how eln work
in the simplest form a 1 000 5 year equity linked note could be structured to use 800 of the fund to buy a 5 year strip bond with a 4 5 yield to maturity and then invest and reinvest the other 200 in call options for the s p 500 over the 5 year life of the note there is a chance that the options will expire worthless in which case the investor gets back the 1 000 initially put in if however the options appreciate in value with the s p 500 those returns are added to the 1 000 that will eventually be returned to the investor equity linked note caps participation rates and leveragein practice an equity linked note will have a participation rate which is the percentage amount that the investor in the note participates in the appreciation of the underlying equity 1 if the participation rate is 100 then a 5 increase in the underlying is a 5 increase for the eventual payout on the note however the cost of structuring the eln and managing it can lower the participation rate in the case of a 75 participation rate for example a 5 appreciation in the underlying is only worth 3 75 to the investor equity linked notes can also use different structures and features some will use an averaging formula to smooth out returns on the equity linked portion or a periodic cap that limits the eln s upside by realizing returns at a particular level on a regular basis there are also types of equity linked notes that use dynamic hedging instead of options deploying leverage to increase returns from the underlying equity overall equity linked notes can be a powerful tool for investors who want to protect their principle while still having the potential upside of an equity investment 