Callable contingent coupon notes

What are callable contingent coupon notes?

Callable contingent coupon notes video

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In this installment of our Scotiabank investors solutions product series, we will discuss callable contingent coupon notes. What are they and how do they work? Callable contingent coupon notes are market linked structured notes which provide investors the opportunity to receive periodic coupon payments over the term of the product if certain predetermined 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’s price falls.

There are a number of features that you need to understand with this product. The contingent coupon feature, the early redemption feature and the maturity redemption amount. Let's start with the contingent coupon feature. This note will pay coupon payments to investors as long as the underlying asset is at or above a predetermined payment threshold called the payment barrier.

The payment barrier is observed on each predefined set of valuation dates. Let's go through an example for which we'll use a three year note, which pays a 2.5% coupon on each coupon valuation date. If the underlying asset is at or above a 70% payment barrier.

The underlying asset falls in value during the first year, but is above the payment barrier on every coupon valuation date. The investor will receive all four coupons over the course of the year, even though the underlying asset had a negative performance. During the second year, the underlying asset falls below the payment barrier at each observation, the investor will receive no coupon payments during this period. In the final year, the underlying asset is below the payment barrier on the first and third quarterly observation date and above the payment barrier on the second and fourth quarterly observation dates.

Here, investors will receive two of the possible four coupons for the year. Now let's look at the early redemption feature. Whether or not this note matures before the maturity date depends on whether the underlying asset is at or above a certain level on set dates called autocall valuation dates. This level is called the autocall level.

In this example, the autocall level is set to 5% above the initial level. On each autocall valuation date, we check if the underlying asset closes at or above the autocall level. If it is, the note will mature early and the investor will receive their principal amount back. If the underlying asset does not close at or above 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. This note includes a contingent principal protection feature at maturity, meaning that an investor will receive back 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 holder of the note 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%. 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 callable contingent coupon notes?

Callable contingent coupon notes are principal at risk market-linked structured notes, which provide investors with the opportunity to receive periodic coupon payments over the term of the product if certain predetermined conditions are met.

A graph that shows a series of coupon payments over the life of the product.

How do they work?

Callable contingent coupon notes have a start 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 three key features to understand with this product:

The contingent coupon feature
The autocall feature
The maturity redemption amount

The contingent coupon feature

This note will pay coupon payments to investors as long as the underlying asset is at or above a predetermined payment threshold, called the payment barrier. The payment barrier is observed on each predefined set of valuation dates.

Illustrative example

For each of the following examples, we’ll use a 3-year note with a 105% autocall level, which pays a 2.5% coupon on each quarterly coupon valuation date if the underlying asset is at or above a 70% payment barrier.

Year 1:

The underlying asset is above the payment barrier.

The underlying asset falls in value during the first year but is above the payment barrier on every coupon valuation date. The investor will receive all four coupons over the course of the year, even though the underlying asset had a negative performance.

The underlying asset falling in value over the first year but is above the payment barrier on every coupon valuation date.

Year 2:

The underlying asset is below the payment barrier.

During the second year, the underlying asset falls below the payment barrier at each valuation date. The investor will receive no coupon payments during this period.

The underlying asset falling below the payment barrier at each valuation date in year 2, resulting in no coupon payments paid during this period.

Year 3:

The underlying asset moves below and above the payment barrier during the year.

In the final year, the underlying asset is below the payment barrier on the first and third quarterly valuation dates. It is above the payment barrier on the second and fourth quarterly valuation dates. Here, investors will receive two of the possible four coupons for the year.

The underlying asset falls below the payment on the first and third valuation dates, and above the payment barrier on the second and fourth valuation dates in year 3.

The autocall feature

Whether 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.

On each autocall valuation date, if the underlying asset closes at or above the autocall level, the note will mature early, and the investor will receive their principal amount back.

If the underlying asset does not close at or above the autocall level, the note will continue until the next autocall valuation date, at which point the same check occurs again.

On each autocall valuation date, if the underlying asset closes at or above the autocall level, the note matures early, and the investor receives their principal back.

The maturity redemption amount

The maturity redemption amount generally includes a contingent principal protection feature. This means that an investor will receive their original investment back, provided that the underlying asset hasn’t 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 holder of the note 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 underlying asset falls by more than the barrier, the principal invested will be at risk.

When to consider a callable contingent coupon note

Callable contingent coupon notes provide potential income to investors in the form of coupon payments provided that the barrier level is not breached. They may be suitable in moderately negative to moderately positive market environments, where holders will receive a steady stream of coupon payments.

Callable contingent coupon notes can be customized to fit specific market outlooks.

Cash flow needs

Callable contingent coupon notes are designed to provide cash flow during slightly negative, neutral, or slightly positive market environments. If investors expect the underlying asset to perform very well, other structures might better suit their market view.

Term preference

Callable contingent coupon 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 monthly and semi-annual.

Benefits of callable contingent coupon notes

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

Risks of callable contingent coupon notes

Principal at risk: The notes are not principal protected, so investors could lose part, or all the initial capital invested
Limited upside participation: Usually callable contingent coupon notes have limited or no participation in positive price performance of the underlying asset
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 asset drops below the payment barrier and doesn't recover, the investor might not see 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 choose 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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Callable contingent coupon notes