Accelerated Return Note (ARN)

What Is an Accelerated Return Note (ARN)?

An accelerated return note (ARN) is a short-to medium-term debt instrument which offers a possibly higher return linked to the performance of a reference index or stock.

Understanding an Accelerated Return Note (ARN)

Accelerated return notes (ARNs) are a type of structured investment product (SIP), otherwise called a market-linked investment. Structured products are a packaged investment strategy in light of a single security, a basket of securities, options, indices, commodities, debt issuances, foreign currencies, or derivatives.

Structured products are intended to work with highly altered risk/reward objectives. They achieve this by taking a traditional security, for example, a conventional investment-grade bond, and supplanting the typical payment highlights with contemporary payoffs.

Traditional payoffs incorporate intermittent coupons and last principals. Contemporary substitutions incorporate payoffs derived not from the issuer's cash flow, but rather from the performance of at least one underlying assets.

An ARN generally caps the total return it will give however typically offers no downside protection. It would benefit those investors who accept the reference index, or stock, will appreciate just possibly however won't decline strongly until the ARN matures.

ARNs are complex and can be risky. They are unsuitable for investors that require 100% principal repayment at maturity as in a Treasury or investment-grade bond. They are additionally unsatisfactory to investors seeking an uncapped return on investment in exchange for accepting 100% downside risk.

Accelerated Return Notes (ARNs) in the Financial Markets

Accelerated return notes (ARNs) appeared in the financial markets in 2010 and were principally offered by Merrill Lynch and Bank of America. The products were promoted with a return of 2x to 3x the reference index through leverage employed by the utilization of derivatives, for the most part call options and futures.

The products were generally offered with a return cap of 18% to 25% and any returns over that amount were taken by the issuer. A large portion of these notes expired in 2013 and are not widely accessible any longer, probably due to their high risk and low liquidity.

Illustration of an Accelerated Return Note (ARN)

Consider an accelerated return note (ARN) that is linked to the S&P 500 and is sent off when the index is at 2,000. The accelerated return note (ARN) is priced at a $100 principal amount and develops in two years.

At maturity, it offers investors an upgraded return equivalent to two times (2x) any positive performance in the underlying S&P 500 index. The ARN is dependent upon a maximum gain of 30% and the investment has exposure to 100% of any decline in the S&P 500. The returns would change as follows relying upon the scenario when the ARN develops.

The S&P 500 is at 2,500 out of two years: The S&P has had a return of 25% while two times the S&P 500 return is half, and the maximum return on the ARN is 30%. An investor in the ARN would receive $130 at maturity for a 30% return.
The S&P 500 is at 2,200 out of two years: The S&P has had a return of 10%, two times of which is 20%. An investor in the ARN would receive $120 at maturity for a 20% return.
The S&P 500 is at 1,500 of every two years: The S&P has had a return of - 25%. The ARN investor has exposure to 100% of a lessening in the index, so would receive $75, addressing a return of - 25%.

Highlights

The payoff of an accelerated return note (ARN) is contemporary, implying that the payoff doesn't come from the issuer's cash flow but instead the performance of at least one underlying assets.
Investors purchase accelerated return notes (ARN) when they accept that the reference index will increase in value.
An accelerated return note (ARN) is a type of structured investment product (SIP) that offers a possibly higher return that is linked to the performance of a specific reference index or stock.
The total return of an accelerated return note (ARN) is typically capped and they offer no downside protection.
The higher returns from an accelerated return note are due to the leverage employed using derivatives.