Five-year income linked to FTSE 100 and the Bank of England base rate

Barclays is offering UK investors a five-year income product based on the fortunes of the FTSE 100 and rises in the Bank of England base rate. Capital is at risk at maturity if the index breaches a 50% barrier

Barclays has launched a five-year income product linked to the FTSE 100 index and the Bank of England base rate. The note pays the higher of 5.76% per annum or the Bank of England base rate plus 3% per annum regardless of index performance. Investors must be prepared for the loss of capital if the index breaches the 50% barrier during the product term.

Investors will receive monthly fixed income payments throughout the life of the product no matter how the FTSE 100 performs. The product will pay the higher of the base rate plus 3% pa or 5.76% pa (equivalent to 0.48% per month). The Bank of England base rate has remained at 0.5%, its lowest ever level, since March 2009. The highest level recorded for the base rate was 17% in November 1979.

If the base rate remains at its current level the product would pay the minimum coupon of 0.48% per month. In order for investors to receive coupons higher than that, the rate would have to increase by at least 2.26%, but even if it remains unchanged the product will pay an income stream well above the risk-free rate. If the rate increases, investors will earn higher coupons to compensate for the higher rate.

Capital is at risk at maturity if the 50% barrier is breached at the close of business on any day during the product term. If it is breached and the final index level is lower than its initial level, capital will be lost at a rate of one percentage point for every percentage decrease in the underlying. If the barrier is not breached, investors will receive full return of capital at maturity. Capital will also be returned in full if the index breaches the barrier but recovers to its initial level by the end of the term. Using the usual FVC index distribution assumptions, there is a 7.8% chance that the index will breach the barrier and finish below its initial level at maturity.

The fixed coupons mean some principal can be lost at maturity without incurring a loss on a total-return basis. If the barrier is breached, the index needs to finish above 94.24% of its initial level for investors to get back at least their principal investment overall. Whether the barrier is breached is critical to the performance of this investment.

Pricing and risk

This structure is an income-generating capital-at-risk product. The pricing can be broken down into three components: a zero-coupon bond that allows for the full repayment of capital at maturity; the coupon stream of the higher of 5.76% per annum or the Bank of England base rate plus 3% pa; and the sale of a put option with a knock-in barrier at 50%, which funds the above-risk-free-rate income.

The product would appeal to investors who want a monthly income and are willing to take on some risk to capital. The interest-rate element means it could also appeal to investors who want to protect the value of their coupons against rising interest rates, or who believe that interest rates will rise over the product term and wish to benefit from this growth. The interest rate feature will come at a cost to investors, so if they are not concerned about rate rises they could achieve a higher annual rate with a standard reverse convertible (capital-at-risk income) product.

Capital is at risk and the barrier is set at 50%, the most common level in the UK retail market. Therefore, as the downside risk is linked to the FTSE 100, the most popular underlying in the UK, the product should be of a relatively standard risk level. As it pays coupons regardless of the movement of the FTSE 100, returns in the case of loss to capital will be higher than a comparable capital-at-risk growth or kickout product with the same barrier level.

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