Coupon income in Barclays regular income bond makes up for capital loss

In March 2008, Structured Products analysed a five-year reverse convertible linked to the Euro Stoxx 50 index that was available in three versions: annual income, quarterly income or a growth version with payment at maturity, returning 7.25% per annum, 1.8% per quarter or 50% at maturity regardless of the performance of the underlying index, respectively.

Initial capital was at risk if the 60% barrier was breached and if the index was below its initial level at maturity.

The barrier was breached in November 2008, eight months after the strike date. As the final index level at maturity was 76.2% of the initial level, there was a 23.8% loss to capital. As well as a return of at least some capital, investors could either receive coupons throughout the life of the product or, in the case of the growth option, a payment of 50%. If the growth option was chosen, investors would have received a payment of 126.2% of their initial investment at maturity. This is equivalent to a rate of 3.95% per annum (the five-year risk-free rate at the time of pricing was 4.89%). Investors in this product would have been looking to make a return above the risk-free rate over the period in exchange for taking on the additional risk to capital.

Although this was a capital-at-risk product and the barrier was breached, with consequent loss to capital, the fixed coupons or growth payment offset that loss, and the product did in fact pay a positive return. A typical growth product issued at the time with the same barrier level would also have suffered loss to capital but would have not necessarily paid any additional returns, as it would have required the index to be above its initial level at maturity to pay a return. Most products on the Future Value Consultants UK research service are structured with a barrier at 50% of the initial level. By offering a higher barrier, this product was able to offer higher rates of interest in exchange for the increased risk to capital. A 50% barrier would also have been breached, but the lower coupons would mean investors would have received a smaller total return had they taken this option.

In 2008, American intra-day or closing-day barriers were the most common form of soft protection. Although both are still used, providers tend to opt for the closing-day barrier as it offers slightly more protection. European barriers, which observe the index only at the strike date and at maturity, are also common. These offer investors more protection as the index can breach the barrier during the life of the product but if it climbs back above the barrier by maturity then full capital will be repaid.

If this product had used a European barrier then investors would have been repaid initial capital in full, but due to the increased cost of the protection the income stream would have been lower.