What is Targeted Accrual Redemption Note ?

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A targeted accrual redemption note (TARN) is an exotic derivative that terminates when a limit on coupon payments to the holder is reached.Target accrual redemption notes (TARN) have the distinguishing feature of being subject to early termination. If the accumulation of coupons reaches a predetermined amount before the settlement date, the holder of the note receives a final payment of the par value and the contract ends.

Definition

A Target Accrual Redemption Note (TARN) is a type of financial derivative that terminates when the preferential payments to the holder reach a predetermined limit. The unique feature of a TARN is its ability to terminate early; if the cumulative amount of preferential payments reaches the target amount before the settlement date, the holder receives a final payment of the face value, and the contract ends.

Origin

The TARN originated from the financial market's need for risk management and yield optimization. As the derivatives market evolved, investors sought products that could provide fixed returns under specific conditions, leading to the development of TARN as a flexible investment tool.

Categories and Features

TARNs can be categorized based on different underlying assets, payment structures, and termination conditions. Key features include: 1. Early Termination Mechanism: The note terminates when cumulative payments reach the target. 2. Risk and Return Balance: Offers fixed returns while limiting potential high returns. 3. Flexibility: Can be customized according to investor risk preferences and market conditions.

Case Studies

Case 1: A financial institution issued a TARN based on a stock index with a target cumulative payment of 10%. In a favorable market, investors reached the target return in a short period, and the note terminated early, providing the expected return. Case 2: Another bank issued a TARN with foreign exchange as the underlying asset, with a target cumulative payment of 8%. Due to market volatility, investors reached the target over a longer period, receiving stable returns upon termination.

Common Issues

Investors may encounter issues with TARNs such as: 1. Early Termination Risk: Market fluctuations may cause the note to terminate early, limiting potential returns. 2. Complexity: The structure of TARNs is complex, requiring investors to fully understand the terms and conditions. A common misconception is that TARNs can provide unlimited high returns, overlooking their early termination feature.

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