Autocallable notes

Autocallable notes video

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In this installment of our Scotiabank investor solutions product series, we will discuss autocallable notes. What are they? And how do they work? Autocallable notes are market linked structured notes which provide investors the opportunity to receive a variable return comprised of a fixed return and an additional return if certain conditions are met.

The notes can mature early on set dates before the maturity date, and they usually offer some degree of principal protection at maturity in case the underlying asset price falls. There are a number of features that you need to understand with this product, the autocall feature, and the maturity redemption amount. Let's start with the autocall feature. Whether or not this note is called before the maturity date depends on whether the underlying asset is at or above a certain level, which we refer to as the autocall level, on any of the autocall valuation dates.

In this example, the autocall level is set to 100% of the underlying assets initial level. On each autocall valuation date, we check if the underlying asset closes at or above the autocall level, and if it does, the note will mature early and the investor will receive the principal amount back plus the variable returns. If the underlying asset closes below the autocall level, the note will continue until the next autocall valuation date, at which point the same check occurs again. Now let's look at the maturity, redemption amount, which includes the variable return and the contingent principal protection feature.

This note pays a variable return if the notes are at or above the autocall level on any of the autocall valuation dates or the maturity date. In this example, we'll use a five year note which offers investors the possibility to receive a 10% fixed return per annum. In addition to the fixed return, investors can receive an additional return of 5% of the amount by which the underlying asset exceeds the fixed return. The underlying asset is below the autocall level in the first year, but then rises above the autocall level in the second year.

In this example, since the underlying asset increases by 7% and is above the autocall level, the note will be called and investors will receive a fixed return of 20% or 10% for each year. Since the underlying asset return of 7% is less than the fixed return of 20%, no additional return is payable. In the next example, the underlying asset increases by 25% in the second year. Since it is above the autocall level, the note will be called and investors will receive not only a fixed return of 20%, or 10% for each year, but will receive an additional return since the underlying asset return of 25% is greater than the fixed return of 20%.

The variable return of 20.25% is therefore payable. In the next example, the underlying asset does not close at or above the autocall level on any of the autocall valuation dates and the note is not called. The investment therefore reaches its final valuation date.

Here, the underlying asset’s return is greater than the autocall level. A fixed return of 50% is therefore payable 10% for each of the five years. No additional return is payable because the asset return is below the fixed return. In the last example, the underlying asset remains below the auto call level for the life of the note, and no variable return is payable on the maturity date.

This type of note also includes a contingent principal protection feature at maturity, meaning that an investor will receive the return of all of their original investment, provided that the underlying asset has not fallen below a certain level on the final valuation date. This level is called the barrier level. If the underlying asset falls below the barrier level, the investor will be fully exposed to any negative underlying asset performance. For example, if the barrier level is set at 70% of the initial level, this means that the note has a contingent principal protection of 30%.

In this scenario, even though the performance of the underlying asset is negative on the final valuation date, it does not breach the barrier level. Therefore, investors will be repaid the principal amount in full. However, if the barrier level is breached on the final valuation date and for example, the underlying asset has fallen by 40% from the initial level, the principal amount will be reduced by 40%. Please speak to your Scotiabank representative for more information.

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What are autocallable notes?

Autocallable notes are principal at risk market-linked structured notes that provide investors the opportunity to receive a variable return if certain conditions are met. They provide investors with the potential to outperform a direct investment in the underlying asset.

How do they work?

Autocallable notes have a start date and a maturity date, with a series of set autocall valuation dates in between.

The notes can mature early at specified dates over the life of the product if pre-determined conditions are met. They also usually offer some degree of principal protection at maturity in case the underlying asset price falls.

There are two key features to understand with this product:

The autocall feature
The maturity redemption amount

The autocall feature

Whether or not this note is called before the maturity date depends on whether the underlying asset is at or above a certain level (the autocall level) on any of the autocall valuation dates. Typically, this level is set at 100% of the asset’s initial level, but this can vary from note to note.

On each autocall valuation date, if the underlying asset closes at or above the autocall level the note will mature early. This means the investment will come to an end and investors will receive their principal amount back, plus any variable return.

The underlying asset closed above the autocall level on the year-2 valuation date, within a set of yearly valuation dates across a five-year period.

If the underlying asset closes below the autocall level, the note will continue until the next autocall valuation date, at which point the same check occurs again.

The maturity redemption amount

Autocallable notes pay a variable return if the underlying asset is at or above the autocall level on any of the autocall valuation dates or the maturity date. They may also pay an additional return based on the performance of the underlying asset, as laid out in the offering documents. The products also typically come with some sort of protection feature at maturity, which could be a barrier, a buffer, or a geared buffer.

Illustrative scenarios

Here’s how the autocall and the maturity redemption amount features work across four different scenarios. For each scenario we’ll use a hypothetical 5-year note paying a fixed return of 10% per year, plus, an additional return of 5% on the amount by which the return of the underlying asset exceeds the fixed return.

