A protection barrier is the measure of Capital Protection built into a certain structured note.
How exactly does it protect your investments?
The protection barrier returns investor’s capital in full at a maturity provided the underlying asset is not below a pre-determined barrier on the final observation date of the investment. It is usually set between 50 and 70% of the initial price of the structured notes listed on our menus.
If this barrier is breached somehow, then the loss of capital will have 1:1 correlation to the downside trend of the underlying assets.
These barriers are observed on a daily basis if it’s an American Barrier. If it’s an European Barrier, they are observed only on the maturity date. Usually, European Barrier is considered to be safer and NEBA Financial Solutions will only use this type of barrier unless it is specifically requested by our clients.
Let’s have a look at one simple example of a note with the following underlyings:
An investor wants to invest $200000. We set a protection barrier at 70% and the maturity date is in 3 years.
If one of the underlying asset (e.g. Amazon) is not doing well at maturity and it went down to 73% (or a 23% drop from its value at the start of the product), in this case, the investor will still receive its initial investment of $200000 back, because the value of Amazon is higher than the 70% Barrier!
If the person had invested directly into Amazon shares at the same time, he/she would have lost -27% of his/her initial capital, which would be an amount of $54000 because there is no downside protection when investing in this way. On the flip side, if Amazon shares had jumped +27%, potential gains would have been capped at the coupon amount offered by the structured product.
This is the one key reason why capital protection barrier is a very attractive feature on a structured product, especially for cautious investors who want to protect their underlying assets against any potential losses.