# Understanding Targeted Accrual Redemption Notes (TARNs) and Their Features

![A banker uses a calculator to determine the number of coupon payments remaining until the termination of a derivative note.](https://www.investopedia.com/thmb/Dp7SueFBd2aQBCRJDkeUeokDuzo=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TargetedAccrualRedemptionNoteWhatItIsHowItWorksGettyImages-2159351550-a69d83142cd240cc8465accbf59e2af1.jpg)

*— Nansan Houn/ Getty Images*

## What Is a Targeted Accrual Redemption Note (TARN)?

A targeted accrual redemption note (TARN) is an exotic [derivative](https://www.investopedia.com/terms/d/derivative.asp) that offers potentially attractive returns but comes with a unique structure and risks. A TARN pays periodic coupons but has an early termination feature: once the cumulative coupon payments reach a predefined target amount, the note automatically redeems early, returning the investor's principal. This makes TARNs appealing for investors seeking the potential for an earlier return of capital along with income.

Typically linked to underlying indexes or other benchmarks, their value fluctuates with market performance. However, because coupon payouts depend on the movement of the linked index and the redemption trigger, TARNs can be challenging to value due to the uncertainty of both timing and total payouts.

### Key Takeaways

*   A TARN is an exotic derivative that terminates once a set limit on coupon payments is reached.
*   TARNs can end early, offering a final payment of par value when the coupon limit is met.
*   FX-TARNs involve currency exchanges based on pre-determined rates rather than equities.
*   Valuing TARNs is complex due to potential early terminations and interest rate volatility.
*   TARNs may be linked to indexes or rates and act like path-dependent options.

## How Targeted Accrual Redemption Notes (TARNs) Work

A targeted accrual redemption note is an index-linked note with a fixed limit on coupon payments. Once the target limit is hit, the note ends, and the par value is paid out. So there is usually an attractive initial coupon combined with the possibility of getting back the par value relatively fast. An index-linked note is an investment product that combines a fixed-income investment with additional potential returns that are tied to the performance of an equity index such as the S&P 500 index. 

Aside from these index-linked features, TARNs are similar to [inverse floating-rate notes](https://www.investopedia.com/terms/i/inversefloater.asp) where the benchmark may be [Euribor](https://www.investopedia.com/terms/e/euribor.asp) or a similar rate. TARNs can also be conceptualized as [path-dependent options](https://www.investopedia.com/terms/p/pathdependentoption.asp): the end-user in effect buys a strip of call options while selling a strip of put options with a notional value that is double the calls'. The contract may include a knock-out provision that terminates it if the benchmark reaches a certain level. 

FX-TARNs are common TARNs where parties swap currencies at a set rate on specific dates. The amount of currency exchanged varies depending on whether the rate is above or below a set forward price. 

## Evaluating the Value of Targeted Accrual Redemption Notes (TARNs)

Valuing TARNs is hard because the timeline depends on how many coupons are received so far. When the knock-out level is reached, the investment ends, and the principal is paid back. From an investor's perspective, a great initial coupon rate for a time and an early return of capital is an ideal outcome. However, depending on how the indexed rates perform, an investor may be stuck in the investment and see the time value of money erode what was once an attractive shorter-term investment.

Generally speaking, the value of a note is the present value of the par and coupon payments. However, there is uncertainty with targeted accrual redemption notes because not all coupon payments will necessarily be received. So instead of a linear calculation on present value, a TARN requires a simulation of interest rate volatility to assess the probability of triggering the knock-out level given the terms of the note. TARNs tied to volatile benchmarks will necessarily be more difficult to accurately value.

## The Bottom Line

A targeted accrual redemption note (TARN) is an exotic derivative that ends once the accumulated coupon payments hit a predetermined cap. This structure can be appealing because it often offers higher initial coupon rates and the possibility of an early return on capital.

However, the timeline and payout depend heavily on the performance of the underlying index, such as in FX-TARNs, where returns are tied to currency exchange movements, which adds volatility and uncertainty to the investment.

The valuation of TARNs is complex because it relies on factors like interest rate volatility and the chance that the coupon target may not be reached before maturity. Investors interested in TARNs should be prepared to navigate their path-dependent nature and understand the dynamics of interest rates and indexes before committing funds.

> **Article Sources**
>
> 1.  Finance Strategists. “[Targeted Accrual Redemption Note (TARN)](https://www.financestrategists.com/wealth-management/alternative-investment/targeted-accrual-redemption-note-tarn/).”