Principal Protection and Capital Guarantee: Two Labels
Principal protection and capital guarantee are two labels printed on the front of documents, and they are not two different legs. Underneath each sits a single promise: a stated amount, owed on a stated date. The first phrase describes the shape of that promise. The second reaches past the shape towards whoever is standing behind it. Neither phrase supplies the name of the party who would have to pay.
Three inputs generate all of the arithmetic below: a spot price of Rs 2,000.00/- for the reference asset, financing of 6.50 per cent a year, and a call premium of Rs 180.00/- which is given rather than worked out. One more condition carries as much weight as the three inputs: the reference asset pays nothing at all while it is held. A payout during the year would move every rupee that follows.
Both sets of words are descriptions of one obligation, and an obligation is only ever as good as the party carrying it. The second clause is a definition rather than a warning about anybody in particular. Being only as good as the party carrying it is simply what an obligation is. Somebody has undertaken to do something, and the name given to that undertaking on the front of a document is not the same kind of thing as the identity of the party who gave it. One is a description. The other is a party. An explanation that lets those two collapse into each other has taught a reader to stop reading at exactly the point where the reading starts being useful.
Before reading on. Two documents sit side by side, one carrying the words principal protection and the other the words capital guarantee. How many different kinds of leg would a reader expect to find inside them?
What do both sets of words sit on top of?
The thing being described comes first. Settling it is what makes everything after it short. Underneath both labelsWords printed on the front of a document describing what is inside it. A label is written by somebody about something, and it is not itself the thing. is one leg: a promise legA promise to pay a stated amount at a stated date. Its terms do not move with the reference asset, and the whole of it is an amount and a date., meaning a promise to pay a stated amount at a stated date. An amount and a date are the whole of its terms. The promise leg does not move when the reference asset moves, it does not pay early, and it does not pay more because things went well.
The everyday version is a slip of paper between neighbours, and it is closer than it looks. A neighbour writes down that she will hand over Rs 40,000/- on the first of next April. The slip can be described in two ways. One description is what it promises: Rs 40,000/-, on the first of April. The other is who is behind it: the neighbour, and behind the neighbour her salary, her savings and whatever else she could reach for if April arrived and the money was not on the table. Both are descriptions of the same slip. Neither replaces the other, and a person who has only the first has not been cheated of the second, they simply have not asked for it yet.
The two labels are not two different legs, not two different instruments and not two different shapes of payment: they are two ways of writing about one obligation on the front of a document. Everything else in this guide is a consequence of that sentence.
Bluntness is worth it here. The two phrases are usually met one after the other, in a conversation, as though a person were being offered a choice between them. A reader who has just been shown both fronts is already hunting for the difference in what is owed. There is none to find. The amount and the date are fixed by the leg, and the phrase on the front is a description written on top of a leg that was already complete before anybody chose the wording.
What do the words principal protection describe?
The words principal protection describe the shape of a promiseWhat is owed and when it is owed, stated without reference to who owes it. A shape can be written down and priced; it names nobody.. Shape has a precise meaning here, and it is a narrow one: what is owed, and when it is owed. Two fields, and nothing else.
Filled from the worked instance below, both fields are covered by the label exactly. The amount is Rs 2,000.00/-. The date is the end of one year. The amount and the date together are a complete description of an obligation's shape, and knowing them is genuinely useful. Written on one line and handed to a stranger, it would say precisely what has been undertaken. Nothing about that is empty, and nothing about it is a trick of wording.
The shape leaves out the rest of the sentence: who owes the amount, what stands behind that undertakingSomething a named party has committed itself to do. An undertaking always has somebody attached to it, even when the document describes it without naming them., and what would happen to a holder who wanted out before the date arrived. None of the three is being concealed by the label. The three are a different kind of information, sitting in a different place, and the label was never in a position to carry them.
So the line to leave with is short. The label describes an obligation's shape. Knowing that shape is worth something, and describing a shape is not the same as knowing the obligation will be met. Both halves of that sentence are true at once, and a reader who drops either half has misread it.
One more field, and it is the one readers skip. The date is part of the shape and it does the same work as the amount. An amount owed at the end of one year is a different obligation from the same amount owed on demand, and it is a different obligation again from the same amount owed in five years. The words on the front do not say which of those a holder is holding. The date has to come off the document, along with everything else that matters.
