What Is an Equity-Linked Security (ELKS)?
Let me explain what an equity-linked security is—it's a debt instrument with variable payments linked to an equity market benchmark. You should think of these as an alternative type of fixed-income investment, often structured as bonds. They're typically used in private market corporate capital financings, offered to investors to help raise corporate capital. That's why you won't find them traded on financial market exchanges.
Key Characteristics of ELKS
Equity-linked securities resemble both stocks and bonds. Although they are debt securities, they provide returns tied to some form of underlying equity, usually a common stock. This means the returns follow the upward and downward movements of that underlying stock. They normally mature within a one-year period, and the yield they pay is usually higher than that of the underlying security. They also make two payouts or distributions to investors before maturity, which is a reason investors often prefer them.
Understanding Equity-Linked Security (ELKS)
When you're looking at an equity-linked security offering, it gives corporations an alternative way to structure interest payments to investors. The issuer can base those security interest payments on a range of equity market products, such as a stock, a group of stocks, or an equity index. They might cap or pay a specified portion of the benchmark’s return. A standard equity-linked security structured as a bond would offer variable interest payments tied to an equity benchmark and the return of principal at maturity. For the issuer, ELKS provide a controlled interest rate product.
Types of Equity-Linked Securities
You might come across opportunities to invest in ELKS from different issuers, and they could be advertised as market-linked. Here are the main kinds available on the market. Corporations typically work with investment banks to structure equity-linked security offerings for capital financing. The Royal Bank of Canada (RBC) is a leading source for these, working with companies to create offerings with various provisions. Retail investors might see equity-linked security offerings from a bank alongside certificates of deposit. For example, an equity-linked security can be any investment with interest payments tied to an equity benchmark. US Bank advertises equity-linked CDs as part of their market-linked CD offering, where the interest is linked to an equity index, with a minimum investment of $4,000.
Market-Linked Securities
Securities with payments linked to a market benchmark are offered across the investment industry. A market-linked security can have payments based on an equity benchmark or other benchmarks like gold or currency. For the issuer, these products allow control over the payment to the investor by choosing a specified benchmark. For you as an investor, they offer an easy alternative to investing directly in the benchmark. If you're in a gold-linked CD, you'd generally aim to earn the same return as gold. Issuers can structure these in numerous ways, but remember, market-linked products are illiquid and not tradable or redeemable without penalty during the investment duration.
Examples and How They Work
Some examples of ELKS include corporate ELKS, bank-offered ELKS, and market-linked securities offered through certificates of deposit or other instruments representing a basket of securities. Now, on equity-linked notes (ELNs), they work by being purchased at a strike price, which is a discount to the spot price. The ELN issuer delivers the stock to you when or if the strike price is reached. Are equity-linked notes equity securities? Well, equity-linked notes pay returns linked to the performance of the underlying security, while equity-linked securities pay a fixed interest rate.
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