Barclays structured note gives digital payout on the DJIA

Fixed returns can rise if the index goes above the fixed-return level

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This four-year product from Barclays has a digital payout and offers returns linked to the performance of the Dow Jones Industrial Average Index (DJIA). Investors will receive a return of 11-12% (to be set on the strike date) if the DJIA is not below its strike level at maturity. If index growth exceeds 11-12% then investors will receive additional returns of 1% for every 1% growth above this level.

Principal is at risk and will be lost if the final level of the index is lower than 85% of the strike level, in which case investors will lose principal at a rate of 1% for any 1% fall in the value of the underlying below the 85% level. For example, if the index finishes at 75% of its initial level, investors would receive 90% of their principal at maturity, incurring a loss of 10%. This figure is calculated by multiplying the fall from the buffer (10%) by the downside gearing (-100%).

In the US market, the most common features used to reduce the risk of capital loss are buffers, European barriers and American barriers. Of these (presuming they are set at the same level), the buffer offers the highest level of protection. In general, barriers are seen more frequently in short-term, high-risk products such as reverse convertibles, while it is more common to see buffers on longer-term growth products.

Like the European barrier, the buffer condition is observed at maturity only. The American barrier is observed throughout the life of the product, however, and is therefore higher risk as there are more observation points on which the index could breach the barrier.

This type of investment is popular with those looking to make a fixed return on their investment within a certain timescale. Investors will be paid the fixed payment with little or no market growth and will be paid returns above that consistent with market growth, making it suitable for investors looking to participate in the index with the extra comfort of the fixed return. Because this product places investors' capital at risk if the index falls below 85% of its initial level it would not be suitable for anyone with a cautious attitude to risk. Investors should also be aware that once they invest, they will not be able to touch their capital until the end of the investment period. Nor will they receive dividends during this period.

Pricing and risk

This product has four components: a zero-coupon bond, a digital option, a European call option and a European put option. The call option has a strike equal to 100 plus the digital amount and therefore covers the returns above the digital payment. The put option has a strike of 85%. The minimum return is 15%, which would occur if the underlying asset fell to zero.

The product has a lower market riskmap rating than other similar products in the UK - probably because of the buffer level of 15% and the choice of underlying. These products can be linked to a wide range of assets - including funds and single stocks - that can be more volatile and would therefore increase the riskmap even if the protection level is the same. Conversely, the credit portion of the riskmap score is higher for this product than similar structures, mainly because of the length of the term rather than the creditworthiness of the issuer itself. Many of the products in this category will have terms of between one and two years, and are therefore less exposed to the issuer's credit risk.

The DJIA is one of the most popular underlying indexes in the US. Structured products such as this one can be a good way for investors to obtain exposure to an underlying asset they are comfortable with while changing the return payout in some way. The buffer and the digital payout offer investors a variation on the risk/return profile compared to investing in a fund that tracks the performance of the underlying.

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The information in this analysis is taken from sources which Future Value Consultants Limited deems reliable but no guarantee is made that the information is complete or accurate and it should not be relied upon as such. Any opinions in the analyses represent those of Future Value Consultants Limited at the time of writing but are subject to change. All valuations and prices shown are indicative only and do not imply an offer or commitment of any kind. The analysis does not constitute advice or recommendations nor should it be relied upon for any purpose. No liability whatsoever is accepted by Future Value Consultants Limited or Structured Products magazine for any loss or expense incurred from using this analysis.

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