A document front reads principal protection. Which pair of things has that phrase just described?
What do the words capital guarantee reach for?
The second phrase is doing something different from the first, and the difference is not one of strength. The words capital guarantee reach past the shape and towards the backingWhatever stands behind a party's undertaking if that party is called on to perform it. Backing is a fact about a party, not a feature of a document.: they are trying to say that somebody stands behind the promise.
The subject has changed. The first phrase is about the obligation. The second is about a party. A difference in subject is not a difference in degree, and that is the reason the two cannot be ranked against each other at the end. Which of a shape and a party is the stronger one cannot be said, any more than whether a length is heavier than a colour. The two phrases are not answers to the same question.
And here is the observation that does the work of the whole guide: a guaranteeA promise by one party to perform if another does not. The second promise is laid over the first, and like the first it is made by somebody. is itself a promise by somebody, so the word moves the question one step along rather than closing it.
Back to the slip of paper. The neighbour promises to hand over Rs 40,000/- next April. Then her brother writes underneath that he will hand it over if she does not. The holder now has something real. A second party has taken on an obligation, and that is genuinely more than there was a minute ago. The holder does not have anything that has stopped being a promise. The second line is a promise too, made by somebody with a name, and the name is the information doing the work. If the brother's identity is never learned, the second line has said that a further undertaking exists and nothing at all about whether it can be met.
So the two things a reader would then want are questions rather than instructions. Who is the party giving that undertaking? And what is it that stands behind theirs? Both are answered by a name and by terms, never by a word on a front. Where that name has to appear in a document, and what has to be said about it, is set by the Securities and Exchange Board of India (SEBI) at sebi.gov.in.
A document says that a second party stands behind the amount. What has the reader just been told, and what do they still need?
What question does neither set of words answer?
The question is the same in both cases and it is four words long. Who owes this amount?
The useful part, and it deserves to come before anything else, is that the answer exists and is findable. The answer is in the document, in the sentence naming the party who will pay. The naming sentence is there because it has to be: what must be told to a person about who owes an amount and what stands behind that promise is set by SEBI at sebi.gov.in.
A label describes an obligation and a name identifies the party carrying it, and no amount of reading the first will produce the second. The failure set out further down is nothing more than somebody who read the first and waited for the second to follow on its own.
The same distinction is drawn everywhere else without effort. When a courier slip says delivery promised by the end of the day, nobody treats the words as the delivery. The reader looks for which company is on the slip. The words describe the undertaking and the mark identifies who took it on. Nobody finds that confusing on a courier slip. The same distinction becomes confusing on a document about money for two reasons that have nothing to do with the reader: the words are longer, and somebody is standing alongside helping the reader through them.
The party who owes the amount has an ordinary name for it. The name is obligorThe party who owes an amount under a document. Every promise has one, and finding which party it is means reading the sentence that names it., and every promise has one whether or not the front of the document mentions it. A promise with no obligor is not a weak promise. A promise with no obligor is not a promise at all.
Both documents are in front of a reader with time for exactly one question about each. What is the question?
What has to happen for either label to produce anything?
An amount owed at a date arrives when the party owing it performs, and that is simply what being owed an amount means. The same is true of a document about a packaged instrument, of a slip of paper between neighbours, and of an invoice sitting in a drawer. There is no arrangement of words anywhere that makes an amount arrive without somebody handing it over.
A reader will hear the next part whether it is said or not, so it is worth stating in the same breath. Whether a particular party will perform is a fact about that party, settled by who they are and what stands behind them. Whether documents carrying either phrase are ones to keep away from is a wider claim again, and a wider claim needs a population, a period and a source before anybody can make it. The worked instance holds one instrument, one year and no source, so it yields no such figure and no impression built on one.
The narrow statement is more useful than either of those. The words on the front describe the undertaking. The identity of the party is a separate fact and it has to be read separately. Two pieces of information, in two places, one of them set in larger type than the other.
The narrow version earns its place because it is actionable and the wide version is not. A reader who leaves with the impression that these documents are dangerous has learned nothing they can do on a Tuesday afternoon. A reader who leaves knowing there is a second sentence to find has a next step, and the next step takes about a minute. A next step is the entire difference between an account that teaches and one that emotes.
