An equity-linked security is a debt instrumentwith variable payments linked to an equity market benchmark.These securities are an alternative type of fixed-income investment—structured products most often created as bonds. Equity-linked securities are usually used in private market corporate capital financings and are offered to investors to raise corporate capital. As such, they are not traded on financial market exchanges.
Key Takeaways
- An equity-linked security is a debt instrumentwith variable payments linked to an equity market benchmark.
- They are offered to investors so the issuer can raise capital.
- These securities are an alternative type of fixed-income investment—structured products most often created as bonds.
- ELKS normally mature within a one-year period and normally pay higher yields than that of the underlying security.
- Some kinds of ELKS include corporate, bank-offered, and market-linked.
What Is an Equity-Linked Security (ELKS)?
Equity-linked securities resemble both stocks and bonds. So although they may be debt securities, equity-linked securities provide returns that are tied to some form of underlying equity—hence the name. This equity is normally a common stock. This means the returns are linked to the upward and downward movements of the underlying stock.
ELKS normally mature within a one-year period. The yield they pay is normally higher than that of the underlying security. They also make two payouts or distributions to investors before they mature, which is why investors prefer these kinds of investments.
Equity-linked securities normally mature within one year.
Understanding Equity-Linked Security (ELKS)
An equity-linked security offering provides corporations with an alternative way to structure interest payments to investors. An issuer can base security interest payments on a range of equity market products including a stock, a group of stocks, or an equity index.
They may also 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. ELKS offer a controlled interest rate product for the issuer.
Types of Equity-Linked Securities
Investors may be offered the opportunity to invest in ELKS from a few different issuers. They may also find ELKS advertised as market-linked. The following are a few kinds of ELKS that are available on the market.
Corporate ELKS
Corporations typically work with investment banks for support to structure equity-linked security offerings for capital financing. The Royal Bank of Canada (RBC) is a leading source of structured finance equity-linked securities. RBC works with companies to structure equity-linked security offerings with various types of provisions.
Retail investors may see equity-linked security offerings from a bank alongside certificates of deposit. An equity-linked security can be any type of investment with interest payments tied to an equity benchmark. US Bank advertises equity-linked CDs as one component of their market-linked CD offering. The interest on the CDs is linked to an equity index. The minimum investment is $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 linked to any type of market benchmark. An issuer could structure a market-linked security to make payments based on an equity benchmark. They can also use any other market benchmark such as gold or currency.
For the security issuer, market-linked products offer the opportunity to control the payment to the investor by choosing a specified benchmark. For investors, they can offer an easy alternative to investing in the benchmark itself. An investor in a gold-linked CD would generally seek to earn the same rate of return as gold. Issuers can structure market-linked products in numerous ways. Market-linked products are also known to be illiquid and not tradable or redeemable without penalty during the duration of the investment.
What Are Examples of Equity-Linked Securities?
Some examples of ELKS are corporate ELKS, bank-offered ELKS, and market-linked securities offered through certificates of deposit or other instruments that represent a basket of securities.
How Does an Equity-Linked Note (ELN) Work?
ELNs are purchased at a strike price, which is a discount to the spot price. The ELN issuer delivers the stock to the investor when or if the strike price is reached.
Are Equity-Linked Notes Equity Securities?
Equity-linked notes pay returns linked to the performance of the underlying security, while equity-linked securities pay a fixed interest rate.
