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Trackers


A tracker replicates the performance of an underlying asset directly and with no leverage.

In technical terms, this is a zero strike Call, but in reality, it is very much like holding the underlying asset directly. Trackers give investors a cost efficient means to trade an asset (such as a currency or commodity) or to diversify their exposure across an index. As with all securitised derivatives, trackers are stamp duty free.


These instruments are typically long-dated or indeed undated with an indefinite lifespan, and can be referred to as bull, tracker or benchmark
certificates.

Tracker

Issuer:

ABC Bank

Issue date:

February 2005

Expiry date:

Undated

Underlying assets:

FTSE 100 (current index level 5000)

Conversion ratio:

1000:1 (1000 trackers per index unit)

Strike:

0

Exercise style:

European

Tracker priced at:

500p

As can be seen from Fig 1, the tracker replicates the index without leverage.  In this case, should the FTSE 100 fall 500 points, the tracker will lose 50p in value and should the FTSE 100 rise 500 points, the tracker will gain 50p in value.


Although no dividend is paid out, any income streams are built into the capital value of the tracker over its lifetime. However, as always, the precise terms should be checked with the Issuer.


Below is a further example – this time the underlying is the S&P 500 index. Trackers are not limited to equity indices, and in fact can be issued on any underlying asset, however this is a useful example because of the currency risk.

In this example, the underlying index on which the tracker is issued is priced in a foreign currency, in this case dollars, and this needs to be taken into account:


Tracker price = index / conversion ratio / exchange rate

                         = 1150/100/1.85

                         = 622p


When investing in trackers based on an underlying denominated in a foreign currency, investors may or may not be exposing themselves to exchange rate fluctuations. Some trackers incorporate a quanto feature which ensures the tracker is constantly fully hedged for currency risk. At listing and expiry there is no currency conversion (see example below for a tracker based onGold spot price). The cost of hedging varies and is built into the price of the instrument. Composite trackers, on the other hand, are unhedged and exposed to currency risk.

Quanto

Composite

Gold spot price at listing

$4.00

$4.00

Exchange rate at listing

 

$1.75

Tracker listing price

400p

229p

Gold spot price at expiry

$4.50

$4.50

Exchange rate at expiry

 

$1.88

Tracker price at expiry

450p

=450/1.88

                                                                                             =239p

Return

112.5%

104.4%



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