anyone knows how to structure an equity linked target redemption note? specifically what options are used?

Not being an expert in this instrument, I'm writing my initial thoughts on this one to inspire further discussion:The key in TARNs is that they mature as soon as the cumulative payoff reaches certain level. Lets assume the following structure:Capital guaranteed 5 year bond100% participation in rise of Equity Index (currently trading at 100)Target redemption is 20% return (which means that the bond is redeemed at par and 20% payed out as soon as (and if) the index hits 120)To replicate this structure (example) we can combine the following to get some idea:1) Long Call on the Equity Index with strike 100 and a Knock-out at 1202) Long American Digital on the Equity Index with strike 120 and a payout of 203) Interest Rate Swap (Paying Libor and Receiving Fixed)4) Long Series of European CAPS at strike 0% that knock in when Equity Index hits 120 (cross market barrier)5) and of course rolling MM deposit for the (principal - total options&caps price)Adjusting size and rate of (3)/(4) is neccesary to make Cashflows match and SUM(NPV)=0The ugly duck is component 4. It can be expressed in other terms than a 0% cap, it's basically a claim on future LIBOR rates if the barrier is hit. Correlation between the factors of the swapcurve and the equity market is very important in pricing of this component. Should be exciting to hedge. If participation is in form of an annual coupon (eg. clichet) then the barrier in the structure above must be modified from 120 to SUM(past coupons).Anyone have a termsheet on equity linked TARN?Best regards,Z

Ziggy,Thanks but do you mean we need both comp 1 and 2? Why isn't either one suffice the need?

QuoteOriginally posted by: pigboyZiggy,Thanks but do you mean we need both comp 1 and 2? Why isn't either one suffice the need?Don't forrget that the example structure gives 100% participation in the rise of the index, capped at 20% return. It's only early-terminated if/when we reach the cap. So if the index has only risen 10% at maturity the owner of the bond gets 10% return.If we only had component (1) the cap would act as a knock-out and the bond owner would lose all equity return, but receive the par valueIf we only had component (2) there is no participation in the rise of the index, only the digital payout when we reach the barriersBoth examples are valid structures, but not the type I was describing in my example.Best regards,Z

If i would have to structure this i would tell the client it's much more convenient to only observe the target once very three months. Than i would price it as:1) 3m libor deposite2) barrier call on index with strike 100, barrier 120 and immediate rebate 20This gives a slight overpricing since i price the rebate continuously and give my client only discrete observations.This could be solved though if you can price bermudan barriers (should not be too difficult)

Its even more simple than that. You can use standard barrier option, no need for bermundian, since if you knock out at any time the payout is 20 which is already the maximum payout the structure can get.Best regards,Z