Targeted Accrual Redemption Note (TARN)

What Is a Targeted Accrual Redemption Note?

A targeted accrual redemption note (TARN) is an exotic derivative that ends when a limit on coupon payments to the holder is reached.

Target accrual redemption notes (TARN) have the distinctive feature of being subject to early termination. On the off chance that the accumulation of coupons arrives at a foreordained amount before the settlement date, the holder of the note gets a last payment of the par value and the contract closes.

Understanding Targeted Accrual Redemption Notes (TARNs)

A targeted accrual redemption note is basically an index-linked note that has a set amount of coupons that address the target cap. After the target cap is reached, the note will be ended with the par of the note being paid. So there is typically an alluring initial coupon combined with the possibility of getting back the par value generally fast. An index-linked note an investment product that joins a fixed-income investment with extra potential returns that are tied to the performance of an equity index like the S&P 500 index.

Beside these index-linked features, TARNs are like inverse floating-rate notes where the benchmark might be LIBOR, Euribor, or a comparable rate. TARNs can likewise be conceptualized as path-dependent options: the end-client in effect purchases a strip of call options while selling a strip of put options with a notional value that is double the calls'. The contract might incorporate a knock-out provision that ends it in the event that the benchmark arrives at a certain level.

Foreign exchange TARNs or FX-TARNs are a common form of TARN where counterparties exchange currencies at a pre-decided rate on pre-decided dates. The amount of currency exchanged shifts relying upon whether the rate is above or below a set forward price.

Valuation of Targeted Accrual Redemption Notes (TARNs)

The valuation of targeted accrual redemption notes can be testing in light of the fact that the redemption courses of events are dependent on the coupons received to date. When the knock-out level is reached, the investment is ended and the principal is repaid. According to an investor's point of view, a great initial coupon rate for a period and an early return of capital is an optimal outcome. Be that as it may, contingent upon how the indexed rates perform, an investor might be trapped in the investment and see the time value of money disintegrate what was once an alluring more limited term investment.

Generally talking, the value of a note is the current value of the par and coupon payments. Nonetheless, there is uncertainty with targeted accrual redemption notes in light of the fact that not all coupon payments will essentially be received. So rather than a linear calculation on present value, a TARN requires a simulation of interest rate volatility to survey the likelihood of triggering the knock-out level given the terms of the note. TARNs tied to unstable benchmarks will fundamentally be more hard to value accurately.

Features

• The cap alludes to the maximum amount of accumulated coupon payments received.
• FX-TARNS are linked to an index of currencies as opposed to equities.
• A targeted accrual redemption note (TARN) is an index-linked derivative containing a target cap.
• When the cap has been reached, the note automatically ends.