What’s Ahead:
- Structured Notes can turn traditional equity returns into an income stream
- Memory Notes are a type of Income Note that “remembers” missed coupon payments and can pay them when the Note’s Underlier recovers from losses
- Investors seeking to increase portfolio yield or more consistent positive return outcomes tend to appreciate this Note Payoff type
Market Exposure with Yield Enhancement
If you’re interested in generating a potentially high yielding income stream that comes with a degree of volatility protection, then Memory Income Notes, one type of Structured Note payoff, may be an appealing investment.
But first, a couple basics:
- Structured Notes are like a hybrid between a stock and a bond. Although they are technically bonds, their market value typically derives from the return of a stock or index, called the Underlier.
- The Structured Note has performance terms that adjust the return of the Underlier to determine the Structured Note’s return. Those adjustments are commonly in the form of protection against negative returns and enhancement of positive returns.
What Differentiates Income Notes
One type of Structured Note is an Income Note — it generates returns differently from traditional investments. Usually, an investment’s returns come in the form of growth (price appreciation) and income (stock dividends or bond interest).
Income notes, on the other hand, generally produce their entire return in the form of income. That can be especially helpful for investors who are looking to increase the income yield of their portfolio and to generate more consistent positive returns.
Memory Note Specifics
Income Notes have periodic coupon payments, just like a traditional bond. However, there is an interesting contingency when it comes to Memory Note coupons. On the dates when coupons are scheduled to be paid, the Underlier’s performance is “checked” to fall into one of two categories:
- The Underlier’s return is above the Coupon Barrier Level: the Memory Note’s coupon is paid
- The Underlier’s return is below the Coupon Barrier Level: the Memory Note’s coupon is not paid, but it is “remembered” for potential payment in the future
Missed coupons accrue and can be paid in a lump sum if the Underlier recovers from below the Coupon Barrier Level on a Coupon Payment Date.
If the Underlier doesn’t recover that level on any of those dates, the missed coupons will not be paid.
Why would investors take the risk that coupons wouldn’t be paid? Very simple: this type of Income Note would have a higher yield than a Fixed Coupon note, holding all else equal.
In conclusion, investors seeking to generate potentially attractive income yield and expect an upward-sloping Underlier return may consider a Memory Note as a downside-protected complement to traditional income sources.
Please see our other important disclosures.
DISCLOSURE:
This document is intended for institutional investors and/or wealth advisers only, and is not intended for distribution to others. Halo Investing, Inc.(“HII”) is a parent company of Halo Securities, LLC. HII is not a registered broker-dealer or registered investment adviser. Securities are offered through Halo Securities, which is an SEC registered broker-dealer and member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Investor Protection Corporation(“SIPC”). Halo Securities acts as distributor and selling agent for certain securities offerings and is not the issuer or guarantor of any security
What are Structured Notes?
Structured notes are securities Issued by financial institutions whose returns are based on, among other things, equity indexes, a single equity security, a basket of equity securities, interest rates, commodities, and/or foreign currencies. Thus, your return is “linked” to the performance of a reference asset or index. Structured notes have a fixed maturity and include two components–a bond component and an embedded derivative. Financial institutions typically design and issue structured notes, and broker-dealers sell them to individual investors. Some common types of structured notes sold to individual investors include: principal protected notes, reverse convertible notes, enhanced participation or leveraged notes, and hybrid notes that combine multiple characteristics.
Risks and Other Considerations with Structured Notes Complexity
You and your broker should take time to fully understand the manner in which your return on a structured note is calculated. You should understand the reference asset(s) or index(es) and determine how the note’s payoff structure incorporates such reference asset(s) or index(es) in calculating the note’s performance. This payoff calculation may include leverage multiplied on the performance of the reference asset or index, protection from losses should the reference asset or index produce negative returns, and fees.
Participation rates
Some structured notes provide a minimum payoff of the principal invested plus an additional payoff to you based on multiplying any increase in the reference asset or index by a fixed percentage. This percentage is often called the participation rate. A participation rate determines how much of the increase in the reference asset or index will be paid to investors of the structured note. For example, if the participation rate is 50 percent, and the reference asset or index increased 20 percent, then the return paid to you would be 10 percent (which is 50 percent of 20 percent).
