To offset this period, investors mainly invest in stock-based RELNs.
The stocks rise if the market is stable or mildly bearish scenarios. Strike prices indicate if investors receive their principal amount as a cash settlement or receive the payout in the form of underlying shares of the said company. The stocks are usually sold when you have a strongly bearish view. These are more predictable products for investors who know how call or put options work on equities or derivatives.
You can look for financial institutions that prevail in the US, Singapore, or other advanced economies wherein you receive structured products like eln or relns at discounted or nominal values. You must comprehend the product to know if relns work under different market scenarios.
What are your thoughts on this? Do let us know in the comments!