Somebody reads this guide as saying that a document carrying either set of words is one to be wary of. Where have they gone wrong?
What does the leg underneath both labels cost?
Price the thing being described. Seeing an ordinary price on it is what stops a label sounding like a special kind of promise. The leg is not a special kind of promise. The leg is an ordinary one, and it costs what an ordinary one costs.
The figures are these. The reference assetThe thing whose level a formula in the document is applied to. It is referenced by the instrument rather than held by the holder. has a spot price of Rs 2,000.00/-, financing costs 6.50 per cent a year, the term is one year, and the reference asset pays nothing while it is held. The buyer's outlay, meaning the amount a buyer puts in, is a price paid for the instrument and it is Rs 2,000.00/-.
A careful reader will already have noticed something. Three separate figures in this guide are Rs 2,000.00/-, and not one of them was copied from another. The spot price of the reference asset is Rs 2,000.00/-. The strike of the option leg is Rs 2,000.00/- because that leg is struck at the moneyAn option leg whose strike matches the spot price of the reference asset. The two figures agreeing is what the phrase means, not a coincidence., and matching the spot is precisely what the phrase means. And the outlay is Rs 2,000.00/- because this worked instance has the buyer put in exactly the value of one unit of the reference asset. The scale the whole example runs against is set by that value. Three figures, three separate reasons, one agreement of arithmetic. A repeated number that goes unexplained gets read as a mistake, and a reader who suspects one mistake stops trusting the rest.
The leg underneath both sets of words is a promise to pay Rs 2,000.00/- at the end of that year. Buying a promise of that shape today costs Rs 2,000.00/- divided by 1.065, which is Rs 1,877.9343/-.
| The leg both labels describe | Working | Amount |
|---|---|---|
| What the promise leg pays at the end of the year | the stated amount, on the stated date | Rs 2,000.00/- |
| Financing, carrying its period with it | 6.50 per cent a year, for one year | 1.065 times |
| What a promise of that shape costs today | Rs 2,000.00/- divided by 1.065 | Rs 1,877.9343/- |
| Check, running the arithmetic the other way | Rs 1,877.9343/- multiplied by 1.065 | Rs 2,000.00/- to the paisa |
The last row repays attention. Multiplying Rs 1,877.9343/- by 1.065 returns Rs 2,000.00/- to the paisa and not to the last decimal place, because the cost has been rounded to four places so that a person can write it down. The check holds to the paisa, and a claim that it held exactly would be claiming something the printed figures do not produce.
Two things follow from that table, in this order, and the order is the teaching.
First, the leg is priceable and the promise is not. Rs 1,877.9343/- is what an undertaking of that shape costs today at these figures. Rs 1,877.9343/- is arithmetic on a rate, and the row above checks it. The figure is not a statement that any particular party will perform an undertaking of that shape. The arithmetic prices a shape. The arithmetic does not price a party, and nothing in the worked instance would let it try.
Second, the label attaches to the leg and not to the price. The same Rs 1,877.9343/- sits under a document carrying either set of words. The words describe the shape, and the shape is what the arithmetic worked on. Change the phrase on the front and not one paisa of that figure moves.
The rest of the instrument is also unchanged by the labelling, and naming it here brings the whole thing into view at once. The option leg is a call struck at Rs 2,000.00/-, and its premium of Rs 180.00/- is given rather than computed. Computing it would need a figure the worked instance does not hold. The two sources stay apart: Rs 1,877.9343/- is arithmetic on a rate, and Rs 180.00/- is a premium handed over. The Rs 2,000.00/- of reference asset that call is written on is exposureThe value of the thing a contract references. Nobody has paid it and nobody owes it as such; it is the base a formula is applied to., being the value of the thing the contract references, and nobody has paid it.
And the one figure this guide cannot produce is the one a reader most wants. Who owes the Rs 2,000.00/-? The name is in the document. The worked instance contains no issuer of any kind. Where a name would be expected, there is a blank: filling it in would attach an invented promise to a party that exists.
Take the document whose front reads principal protection and reprint it with capital guarantee on the front instead, changing nothing else. What happens to the Rs 1,877.9343/-?
