Equity-linked note
Unlike what the name suggests, share bonds (reverse convertibles) belong to the security category of certificates. Share bonds pay a fixed interest rate that is not tied to any further conditions. In this respect, share bonds are similar to standard bonds. In contrast to a classic bond, however, the redemption of a share bond depends on the price of the underlying asset. At or above a certain price level, redemption is made at the nominal value. This redemption can take place either in cash or in the form of shares, at the issuer's discretion. If the price of the underlying asset, i.e. a share, is below an initially specified price at the end of the term, the investor does not receive the full amount back. In the worst-case scenario, the redemption amount can also be 0, namely if the shares have become worthless.
What is an equity-linked note?
Equity-linked notes (reverse convertibles) are a development of the financial sector that sit between bonds and equities in terms of their risk and return structure. With bonds, investors usually receive a lower return in the long term, but with a high level of security.
With equities, investors get a better return in the long term, but must accept a higher risk in return. Equity-linked notes offer a higher return than bonds, but in exchange they also carry higher risks than bonds in the traditional sense.
Generally, an equity-linked note has a better risk profile than equities. However, it should be noted that an equity-linked note is a structured product (certificate).
As a result, you are additionally exposed to issuer risk. Furthermore, as equity-linked notes are complex structured products, they should not be traded by beginners.
Characteristics of an equity-linked note
1) The interest rate on an equity-linked note is usually higher than on traditional corporate and government bonds. Another difference is that equity-linked notes are issued at a nominal value. This is often €1,000.
2) Equity-linked notes are usually traded as a percentage of their nominal value. This means that an equity-linked note can trade, for example, at 90%. With a nominal value of €1,000, the equity-linked note would therefore still be worth €900.
3) The price of the underlying asset, e.g. a share from the MDAX, determines the amount at which the equity-linked note is redeemed at maturity.
If the closing price of the underlying asset is at least at the strike price determined at the start, the nominal amount is repaid.
However, if the share price is below this level, shares of the underlying asset are delivered as redemption. The number of shares you receive is determined by the so-called "conversion ratio". If the issue arises that, say, 4.5 shares must be delivered, 4 shares plus the cash equivalent of half a share will be delivered.
Risiken einer Aktienanleihe
It is important to understand that an equity-linked note belongs to the category of certificates/structured products, even if the name does not explicitly imply this. If the issuer defaults, as Lehman Brothers did in the 2008 financial crisis, in the worst-case scenario investors will receive no redemption at maturity.
When purchasing such products, care should therefore be taken to ensure that only issuers with a very good credit rating are selected. In addition, it should be understood that the return is capped. Even if the underlying asset, e.g. a share in the MDAX, performs brilliantly and rises by 80%, you "only" receive the previously agreed interest rate as a return. This is because if the share is worth at least the level of the strike price at maturity, you simply receive "only" the nominal amount back as redemption.
Conversely, however, it is possible to incur heavy losses if the share should fall by, say, 80%. In the event of a price below the strike price at maturity, the investor receives redemption in the form of shares (which have now fallen significantly in value).
Note: This information only applies to investors resident in Germany for tax purposes. The information provided above does not constitute tax advice and is in no way a substitute for individual advice from a tax advisor. If anything is unclear, please contact your tax advisor directly.