An equity-linked security is a debt instrument with 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 instrument with 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 often pay higher yields than that of the underlying security.
- Some types of ELKS include corporate, bank-offered, and market-linked.
What Is an Equity-Linked Security (ELKS)?
Equity-linked securities resemble both stocks and bonds. Although they may be debt securities, equity-linked securities provide returns tied to some form of underlying equity, normally a common stock. This means that the returns are linked to the upward and downward movements of the underlying stock.
ELKS typically mature within a one-year period and usually offer higher yields than the underlying security. They also make two payouts to investors before they mature, making them an attractive investment option.
Understanding Equity-Linked Security (ELKS)
Equity-linked security offerings provide corporations an alternative way to structure interest payments to investors. An issuer can base these interest payments on a range of equity market products, including a stock, a group of stocks, or an equity index.
They may also cap returns or pay a specified share of the benchmark’s return. A standard equity-linked security structured as a bond would offer variable interest payments tied to an equity benchmark, with the principal returned at maturity. This control over interest payments makes ELKS an attractive financing option for issuers.
Types of Equity-Linked Securities
Investors have numerous types of ELKS to choose from, with market-linked and corporate offerings being particularly prominent.
Corporate ELKS
Corporations often collaborate with investment banks to structure equity-linked security offerings for capital financing. These banks support companies in creating securities with various provisions.
Retail investors may also find these securities alongside certificates of deposit (CDs) offered by banks. For instance, an equity-linked CD might have its interest tied to an equity index. The minimum investment required for such offerings can vary, with some starting at $4,000.
Market-Linked Securities
Market-linked securities have payments that are tied to a market benchmark, which could be any form of market data, such as an equity benchmark, gold, or even currency.
For issuers, market-linked products offer control over payment structures by selecting specific benchmarks, while for investors, these offer a simplified way to invest in benchmarks without directly holding them. Though lucrative, market-linked products can often be illiquid and may have penalties for early redemption.
Examples of Equity-Linked Securities
Examples of ELKS include:
- Corporate ELKS: Structured with the assistance of investment banks for corporate capital financing.
- Bank-offered ELKS: Sold alongside other products like certificates of deposit.
- Market-linked securities: Include options like gold-linked CDs or securities connected to other market benchmarks.
How Does an Equity-Linked Note (ELN) Work?
Equity-Linked Notes (ELNs) are bought at a strike price lower than the spot price. The issuer agrees to deliver the underlying stock to the investor if the strike price is reached, functioning as a blend between bonds and equities.
Are Equity-Linked Notes Equity Securities?
Unlike equity-linked securities that pay a fixed interest rate, equity-linked notes have returns connected to the performance of the underlying security, making them distinct yet closely related financial instruments.
Related Terms: Debt Instrument, Bonds, Corporate Capital, Interest Rate, Market Benchmark.
References
- Navian Capital. “What Is a Market-Linked CD?”