What do the words say about the rest of the instrument?
Nothing. Nothing is the entire answer, and it is worth splitting into the three items a reader most often assumes the label covers.
First, neither set of words says what share of a move in the reference asset reaches the holder. The share is a separate figure with a name of its own, the participation rate, and it comes out of what the promise leg costs and what the option leg costs rather than out of anything printed on a front. At the figures here, an outlay of Rs 2,000.00/- less the promise leg at Rs 1,877.9343/- leaves a budget of Rs 122.0657/-, which set against a call premium of Rs 180.00/- is 67.8143 per cent. The participation arithmetic is worked through in full separately. All that belongs here is that no label carries it and no label could.
Second, neither set of words says what the parts cost, so neither says anything about where the packaging is paid for. The figure is the price asked less the cost of the legs on the same date. The shape of the subtraction is completely defined and its second term, the price asked, is a figure the worked instance does not contain in either direction. The gap is named and left open. A plausible number in its place would be the one figure a reader might actually carry away and use, and it would be invented.
Third, neither set of words says what leaving before the end date would cost. Every figure above assumes the year runs to its end. A holder may act before the end date on terms set out in the document, and what the seller must provide when they ask is settled by SEBI at sebi.gov.in.
| What a reader often thinks the front covers | What the front actually says about it | Where the answer sits |
|---|---|---|
| The share of a move in the reference asset that reaches the holder | Nothing | Arithmetic on the two leg costs |
| Where the packaging is paid for | Nothing | Price asked less the leg costs |
| What leaving before the end date would cost | Nothing | The document, on terms set by SEBI |
| What is owed, and on what date | Both, and completely | The front itself |
Put together, those rows show the size of the silence. The front of the document describes one leg, in one respect, and describes it accurately. Everything else about the instrument, including the number a reader is usually most interested in, is written somewhere else in the same stack of paper.
A document carries one of these labels. What does that say about how much of a move in the reference asset reaches the holder?
Which of the two labels is the better one to see on a document?
Nearly everybody arrives with that question, so here it is in the reader's own words rather than dressed up in something safer. The two are not ranked here, and neither carries an instruction about what to do with it.
The reason is worth stating in full rather than as a shrug. The words are descriptions. The thing being described is an undertaking by a party. Comparing two undertakings means knowing who gave each of them and what stands behind each, and not one word of that is in this guide, in the worked instance, or derivable from any arithmetic above. Ranking the two phrases would be ranking two descriptions while giving the impression of ranking two obligations, which is a more expensive error than saying nothing.
On a subject like this the pull runs the other way, so the second half matters as much as the first. Neither set of words is empty. Using either phrase is not in itself wrong, and holding a document carrying one of them is not in itself a mistake. Somebody who has just worked out that the wording does not answer the central question is one short step from warning everybody off, and that would be advice as surely as pushing the other way would be. Neither direction can be reached from anything set out above.
Whether to hold one of these turns on four things that would have to be known first, and not one of them is here:
- Who owes the amount, and what stands behind that promise A name in a document with terms attached to it, not a phrase set in large type on a front page.
- The cost of the parts on the day the instrument is offered Not the figures worked above, which belong to one example on one date and travel nowhere.
- What leaving before the end date would cost Every figure above assumes the year runs all the way to its end, and a holder who needs the money in month seven is in a different arrangement entirely.
- The circumstances of the person asking Which this guide cannot see, which no general account ever can, and which is usually the field that decides it.
One question, and the place its answer is written: that is what can honestly be handed to a reader here. The question is less than a reader wants and more than the front of a document gives them.
So, finally: which of the two labels is the better one to see on a document?
The failure: taking either label as the answer to who owes the money
Somebody is shown a document and reads the words on the front. The reader understands correctly that an amount is due back at a date, exactly as those words describe, and was right to understand it. Then the reading stops. The wording sounded like the end of an enquiry rather than the beginning of one.
Afterwards they hold a document whose central fact they have never located. The central fact is not hard to reach: it is a sentence in the same document, naming the party who will pay, and getting to it takes one turn of the paper.
Who makes this error: somebody shown two documents and asked to choose between them on the words on their fronts, which is how the choice is usually put, in a conversation, by a person helping them through it. The error is not a careless reader's mistake. The error belongs to a reader who did exactly what the layout invited them to do.
