Targeted Accrual Redemption Note (TARN)

Key takeaways
* A TARN is an exotic, index-linked note that pays periodic coupons and redeems early once cumulative coupon payments reach a preset target.
* Early redemption returns principal (par value) when the coupon cap is hit; otherwise the note continues to maturity.
* FX-TARNs are a common variant tied to currency movements; other TARNs may reference interest rates or equity indexes.
* Valuation is complex and path-dependent, requiring models or simulations that incorporate volatility and the probability of early knock-out.

What is a TARN?

A Targeted Accrual Redemption Note (TARN) is a structured financial product that combines a fixed-income wrapper with payout features tied to an underlying benchmark (equity index, interest rate, or currency). The defining feature is a target (cap) on cumulative coupon payments: once aggregate coupons reach that target, the note terminates early and the issuer returns the investor’s principal (par).

How TARNs work

• Periodic coupon payments are calculated based on the linked benchmark and the note’s coupon formula.
• Each coupon accrues toward a predetermined cap. When the accumulated coupons reach the cap, the note “knocks out” and redeems early at par.
• If the cap is not reached, the note continues until scheduled maturity with remaining coupons and final principal repayment.
• Some structures include knock-out triggers tied to the benchmark level (e.g., if a rate or index reaches a certain threshold, the contract ends).

Variants and structural features
* FX-TARNs: Parties exchange currencies at preset rates on specified dates. The exchanged amounts depend on whether observed rates exceed or fall below agreed forward prices.
* Interest-rate–linked TARNs: May reference benchmarks such as Euribor and resemble inverse floating-rate notes.
* Option interpretation: TARNs can be viewed as path-dependent option portfolios (e.g., buying a strip of calls while selling a larger notional of puts), which helps explain nonlinear payoff and early termination behavior.

Valuation considerations

Valuing a TARN is more complex than valuing standard bonds because future cash flows depend on the path of the underlying benchmark and the timing of knock-out events. Key valuation points:
* The theoretical value equals the expected present value of remaining coupons plus principal, weighted by the probability distribution of knock-out times.
* Accurate valuation typically requires stochastic models or Monte Carlo simulation to capture interest rate or underlying volatility and the path-dependence of coupon accrual.
* Volatile benchmarks increase uncertainty about timing and total payments, making pricing and risk assessment more difficult.
* Sensitivities include volatility, correlation among underlying factors (for multi-asset notes), and assumptions about forward rates or expected index paths.

Risks and suitability

• Early redemption risk: Attractive initial coupons may end sooner than expected if the cap is reached, limiting upside from further favorable movements.
• Market and model risk: Pricing depends on models and assumptions; incorrect volatility or correlation estimates can lead to mispricing.
• Complexity: TARN payoffs are path-dependent and may be hard for retail investors to fully understand.
• Counterparty risk: As structured notes, TARNs depend on the issuer’s creditworthiness.

Bottom line

A TARN offers potentially higher initial coupon rates and the prospect of an earlier return of principal through a capped, path-dependent payout mechanism. That structure can suit investors seeking income with a defined accrual target, but it brings valuation complexity, early redemption risk, and exposure to volatility of the linked benchmark. Thorough model-based valuation and an understanding of the note’s triggers and counterparty risk are essential before investing.