Diagram depicts the payoff of the example, including a 10% fixed rate per annum plus an additional return of 5% of the amount by which the return of the underlying exceeds the fixed return.

Scenario 1:

The level of the underlying asset is above the autocall level, and the note is called
The underlying asset’s return is below the fixed return rate

In this first scenario, the level of the underlying asset is below the autocall level in the first year but rises above the autocall level on the valuation date in year 2. In this example, since the return on the underlying asset increases by 7% since the initial valuation date and is above the autocall level, the note will be called, and investors will receive a fixed return of 20% (10% for each year). No additional return is paid since the return on the underlying asset is less than the fixed return rate.

The level of the underlying asset closed above the autocall level on the year-2 valuation date and gets called. It has increased by 7% since the initial valuation date. Graphic of a 20% fixed return rate at year 2, within a set of yearly valuation dates across a five-year period. No additional return is paid.

Scenario 2:

The level of the underlying asset is above the autocall level, and the note is called
The underlying asset’s return is above the fixed return rate

In this second scenario, the underlying asset’s return increases by 25% in year 2. Since it’s above the autocall level, the note will be called. Investors will not only receive a fixed return of 20% (10% for each year), but also an additional return of 0.25% since the underlying asset return is greater than the fixed return of 20%.

The level of the underlying asset closed above the autocall level on the year-2 valuation date. It has increased by 25% since the initial valuation date, depicting a 20.25% fixed return rate, within a set of yearly valuation dates across a five-year period.

Scenario 3:

The note reaches its final valuation date, and the note is not called.

In this third scenario, the level of the underlying asset is not at or above the autocall level on any of the autocall valuation dates, and therefore reaches contractual maturity.

The note reached its final valuation date. It shows a 5 x 10% fixed return rate or a 50% rate, within a set of yearly valuation dates across a five-year period.

Since the level of the underlying asset is above the autocall level on the year-5 (that is, final) valuation date, a fixed return of 50% is payable. No additional return is paid since the underlying asset’s return is less than the fixed return.

Scenario 4:

The level of the underlying asset remains below the autocall level, and the note is not called.

In this fourth scenario, the level of the underlying asset remains below the autocall level for the life of the note and no variable return is payable on the maturity date.

The level of the underlying asset remains below the autocall level for the entire life of the note, within a set of yearly valuation dates across a five-year period.

This type of note includes a contingent principal protection feature at maturity, also known as a barrier. This means that an investor will receive the return of all of their original investment, provided that the level of the underlying asset has not fallen below a certain level on the final valuation date. This level is called the barrier level.

If the level of the underlying asset falls below the barrier level, the investor will be fully exposed to any negative underlying asset performance.

For example, if the barrier level is set at 70%, this means that the product has a contingent principal protection of 30%. If the note is not autocalled and the barrier is not breached at maturity, the investor’s initial investment will be repaid in full.

If, however, the level of the underlying asset falls by more than the barrier level, the principal amount invested will be at risk. For example, if the underlying asset falls by 35%, the investor will lose 35% of their invested principal.

When to consider an autocallable note

The typical autocallable may be suitable for an investor with a flat to moderately positive market view. However, autocallable notes can be customized to fit specific market outlooks.

Cash flow needs

Autocallable notes do not provide any periodic cash flows, but the autocall feature can provide liquidity prior to the contractual maturity date if the note is called.

Term preference

Autocallable notes are callable if the level of the underlying asset is at or above the autocall level on any call valuation date. Typical autocall frequencies are annual and semi-annual.

Benefits of autocallable notes

They have the potential to outperform the underlying asset in moderately negative, flat, or moderately positive market conditions
Customizable risk-return features provide more flexibility to investors with varying levels of risk tolerance
Partial or contingent downside protection reduces risk compared to equity alternatives

Risks of autocallable notes

Principal at risk: The notes are not principal protected, so investors could lose part or all their initial investment
Limited upside participation: Usually autocallable notes will underperform a direct investment if the underlying asset appreciates in value substantially
Reinvestment risk: Structured notes may be automatically called due to the performance of the underlying asset, potentially subjecting investors to re-invest at lower yields
Variable return not guaranteed: If the value of the underlying asset drops below the payment barrier and doesn’t recover, the investor will not receive a variable return
Credit risk: Scotiabank structured notes are debt obligations of Scotiabank and are subject to the Bank’s creditworthiness
Interest rate risk: The secondary market price of the notes is sensitive to changes in benchmark interest rates
Market risk: How well a structured note performs depends on many factors related to how the underlying asset performs in the financial markets
Expiry considerations: Investors should know their investment time horizon and select a note with an appropriate term product
Tax considerations: Investing in structured notes may have tax implications to the investor. Investors should obtain their own tax advice
CDIC considerations: Except for market linked GICs, structured notes are not eligible for insurance by the Canada Deposit Insurance Corporation

Get expert advice

Structured notes are flexible and customizable to meet your unique investment needs and risk-return objectives. Speak with an advisor to discuss how structures can be tailored specifically for you.

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Autocallable notes