What is an implicit cost of principal protected notes?

Implicit costs are indirect costs or opportunity costs embedded in a financial product's structure, as opposed to explicit, separately disclosed fees. For a Principal Protected Note (PPN), a performance participation cap is a key implicit cost. This cap limits the potential upside an investor can earn from the underlying asset. By accepting this cap, the investor forgoes some potential gains in exchange for the principal guarantee. This forgone potential return is a significant, though not separately itemized, cost of the product.

A. Structuring costs and guarantee fees are direct expenses charged by the issuer and are considered explicit costs, which must be disclosed.

C. Commissions are explicit fees paid to the sales representative or dealer for the transaction and are disclosed to the investor.

D. Early redemption fees are penalties charged for cashing in the note before maturity. They are a disclosed, explicit, and conditional cost.

1. Ontario Securities Commission. (2022). Principal-Protected Notes (PPNs). OSC Investor Education Fund publications. These guides explain that features like participation rates and return caps limit potential returns and are key considerations (i.e., implicit costs) for investors. (See "GetSmarterAboutMoney.ca" resources).

2. Canadian Securities Administrators. (2012). CSA Staff Notice 46-304: Report on Principal Protected Notes. This notice discusses the complexity and features of PPNs, including participation rates and caps as key structural elements affecting investor returns.