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What are 'Exchange Traded Notes - ETN'

Exchange-traded notes (ETNs) are a type of unsecured, unsubordinated debt security first issued by Barclays Bank PLC based on the performance of a market index minus applicable fees, with no period coupon payments distributed and no principal protections. Similar to exchange-traded funds (ETFs), ETNs are traded on a major exchange, such as the New York Stock Exchange (NYSE) during normal trading hours.

BREAKING DOWN 'Exchange Traded Notes - ETN'

One factor that affects the ETN's value is the credit rating of the issuer. The value of the ETN may drop due to a downgrade in the issuer's credit rating, even though there is no change in the underlying index.

Banks and other financial institutions typically issue ETNs at $50 per share. Part of the market price depends on how the underlying index is performing. ETNs do not show ownership in a pool of securities; they simply track the performance of a specific market index. When the ETN matures, the financial institution takes out fees, then gives the investor cash based on the performance of the underlying index.

Tax Treatment of ETNs

Barclays suggests investors treat ETNs as prepaid contracts. The difference between the purchase price and selling price of the ETN should be treated as a capital gain or loss for income tax purposes. The investor may defer the gain until the ETN is sold or matures.

Risks Involved with ETNs

The repayment of principal depends somewhat on how the underlying index performs. If the index either goes down or does not go up enough to cover the fees involved in the transaction, the investor will receive less at maturity than what he originally invested. Also, the issuer of the ETN may be unable to pay the principal or extra return on time or may default on the loan. Political, economic, legal or regulatory changes or natural disasters may affect the financial institution's ability to pay ETN investors on time. Also, because the secondary market may be limited, and because the underlying index may change rapidly, selling an ETN before maturity may result in a large loss or gain.

Example of an ETN

In July 2016, Janus Capital Group Inc. announced the launch of three Volatility-Strategy ETNs. The ETNs use a systematic approach to investing in volatility index (VIX) futures that have a net long or net short volatility position that varies based on changes in the market. The ETNs let institutional investors use volatility in part of their portfolios without actively trading underlying positions every day. The Volatility-Strategy ETNs are issued by UBS AG, and the underlying indices have been published since 2011.

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