In our last post, the ABC’s of Market-Linked CDs, we covered the basics of MLCDs. Now, let’s say you’re considering an investment in a Market-Linked CD — what information is critical to help you select which MLCD offering may be right for you?
The fine print
On each Market-Linked CD offering it’s important to read the fine print to determine if it’s a match for your investing strategy. When looking at an offering it may be helpful to refer to the chart below:
The horizontal axis is the return of the market’s index (annual), while the vertical axis is the MLCD’s performance. During times of high market returns (right side of graph), the MLCD’s return will track the corresponding index (with enhanced returns if the MLCD has a greater than 100% participation rate). During times of poor market returns (left side of graph), the MLCD can limit its losses by holding its principal value.
To understand how different MLCD terms may impact your returns, use the information below:
How are the returns calculated?
The return of the underlier is calculated as follows:
- The Initial Level is typically the closing price of the underlier on trade date
- The Final Level is typically the closing price of the underlier on the determination date.
- The trade date, determination date, Initial Level and Final Level of the underlier are always specified in the accompanying offering document of any investment you choose to make.
The Max in the formula indicates that the investor will only participate in positive returns of the underlier.
- What is the participation rate?
Also known as the index rate, a participation rate is how much the index’s appreciation will be used to calculate your return. For example, if the participation rate on an MLCD based on the index is 110 percent and the underlying index increases 10 percent for the year, the value of your MLCD would increase 11 percent (110 percent of the 10 percent gain).
- Is the MLCD non-callable?
When reading the offering circular, search for the keyword “callable” to see if the MLCD has a call provision that may add risk to the position after purchase. If your search returns no results, then the MLCD is non-callable.
When a CD or MLCD is ‘callable’ it gives the issuing bank the right to call back your CD from you for the full amount before it matures. In this case, your return may be less than the yield the CD would have earned had it been held to maturity.
- Will I get the full return of the index at maturity? You will get the full return when the index is positive at maturity and if there are no caps stated in the offering circular. If there is a cap stated, then you can earn up to the cap. For example, if the underlying market index increases 30 percent over the investment period, and the contract has a 15 percent cap, your return will be limited to 15 percent.
- What fees are associated with MLCDs?
Each MLCD may charge an initial placement fee that is included in the offering price. While typically this fee falls between 1-3%, you will get your full investment amount back if you hold onto your MLCD until its maturity date — in effect, these fees are credited back to you for good behavior of holding the position to term.
As with any financial product, before you purchase an MLCD, it’s important to carefully review the offering circular and disclosures and make sure you understand the terms, which you can review in each MLCD’s Offering Circular. As mentioned before, MLCDs are intended to be held until maturity and while you can sell them prior to maturity date you may lose out on a host of benefits.
What’s the bottom line? If you want to invest in the market while protecting your principal, and you have the proper time horizon in mind, consider MLCDs. In times of uncertainty, investing in the stock market can be intimidating, but knowing that your principal investment is protected can be an attractive way to cover your bases.
*Note that if the return of the underlying stocks is zero, or less, the MLCD will not pay any return above your principal investment. In this case, you’ll only get back your initial principal.
Investing involves risks, you should be aware of prior to making an investment decision. An investment in individual stocks, or a collection of stocks focused on a particular theme or idea, such as a motif, may be subject to increased risk of price fluctuation over more diversified holdings due to adverse developments which can affect a particular industry or sector.
Motif makes no representation regarding the suitability of a particular investment or investment strategy. You are responsible for all investment decisions you make including understanding the risks involved with your investment strategy. Past performance is no guarantee of future results.
Comparisons and descriptions of products described above are for provided informational purposes and are not intended to be comprehensive and actionable information which an investor should solely rely on to determine if an investment is right for them. Investors should carefully review the offering documentation for each product in order to understand the possible risks, restrictions, and possible fees, prior to making an investment decision.