WOULD-BE punters with a cautious streak can enjoy the thrill of dabbling in the local stock market while limiting their loss - or gain - thanks to derivatives. Banks offer 'principal-guaranteed participation notes' to risk-averse retail clients, particularly those who are unsure of the market's direction. These two-part products include a note with an embedded option. The note - through which the investor 'participates' in ownership of the underlying assets - might or might not pay interest. It is linked with an individual company's shares or an index. So, for example, the banker might say you have 'bought the Hang Seng at 12,000'. Any movement above this level, the note's 'strike' price, will generate a pay-out in addition to any interest earned. The rate of this pay-out, the 'participation' rate, would have been specified at the time of purchase as a certain percentage of the market's rise. There is no comparable down-side penalty. Say you bought an index-linked note carrying a strike price of 12,000 and a participation rate of 50 per cent. If the index stood at 15,000 at the end of the note's term - a 25 per cent rise - you would earn a return of 12.5 per cent on your investment. In a sharply rising market, the investor in notes would miss some of the up side compared with the direct investor in shares. In a falling market, however, the note investor would be glad his principal was guaranteed - but he might find himself looking yearningly at the higher rate paid on a time deposit.
