Enhanced participation notes video
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with an optional subtitleWhat are enhanced participation notes?
Enhanced participation notes are principal at risk products designed for investors seeking an enhanced return based on the price performance of an underlying asset.
The most common version of this product provides investors with the opportunity to participate in the uncapped accelerated returns of any positive performance of an underlying asset, usually an equity index or a basket of stocks.
If the underlying asset falls in value during that period, no return is paid, and this means that the investor may also lose some or all of the principal amount invested.
How do they work?
If the underlying asset increases in value from the initial valuation date to the final valuation date, investors will receive a return based on the performance of the underlying asset multiplied by a factor called the participation rate.
Illustrative example
For example, a participation rate of 300% means that for every 1% increase in the underlying asset, the product would pay 3%. Therefore, if the underlying asset is up 50%, the product will pay a return of 150%.
For example, for a $10,000 investment:
| Where the underlying asset performance increases by: | Note return at a 300% participation rate is: | Note maturity redemption amount is: |
|---|---|---|
| 50% | 150% | $25,000 |
If the underlying asset is at or above the initial level on the final valuation date, investors will be repaid the principal amount invested in full.
When the underlying asset falls below the initial level, the participation rate no longer applies. In this scenario, investors bear the same risk of loss as with a direct investment in the underlying asset.
For example, if the underlying asset has fallen by 40% from the initial level, the principal amount will be reduced by 40%.
Customization features
Enhanced participation notes may be customized to meet specific investment objectives, such as level of protection, risk profile, and time horizon.
Barrier feature
One common customization is to add contingent principal protection, which is also known as a barrier. With a barrier, the investor is also protected against a decrease in the underlying asset, so long as it does not breach the barrier level. So, if you have a barrier level of 70% of the initial level (a protection against a 30% decline in the underlying asset) and the underlying asset falls by 20% (to a level of 80%), the principal amount is repaid in full.
If the underlying asset falls below the barrier level, the note will be fully exposed to any negative underlying asset performance. If the underlying asset falls by 40% at maturity, the investor’s principal amount gets reduced to $6,000 from $10,000.
Buffer feature
Alternatively, this product can be built with partial principal protection, which is also known as a buffer. With a buffer, the investor is protected from a specified decrease in the performance of the underlying asset. Therefore, even if the performance of the underlying asset is negative at maturity, the investor’s principal will be returned in full if the underlying asset does not fall below the buffer level.
If the underlying asset falls below the buffer level, the note is subject to losses on the amount by which the decline of the underlying asset exceeds the buffer. Therefore, if the buffer level is 70% of the initial level, and the underlying asset falls by 40% at maturity, the maturity payment will be reduced by 1% for every 1% the underlying asset falls below the buffer level.
Cap feature
Enhanced participation notes can also have a capped maturity amount, which represents a maximum return of the note, but increases the participation rate for the investor as compared to a similar uncapped version. Investors may consider a cap if their market view is that the performance of the underlying asset will not rise above the cap.
When to consider an enhanced participation note
Enhanced participation notes may be suitable for investors who have a view that the underlying asset will increase in value over the term of the product. These notes can be customized to achieve the investor’s desired risk appetite and return expectations.
Cash flow needs
Enhanced participation notes do not typically provide periodic cash flows. This product may not be suitable for investors who require cash flows prior to the product’s contractual maturity.
Term preference
Enhanced participation notes are typically term products which are intended to be held until maturity. The sale of a note in the secondary market may be subject to early trading fees, or loss on the principal amount or both.
Benefits of enhanced participation notes
- They have the potential to outperform the underlying asset in 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 enhanced participation notes
- Principal at risk: The notes do not offer complete principal protection, so investors could lose part, or all the initial capital invested
- 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
