Structured notes exist in
two forms – those with a principal guarantee and those without.
Profits from notes with guaranteed principal are taxed as
interest. In the form of CDs tied to the market (also
available as exchange-traded notes or over-the-counter privately
negotiated contracts), they present a safe bet on a risky asset,
offering upside participation on the market with the assurance of
One can replicate the principal
guarantee by purchasing a zero-coupon bond due at the maturity of
the note. A five-year U.S. Treasury zero costs about 80
cents on the guaranteed dollar. Next up is the possible
payoff tied to an index or asset. The issuer will have about
20 cents on the dollar left to buy an option to produce the upside
exposure linked to a particular asset or index. In the
example of a CD linked to the Standard & Poor's 500 stock
index, the issuer could buy an at-the-money call on an S&P 500
exchange traded fund. The triple-A Options Clearing Corp.
guarantees these listed options. By purchasing these two
instruments, the adviser can offer the investor the upside of the
market with no downside.
Take New York-based
EverBank's MarketSafe Gold Bullion CD. A five-year CD
guaranteeing the purchaser's money back if gold declines, and a
payoff if gold rises. Today, a five-year U.S. government
zero-coupon bond costs 83 cents on the dollar and an at-the-money
call option on gold costs about 15 cents on the dollar. If
an adviser bought these instruments himself instead of EverBank
buying them to offer a CD, the adviser would save 2%, investing
just $98 instead of $100.
Further, if gold rose, any profits
on the gold option would be capital gain rather than higher taxed
interest income. For those sophisticated enough to break a
principal guaranteed note into its components, this seems the
article and other articles are provided for
information purposes only. They are not intended to be
an offer to engage in any securities transactions or to
provide specific financial, legal or tax advice. Articles
may have been rendered partly inaccurate by events that have
occurred since publication. Investors should consult
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