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Definition: Credit Linked Note - CLN
Credit Linked note is a type of debt security. So how credit linked note is different from any other form of debt security is that it is a security embedded with Credit default swap, but I this type the issuer has a extra provision to transfer a specific credit risk to any of the credit investors.
So let us understand what a credit default swap is, it is type of security that is designed to transfer a securities credit exposure to the other party. So in this type of contract, the purchaser of the contract will have to make payments till the end of the contract to the seller. For these payments, the seller has agreed to pay off a third party debt if the borrower defaults on any loan.
CLN securities can be issued only by a Special Purpose Company and it had to be collateralized by a AAA backed securities. So investors can buy these securities from trusts that issue these CLSN’s and in return the investor receives a coupon stating that the amount will be paid over the lifetime of the note. Also at the maturity, the investor will receive the complete amount, this will be done unless the owner of the security defaults or he is declared as bankrupt. So in case the trust of the security goes into a default, the investor receives an amount equal to the recovery rate of the trust. SO after this the trust enters into a default swap with the deal arranger.
As with other securities, the price of the note or the coupon is always linked to the performance of a reference asset. But in additional it provides the borrower a hedge against credit risk, and so gives investors a very high yield on the note for accepting exposure to a specified limit.