Definition and Example of a Principal Protected Note (PPN)
How Principal Protected Notes (PPNs) Work
Advantages and Disadvantages of Principal Protected Notes (PPNs)
Definition and Example of a Principal Protected Note (PPN)
A Principal Protected Note (PPN) is a type of structured investment product that is increasingly offered by brokers and investment dealers. A PPN combines components of a bond and derivatives and provides a guaranteed return at maturity.
Definition and Example of a Principal Protected Note (PPN)
A Principal Protected Note (PPN) is a type of structured note that comes with a capital protection feature. In recent years, the popularity of this type of investment product has increased. Capital protection can also be referred to as capital guarantee, guaranteed return, or minimum return. These terms mean that your investment is protected from losses related to the market. Typically, these notes pay a return correlated to the market.
When an investment has a market-linked return, it means it has a return linked to the performance of additional assets. Typically, these investments come with fixed terms. A Principal Protected Note (PPN) offers a full or partial repayment of capital at its maturity date. However, contrary to popular belief, Principal Protected Notes (PPNs) are not risk-free, even though they are designed for risk-averse investors.
While the return on the investment is guaranteed, this does not always protect you. You will not receive any payout if the issuer of the Principal Protected Note (PPN) goes bankrupt.
How Principal Protected Notes (PPNs) Work
A Principal Protected Note (PPN) is a type of structured investment product that guarantees a return (full or partial) on the investment when it matures. When you invest in a structured product like this, it often means that you do not own a portfolio of assets. Instead, you are promised a payout by the issuer of the investment product.
To better understand how a Principal Protected Note (PPN) works, it can be helpful to have more context on how structured notes work in general. Structured notes do not pay any interest until the note matures. Structured notes with capital protection are a combination of two things:
- A zero-coupon bond (a product that will not pay interest before maturity)
- An options or derivative product that has a return linked to an index, benchmark, or any type of underlying asset
Typically, investment brokers and securities dealers create structured notes. Some banks also provide clients with the option to invest in structured notes with capital protection.
There are four main components of structured notes, as outlined below:
- Maturity: Maturity refers to the length of time for holding the structured note. This period can range from six months to 20 years. It is most common for a structured note to mature between two to five years.
- Underlying Assets: The underlying assets are the benchmarks that the Principal Protected Note (PPN) follows during its maturity. This is usually a stock, commodity, foreign currency, index, or a basket of stocks.
- Protection Amount and Type: The protection amount is the sum you are protected against if the price of the underlying asset decreases. If it does not drop below the protection amount, you will recover your capital without incurring any losses. There are two types of protection: hard protection and soft protection. Hard protections act as barriers against losses. If the price goes down, you’ll only incur losses below the protection amount. Soft protections act as barriers against losses, but if losses drop below that barrier, you will incur full loss, not just the difference between the final price and the barrier price.
- Return or Payout: This is the amount of money you will receive at the end of the term if the necessary market conditions are met.
Advantages
Advantages and Disadvantages of Principal Protected Notes (PPN)
Advantages:
- Partial or full return guarantee
- Opportunity for growth
Disadvantages:
- Complex terms
- No FDIC insurance
The advantages explained in detail:
Partial or full guarantee: The principal protected note (PPN) offers a full or partial return of capital at maturity, as long as the issuer of the principal protected note (PPN) does not go bankrupt.
Opportunity for growth: An investor can achieve a level of participation in growth through the underlying assets of the principal protected note (PPN).
The disadvantages explained in detail:
Complex terms: Principal protected notes (PPN) may come with more complex terms than traditional bonds. This can make evaluating the investment opportunity difficult.
No FDIC insurance: Principal protected notes (PPN) are not insured by the FDIC.
Source: https://www.thebalancemoney.com/principal-protected-note-ppn-5218445
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