Accelerated Return Note (ARN)

DEFINITION of 'Accelerated Return Note (ARN)'

A short- to medium-term debt instrument that offers a potentially higher return linked to the performance of a reference index or stock. An Accelerated Return Note (ARN) generally caps the total return it will provide, but typically does not provide any downside protection. This restricts its appeal to a narrow segment of the investor populace, viz. investors who believe that the reference index or stock will only appreciate marginally until the ARN matures, but will not decline sharply.

BREAKING DOWN 'Accelerated Return Note (ARN)'

Consider an ARN that is linked to the S&P 500 and is launched when the index is at 2,000. The ARN is priced at $100 (principal amount) and matures in two years. At maturity, it offers investors an enhanced positive return equal to two times (2x) any positive return in the S&P 500, subject to a maximum return of 30%. The ANR will be exposed to 100% of any decrease in the S&P 500.

Let's analyze the potential returns based on various scenarios when the ARN matures  –

  • The S&P 500 is at 2,500 in two years: The S&P has had a return of 25%; while twice the S&P 500 return is 50%, the maximum return on the ARN is 30%. Thus, an investor in the ARN would receive $130 at maturity, representing a 30% return.
  • The S&P 500 is at 2,200 in two years: The S&P has had a return of 10%, two times of which is 20%. An investor in the ARN would therefore receive $120 at maturity, representing a 20% return.
  • The S&P 500 is at 1,500 in two years: The S&P has had a return of -25%. Since an investor in the ARN is exposed to 100% of a decrease in the index, he or she would receive $75, representing a return of -25%.

ARNs are structured investments whose relative complexity makes them unsuitable for conservative investors. They are also not suitable for investors who require the promise of 100% principal repayment at maturity that is implicit in a Treasury or high-grade bond, or for investors who seek an uncapped return on their investment in exchange for assuming 100% downside risk.