TABLE OF CONTENTS Principal-protected structures are coupon-paying financial products that guarantee the return of one s initial investment at the maturity of the structure, regardless of the performance of the underlying (reference) assets. The coupon payments themselves are stopped in the event of default by the reference entity. Principal-protected structures can be thought of as a form of a funded credit derivative.
It may be useful to start by reminding ourselves about the mechanics of traditional (nonprincipal-protected) debt instruments. For instance, assuming a fixed-rate bond is valued at par, an investor in that security hands over the face value of the bond to the issuer and, in exchange, the issuer promises to return the full par amount of the note to the investor at the maturity date of the note and to make intervening coupon payments until that date. Should the issuer run into financial difficulties and default on its debt obligations, however, the investor loses both its initial investment (or part of it in the case of a nonzero recovery rate) and any remaining future coupon payments that would otherwise be made by the note.
We shall focus on single-name principal-protected notes (PPNs), the simplest form of a principal-protected structure. Such notes have some similarities with traditional fixed-rate bonds, but there are a few key differences. As with the bond in the previous paragraph, PPNs are funded instruments, generally sold at par, that promise regular coupon payments at prespecified dates and the return of principal at the...
