Target Accrual Redemption Notes (TARNs)

Target Redemption Notes or TARNs are a type of exotic structures with redemption triggers. TARNs are an index linked note that provides a guaranteed sum of coupons (target cap) with the possibility of early termination. A target redemption note is similar to an inverse floating rate note, embedded with additional features like the possibility of early termination and a guaranteed sum of coupon payments. This structure has the same cashflow characteristics of an inverse floater after the initial coupon period. The inverse floater formula is for e.g.: max {11% -2 x 6-month LIBOR (in arrears), 0} The lure of a handsome initial coupon combined with the perception that the par may be received within a short span of time had made these notes attractive to Asian retail investors in the early 2000s when the interest rates were at a low level. These products have become popular in Europe and in the Americas as a way of targeted payouts on certain investments. There are some risks involved with these notes. For the investor, the initial coupon in the 1st year may be followed by very low returns and the note may not redeem for the next 10 years. For the issuer, after they pay a high initial coupon, the complex formula may pay the remaining coupons (up to the target cap) in the following year and be forced to redeem and return the money to the investor in a relatively short time.

Target Accrual redemption Notes (TARNs) are available with the Numerix model and can be launched from New deals / Exotics / TARN (nx). Given above is the main screen for this structure. This wakes up to a 5 year structure with a target coupon of 12%. For an example TARN, please look at ISIN # XS0173996918. This is a TARN with an 11.5 % target coupon and an inverse floater formula of 9 % - 2 x USD 6M Libor set in arrears after the initial period coupon of 7.25 %. See below for DES page.

We structure this TARN per the DES page above (see below). Most details are standard except for the following; leverage is 2.00, intro coupon of 7.25 and a coupon (Base Rate) of 9.00 % which is used for the inverse floater formula after the intro period. Click on arrears for the floating reset function. Enter a target coupon of 11.50 % and Press calculate to price this trade.

The Cashflow screen below gives you the details on the flows for this structure. It also shows you the cumulative coupon at each payment date. This TARN will continue till maturity if the Target coupon is not reached. It will pay the Target coupon less the cumulative on the final payment date.

Curve section is similar to other SWPM structures. Here you can do simple parallel shocks. Numerix models for TARNs for now will not show any risk parameters / sensitivities but will be added later. For a quick dv01 calculation on the Numerix models, Shift the curve (Curve tab) by 1 basis point and take the difference in valuation before and after (see below).

ASW, YAF and Multi Leg coverage of structured products will follow later.

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