Exchange traded notes are a variant of debt security that involve an investor paying cash to a firm and then receiving payments in return, which are linked to a market's performance. Unlike investments such as equity indexes, people buying exchange traded notes do not get ownership of any company.
The most significant characteristic of exchange traded notes is that they combine advantages and disadvantages of both debt and equity products. Both of these are ways in which a company can raise cash. The difference is that a debt product involves an investor paying now and then receiving money back from the company later on, ideally making a profit. An equity product involves the investor paying money in return for a part-ownership of the company. The company does not then have to pay back any money to the investor beyond any appropriate dividends.
The exchange traded note blurs the line between the two types of products. It is technically a debt product, as the investor pays money and then later the company pays money back. Unlike most debt products, though, the return is not guaranteed and instead depends on a market's performance. Any market can be used with exchange traded notes. The company issuing the note does not have to be listed on the market used for the deal.
Among the advantages of exchange traded notes are that they are considered tax efficient. Most equity based investments include dividend payments each year which attract taxation. With an exchange traded note, the investor does not receive a taxable payment until they either sell the ETN to another investor, or the ETN reaches maturity. Though the investor will still have to pay tax on the gains, this set-up allows them more control over when they pay it. In some countries, including the United States, this can allow the investor to delay the payment long enough that the investment counts as long-term rather than short-term and attracts a lower rate of tax.
The other major advantage of an exchange traded note for an investor is that the potential for profit is higher than with a standard debt equity. Rather than have a guaranteed rate of return, the investor's profits can vary depending on the tracker market's performance. There is, of course, a risk that the market may fall and the return will be lower than the amount invested. The set-up of exchange traded notes also adds the risk that the issuing company may default on the payment, making the investment worthless.