Principal-Protected Equity-Linked Note

5 Pages Posted: 30 May 2017

See all articles by Pedro Matos

Pedro Matos

University of Virginia - Darden School of Business; European Corporate Governance Institute (ECGI)

Date Written: 2016

Abstract

The case puts students in the shoes of a private banker who wants to price a structured note for European high net worth clients with low levels of risk tolerance. The principal-protected equity-linked note (PP-ELN) provides investors with fixed income–like principal protection together with upside exposure to the S&P 500 Index. The students are asked how the bank should allocate the client's money to buy call options and invest in zero-coupon bonds to deliver this PP-ELN and still earn a fee. By adjusting the amount of principal protection or capping the upside potential, the students can calculate whether there is an opportunity for increased upside participation. This financial engineering case can be used to teach put-call parity, option strategies, and Black-Scholes pricing.

Excerpt

UVA-F-1752

Mar. 10, 2016

Principal-Protected Equity-Linked Note

At the end of the year, Mario Casals was flying out of Geneva for a small European country where he was the market leader for a Swiss bank. As a private banker, he provided full-service banking and investment advice to high net worth individuals. His private banking clientele consisted mostly of fairly conservative investors. Many were members of well-established families who had inherited their wealth. Others were entrepreneurs who had taken risks in their businesses but now were more interested in preserving wealth rather than taking large risks in financial markets.

The bank used structured notes to cater to its clients' low levels of risk tolerance. Casals had found principal-protected equity-linked notes (PP-ELNs) to be the instrument of choice. The simplicity of the notes was their strongest selling point. These instruments provided investors with fixed income–like principal protection together with upside exposure to a reference asset of their choosing (e.g., an equity index). PP-ELNs were appropriate for investors who desired equity exposure with controlled risk. Investors had a good sense of the minimum amount of wealth they wanted to preserve, and potential returns above this minimum amount were nice to have but not necessary. Investment strategies leaving them with less than the current wealth, however, were not tolerable. Unlike typical insurance policies, PP-ELNs did not require investors to make an upfront payment for the protection they received. Instead, the protection was paid for by giving up their dividend, not receiving interest income, and giving up a portion of the upside gains in the event that equity markets rallied. Casals had reserved the short-haul flight to review again the characteristics of these notes and their pricing features. He had brought with him a short primer on PP-ELNs to refresh the basic concepts (see Exhibit 1). How attractive would these notes be to his private banking clients?

. . .

Keywords: derivatives, options, black-scholes, structured notes, financial engineering, private banking, wealth management

Suggested Citation

Matos, Pedro, Principal-Protected Equity-Linked Note (2016). Darden Case No. UVA-F-1752. Available at SSRN: https://ssrn.com/abstract=2974582

Pedro Matos (Contact Author)

University of Virginia - Darden School of Business ( email )

University of Virginia
P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434 243 8998 (Phone)
434 924 0726 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty-research/directory/pedro-matos/

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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