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The Anatomy of Principal-Protected Absolute
Return Barrier Notes

Geng Deng, Ilan Guedj, Joshua Mallett and Craig McCann
The Journal of Derivatives Winter 2011, 19 (2) 61-70; DOI: https://doi.org/10.3905/jod.2011.19.2.061
Geng Deng
is the director of research at the Securities Litigation & Consulting Group in Washington, DC.
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Ilan Guedj
is a principal at the Securities Litigation & Consulting Group in Washington, DC.
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  • For correspondence: ilanguedj@slcg.com
Joshua Mallett
is a research associate at the U.S. Securities and Exchange Commission in Washington, DC.
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  • For correspondence: mallettj@sec.gov
Craig McCann
is a principal at the Securities Litigation & Consulting Group in Washington, DC.
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Abstract

There are many different investment vehicles featuring downside protection of principal. Such a payoff pattern is especially appealing to retail investors. One such contract is a principal- protected absolute return barrier note (ARBN). As is typical of such instruments, repayment of the principal at maturity is guaranteed, but the interest component is a function of the performance of some underlying asset, usually a stock index like the S&P 500. In the case of an ARBN, the payment in excess of the principal is equal to the absolute value of the final index minus its initial value, as long as over the option’s lifetime, the index never traded outside a price range defined by a lower and an upper barrier. This odd structure leads to unusual Greek-letter sensitivities, since the contract loses value as it get close to the barrier. How such a path-dependent payoff should be valued is a significant problem that the article addresses. Not too surprising is the finding that the issuers typically sell the contracts at prices well above theoretical values.

TOPICS: Futures and forward contracts, downside-only measures

  • Copyright © 2011 Securities Litigation & Consulting Group. All rights reserved. Not to be reproduced or redistributed without permission.
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The Journal of Derivatives: 19 (2)
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Winter 2011
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The Anatomy of Principal-Protected Absolute
Return Barrier Notes
Geng Deng, Ilan Guedj, Joshua Mallett, Craig McCann
The Journal of Derivatives Nov 2011, 19 (2) 61-70; DOI: 10.3905/jod.2011.19.2.061

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The Anatomy of Principal-Protected Absolute
Return Barrier Notes
Geng Deng, Ilan Guedj, Joshua Mallett, Craig McCann
The Journal of Derivatives Nov 2011, 19 (2) 61-70; DOI: 10.3905/jod.2011.19.2.061
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