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In the previous lesson, we introduced the basic concepts and advantages of Fixed Coupon Notes (FCN). We believe everyone now has a preliminary understanding of FCN products. In this lesson, we will explore how FCN is linked to stocks and the differences between FCN and other similar financial products.

As mentioned earlier, FCN can be linked to a single stock, a design that is relatively simple and straightforward. However, compared to linking to an index, the volatility of a single stock is higher, making it more prone to triggering knock-in and knock-out, posing greater risks. On the other hand, while linking to an index can mitigate this drawback, it introduces systematic risk (all constituent stocks experiencing significant gains or losses).

If FCN is linked to multiple stocks through structured rule designs, it can effectively reduce the mentioned risks and potentially increase returns. To understand this better, let's first explore how FCN is linked to multiple stocks.

1. How FCN Hooks Multiple Stocks

Generally, FCN hooking multiple stocks follows two main rules:

1.1 Based on the Performance of the Worst-Performing Stock:

Assume an FCN product is hooked to three stocks, each with its own knock-in (exercise) and knock-out prices. When determining whether to knock out on the observation day, the decision is based on the worst-performing stock. If that particular stock triggers a knock-out, the FCN will knock out.

Conversely, when it comes to knocking in, only the worst-performing stock needs to fall below the knock-in price to trigger a knock-in for all three stocks.

1.2 Based on the Performance of the Best-Performing Stock:

This scenario is the opposite. In a situation where an FCN product is hooked to three stocks, each with its own knock-in and knock-out prices, the decision to knock out on the observation day is determined by the best-performing stock. If that stock triggers a knock-out, the FCN will knock out.

On the flip side, when it comes to knocking in, the best-performing stock falling below the knock-in price will trigger the FCN to knock in. If all the best-performing stocks trigger a knock-in, it implies that all three stocks have knocked in.

In summary, the approach of hooking multiple stocks in FCN is more flexible but also more complex. Therefore, when selecting FCN hooked to multiple stocks, careful consideration of contract details, understanding potential risks and returns, and seeking professional advice when necessary is crucial to align investment strategies with risk tolerance and investment goals.

2.FCN and Comparison with Other Financial Instruments

2.1 Comparison between FCN and Options

In terms of investment outcomes, FCN products have similar effects and applicable scenarios to selling put options. Let's first explore the basic concept of selling put options.

A put option allows the buyer the right, but not the obligation, to sell their stocks to the seller at a predetermined price in the future. As the seller, there is an obligation to buy the stocks from the buyer at the agreed-upon price if the buyer exercises the option.

Theoretically, the seller of a put option may incur losses only if the stock price falls below the specified strike price in the future. Otherwise, the seller can earn the option's time value, represented by the premium.

For example, the well-known story of Warren Buffett involves selling put options to buy Coca-Cola stocks. Buffett wanted to buy Coca-Cola stocks when the price fell to $35 per share. Since the current price was $40 per share, Buffett sold put options with a strike price of $35. If Coca-Cola did not drop below $35, Buffett would collect the entire premium as the time value of the option. However, if the stock price fell to $35 or below, Buffett would be obligated to fulfill the seller's duty and buy the stocks at the strike price, potentially facing the risk of further price declines.

This situation is similar to FCN products. Buffett's selling of put options is equivalent to buying an FCN with a strike price of $35 and a knock-out price of $40 or higher. However, FCN products offer two advantages over selling put options:

1. Lower Risk than selling put: In the three scenarios, the risk of potential losses exists only when FCN involves knocking in (exercising) stocks. However, during the holding period, as long as the stock price does not touch the strike price, FCN will not incur a loss, but selling a put option may incur a floating profit and a floating loss.

2. No Margin Requirements: Selling put options requires substantial margin usage, potentially leading to lower actual investment returns. FCN does not involve margin requirements; investors only need to pay the investment amount as the principal, providing clear returns without calculating implicit capital costs.

2.2 Comparison Between FCN and Snowball

Many investors are likely familiar with Snowball, another structured investment product. While FCN and Snowball share a similar structural goal of capturing interest within a stock price range, there are several key differences in their details:

1. Observation Days:

   1. FCN typically sets observation days on specific days each month. Knock-in and knock-out events are triggered only if the stock price touches the respective levels on these observation days. This design helps mitigate the risk of frequent triggering events on non-observation days.

   2. Snowball, on the other hand, observes on a daily basis. This means that any day the stock price touches the specified levels triggers knock-in and knock-out events. This may lead to more frequent knock-in and knock-out events since stock prices can fluctuate to specific levels on any given day.

2. Post-Knock-In Handling:

   1. After a knock-in event in FCN on the observation day, the entire invested principal is used to acquire the stocks, and all accrued interest is settled. This design ensures immediate participation in the underlying assets after a knock-in event.

   2. In Snowball, post-knock-in handling varies. Generally, there are three scenarios:

      • If there's a subsequent knock-out after a knock-in, the knock-in is void, and the accrued interest up to the knock-out is paid.

      • If the stock price rises post-knock-in but remains below the knock-out price, investors receive the difference between the stock price and the initial price as profit, excluding interest.

      • If the stock price rises post-knock-in but stays below the initial price, investors bear the difference between the stock price and the initial price as a loss, excluding interest.

It's important to note that these are general scenarios, and different structured investment products may have variations in their design and operation. Therefore, thorough reading of the product's terms and conditions is crucial before making an investment

In conclusion, FCN, compared to other similar financial products, offers controlled risk and stable returns, making it more suitable for investors less familiar with derivative investments. In the next lesson, we will delve into the risks and returns that investors may face after purchasing FCN products through case studies.

Structured notes may involve financial derivatives and carry specific product risks. It is a non-principal protected product and is limited to professional investors only. Investors should carefully review product information and terms and conditions to understand product details and risk disclosures. Please be fully aware of the investment risk and market risk. This material is for investor education purposes only. It should not be treated as investment advice.