Scenario 2: If ABC closes above the Strike Price of $8, you will get your $10,000 back plus a coupon of 12% p.a. (which works out to be 3% for a 3 month structured note) of $10,000, totaling $10,300.
If we were to break this down further, this product can be replicated by having the following in a portfolio:
- Buy a 3 months bond and
- Sell a 3 months put option on ABC with a strike at $8.
Why is the coupon paid by ELN higher than that of a typical bond or deposit with the same issuer and maturity? By replicating the portfolio, we can see that the investor is, in fact, selling a put option on ABC stock to the note issuer, and is compensated for the risk by receiving a higher “premium”.