What are Equity Linked Notes?
Equity-linked notes (ELNs) are a type of debt instrument which are similar to fixed income security but the risk involved in this instrument depends on the market movement of particular stock or security an individual invests. The equity-linked note is basically a short-term instrument trade for 1 to 4 months in which investors are allowed to purchase their selected security at a discount price from the market price which results into a high return to an investor. Similarly, there is another term called Reversed Equity Linked Notes (RELNs) under this instrument an investor has an option to sell their selected security at a higher price than the price prevailing in the market. In short Equity, Link Notes are the instrument which helps an investor to get a high return from various type of security but the amount of risk involved in of the security will highly depend on the market movement
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How do Equity Link Notes work?
Investors who invest under equity-linked notes have an option to bid the price of their security on the basis of the market expectation. When an investor bids its investment at a particular price it is known as the strike price for that investor and according to the market, movement investors will fall under various situations to earn their return.
Let’s say for example,
- A share is having Rs. 100 as it market price and an investor has put its strike price to 90% of the share price this means that when the price of share fall below 90% the issuer will deliver the share to the investor this is the first scenario.
- In the second case if the price of the share moves above the strike price then in this scenario an investor will receive his entire principal amount along with the yield generated by the share.
- And in the third case, if the price of share comes to zero because the company has made any default or speculation of the share had occurred or because of any reason if the price comes to zero then the investor will lose his return along with the principal amount he invested in the share.
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Benefits of Equity Link Notes
- Under Equity Link Notes investors can earn better returns than regular purchases and sales of shares.
- Income earning opportunity is higher in Equity Link Notes than usual trading of the security.
- An investor can lock his price on this security in accordance with his wish and can earn a return by purchasing at a discount and selling at a premium.
- Equity Link Notes provide flexibility to the investor for buys his security and setting strike rate on it.
Risks of Equity Link Notes
- The biggest risk associated with Equity Link Notes is the market movement. As seen in the second and third scenarios if the price of share or security goes below the strike rate that investors can lose this entire investment amount also.
- Under the trading of Equity Link Notes, an investor is connected to the issuer and is not in contact with the company thus if the issuer makes any default then the investor has to pay the price for it.
- If an investor has invested in the share related to another currency then a change in the currency market can impact the decision of investment of the investor and the wrong decision can impact a huge loss than regular trading of the share price.
Thus, we can say that Equity Link Notes gives an investor a higher return than he accepts from the regular purchase and sales of shares and other security in the market but at the same time analysis of the market should be done by the investor to minimize his loss because if this is not done than an investor may suffer a bigger loss then purchasing and sell it on the regular market. It is advisable that investors who continuously monitor the market and has a fund to invest for medium-term purpose can invest in such an instrument.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing MBA with the specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated about financial market.