A. Exchange-traded-notes (ETNs) are similar to exchange-traded funds (ETFs) in that they trade on a stock exchange and track a benchmark index. However, there are important differences:
- An ETN is a senior, unsecured debt security issued by a bank, unlike an ETF which holds assets such as stocks, commodities, or currencies which are the basis of the price of the ETF. The return of an ETN is linked to a market index or other benchmark.
- An ETN promises to pay at maturity, the full value of the index, minus the management fee. Like any other debt security, the investor is subject to the credit risk of the bank issuer.
ETNs were developed in 2006 by Barclays Bank to make it easier for retail investors to invest and maximize the returns in hard-to-access instruments, particularly in the commodity and currency areas.
By moving to a debt structure, Barclays eliminated the costs associated with holding commodities, currencies, and futures and improved the tax structure for investors.
An ETN is essentially a bet on the index's direction guaranteed by an investment bank. As the index moves, so moves the ETN. The financial engineering underlying ETNs is similar to the financial engineering that investment banks have long used to create structured products for institutional clients. ETNs are different from ETFs because they don't own the underlying assets that their return tracks. ETNs are unsecured debt obligations.
In our next blogpost, we will discuss what are the advantages of ETNs.