Exchange-Traded Note (ETN)
Exchange-traded notes (ETNs) are types of unsecured debt securities that track an underlying index of securities and trade on a major exchange like a stock. ETNs are similar to bonds but do not pay interest payments. Instead, the prices of ETNs fluctuate like stocks. The ETN pays investors the return received from the index they track at the maturity date, less any fees or commissions.
An ETN is typically issued by financial institutions and bases its return on a market index. ETNs are a type of bond. At maturity, the ETN will pay the return of the index it tracks. However, ETNs do not pay any interest payments like a bond.
ETNs are different than exchange-traded funds (ETFs). ETFs own the securities in the index they track. For example, an ETF that tracks the S&P 500 will own all 500 stocks in the S&P. ETNs do not provide investors ownership of the securities but are merely paid the return that the index produces. As a result, ETNs are similar to debt securities. The investors must trust that the issuer will make good on the return based on the underlying index.
Risk From an ETN Issuer
The repayment of the principal invested depends, in part, on the performance of the underlying index. If the index either goes down or does not go up enough to cover the fees involved in the transaction, the investor will receive a lower amount at maturity than what was originally invested.
The ETNs ability to pay back the principal—plus gains from the index it tracks—depends on the financial viability of the issuer. As a result, an ETN’s value is impacted by the credit rating of the issuer. The value of the ETN could decline due to a downgrade in the issuer’s credit rating, even though there was no change in the underlying index.
Investors must be aware of the risks that the issuer of an ETN may be unable to repay the principal and default on the bond. Also, political, economic, legal, or regulatory changes may affect the financial institution’s ability to pay ETN investors on time. (source: Investopedia)
