The Structured Note Pitch
A bank offers a client a 5-year autocallable note linked to an index. It pays 8% per annum if the index is at or above its starting level on an annual observation date, and returns capital at maturity unless the index falls more than 40% (the barrier). If the barrier is breached, the client receives the index's fall in capital, with no protection. The client, 58, has £200,000, wants capital preservation, and plans to retire in 6 years. The note has a 2% upfront distribution fee embedded, no secondary market, and issuer credit risk. The adviser compares it to a 5-year gilt yielding 4.2% and a diversified corporate bond fund yielding 5.5%.
1. Decompose the note's payoff and assess whether the 8% coupon is attractive relative to alternatives.
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The note is economically a combination of a bond (return of capital subject to issuer credit risk) plus a short put on the index struck at the 40% barrier. The 8% coupon compensates for selling that downside protection and for issuer credit risk, not for free. The client keeps the first 40% of losses only if the barrier is untouched; beyond that, losses are nearly 1:1 and could be severe in a prolonged fall. Compare: a 5-year gilt at 4.2% is government-backed and liquid; a corporate fund at 5.5% is diversified. The note's extra 2.5-3.8% gross is reduced by the 2% upfront fee and illiquidity. On a risk-adjusted basis the coupon is not clearly superior.
2. Advise whether the note suits the client and explain the key risks to disclose.
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It conflicts with the client's stated capital-preservation objective: the barrier exposes capital to a 40%+ index fall at exactly the point (year 5-6) he retires. Add no secondary market (cannot exit), issuer credit risk (coupon and capital depend on the bank), and the autocall feature (early redemption caps upside and forces reinvestment). The 2% fee reduces the effective return. Recommendation: decline or limit to a small satellite allocation only if he fully understands the downside, with the bulk in gilts and a diversified bond fund matched to his 6-year horizon. Document the risk discussion, the alternatives, and his decision.