What it costs: they cannot answer the one question a holder of a promise has to be able to answer, and they will not discover that they cannot until the date arrives and the answer starts to matter.
Say plainly what the error is and is not. The error is not that the party will fail to perform. The error is not that the reader should have bought something else. The error is treating a description of an obligation and the identity of the party carrying it as one thing, when they are two different pieces of information and only one of them is printed on the front.
The fix is a single habit and it fits on one line: find the sentence that names who pays, and read the front afterwards.
How does somebody with a document in front of them use this?
Everything above is description until somebody has paper in their hands, so here is what the distinction actually does when they do. The routine is the same short one whether the reader is a household being shown a document across a desk, an analyst putting a note together, or a lender working out what a borrower is holding. The routine does not change with the reader because the document does not change with the reader.
- Turn to the naming sentence before reading the front Not after. The order is the whole trick. A reader who has already absorbed the front reads the naming sentence as a formality, and a reader who reaches the naming sentence first reads the front as a description of something a specific party has taken on.
- Write the amount and the date on one line, from the document Not from the phrase on the front. Rs 2,000.00/- at the end of one year, in this worked instance. If the document says something different from what the wording on the front implied, the document is the thing being held.
- Ask what stands behind that party, as a question addressed to somebody who has the answer This is the field with no arithmetic in it, and it is usually the one that decides the whole thing. A promise leg is worth what the party carrying it is worth, and no amount of accurate discounting substitutes for that.
- Ask what leaving before the end date would cost, in the same breath Because the answer is in the document, because it is a fair question, and because a holder who has never asked it has priced one year of patience they may not have.
- Read the front last, as a summary rather than as a finding By then the wording has nothing left to say that has not already been read in a more precise form, which is the correct relationship between a label and the thing it labels.
None of that produces a verdict, and none of it was meant to. The routine produces a description of what is owed and by whom. A person has to have that description in hand before any of the harder questions can even be put sensibly. A reader who finishes the routine has not been told what to do. The reader has been put in a position to ask.
Who sets what may be claimed in an instrument's name?
Everything above is description and arithmetic, and it holds wherever the arithmetic is done. No statement about what may be printed, promised or claimed on a document travels, and that matters more here than in any other treatment of these instruments. Here the wording is the subject rather than the packaging around it.
Which of these phrases may be used at all is itself set by an authority, and it moves. So this guide sets out what each set of words describes, and which of them may be printed on anything is set by that authority rather than stated here. A copy of that requirement would not merely be out of date on the day the requirement changed. A copy would be wrong. Being wrong is a different and worse thing than being out of date, and a reader could act on it.
The rows are ordered deliberately. The first row is the wording itself. Elsewhere in the treatment of these instruments the routed rows are about conduct and disclosure, and the wording sits quietly in the body of the text. Here it is the subject, so it moves into the block with the authority beside it and nothing written in the value cell.
References
| Source | What it is named for here | Where |
|---|---|---|
| Securities and Exchange Board of India | What an instrument of this kind may be called, and what may be claimed in its name | sebi.gov.in |
| Securities and Exchange Board of India | What must be told to a person about who owes the amount and what stands behind that promise | sebi.gov.in |
| Securities and Exchange Board of India | The assessment a seller must make of a buyer before offering one | sebi.gov.in |
| Securities and Exchange Board of India | Who may offer an instrument of this kind at all, and on what registration | sebi.gov.in |
| Securities and Exchange Board of India | The terms on which a holder may leave before the end date, and what the seller must provide | sebi.gov.in |
| Reserve Bank of India | The equivalent arrangements where what the instrument references is a rate or a currency | rbi.org.in |
| International Organization of Securities Commissions | Cross-border conduct principles where an offer crosses a border | iosco.org |
| Research Papers in Economics | Source texts for the present value arithmetic used above | ideas.repec.org |
The packaged instrument, the reference asset, the spot price of Rs 2,000.00/-, the strike of Rs 2,000.00/-, the outlay of Rs 2,000.00/-, financing of 6.50 per cent a year and the call premium of Rs 180.00/- are invented.
Educational material. Not advice on any investment, tax, budget or market position.