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The Anatomy of Principal Protected Absolute Return Notes

16 Pages Posted: 8 Jan 2012 Last revised: 26 Dec 2012

Geng Deng

Wells Fargo

Ilan Guedj

Bates White, LLC

Craig J. McCann

Securities Litigation and Consulting Group

Joshua Mallett

Securities and Exchange Commission (SEC)

Date Written: August 16, 2011

Abstract

Principal Protected Absolute Return Barrier Notes (ARBNs) are structured products linked to an underlying security or an index. While these notes guarantee principal protection – return of face value – their upside potential is dependent on the level of the underlying security never falling outside of a predefined range. This, combined with the credit risk of the issuer to which all structured products are subject, makes these products difficult to value.

In this paper we value ARBNs by decomposing the note into a zero coupon bond and double barrier linear segment options. We derive closed form solutions for ARBNs and their Greeks, then value 214 publicly-listed ARBNs issued by six different investment banks between 2006 and 2009. We find that the ARBNs’ fair price is approximately 4.5% below the actual issue price on average.

Keywords: Structured Products, Barrier Option, Absolute Return Barrier Notes, Principal Protected

Suggested Citation

Deng, Geng and Guedj, Ilan and McCann, Craig J. and Mallett, Joshua, The Anatomy of Principal Protected Absolute Return Notes (August 16, 2011). Journal of Derivatives, Vol. 19, No. 2, pp. 61-70, 2011. Available at SSRN: https://ssrn.com/abstract=1981307

Geng Deng (Contact Author)

Wells Fargo ( email )

1753 Pinnacle Dr
7th Floor
Mc Lean, VA Virginia 22102
United States

Ilan Guedj

Bates White, LLC ( email )

2001 K St., NW
Suite 700
Washington, DC 20006
United States

HOME PAGE: http://www.bateswhite.com/professionals-Ilan-Guedj.html

Craig J. McCann

Securities Litigation and Consulting Group ( email )

3998 Fair Ridge Drive, Suite 250
Fairfax, VA 22033
United States

Joshua Mallett

Securities and Exchange Commission (SEC) ( email )

450 Fifth Street, NW
Washington, DC 20549-1105
United States

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