Point to point

What Is Point to Point?

Point to point refers to a method of calculating a financial instrument's performance or the change in a specific metric between two distinct points in time. This approach, common in investment performance measurement and financial metrics, focuses solely on the value at the beginning and end of a defined period, disregarding any fluctuations or intermediate values that occurred during that period. It is frequently used for assessing the return of various investment vehicles, particularly those with structured payoff mechanisms, such as structured products and certain types of annuities. The simplicity of point-to-point calculation makes it useful for quick assessments, but it also means it overlooks the path taken to achieve the final value.

History and Origin

The concept of measuring change from one specific date to another is fundamental to financial analysis and has been inherent in return calculations since the advent of organized financial markets. While "point to point" as a named feature gained prominence with the rise of complex investment vehicles, its underlying principle is as old as calculating simple interest or the appreciation of an asset. Its explicit adoption in product design, such as indexed annuities and structured notes, became more common in the late 20th and early 21st centuries. These products often sought to offer investors exposure to an underlying asset's potential growth while providing some level of principal protection, with their returns explicitly tied to the asset's performance from the initial "point" to the final "point" of the term. The U.S. Securities and Exchange Commission (SEC) has issued investor bulletins to help explain the features and risks associated with structured notes, many of which use point-to-point calculations for their returns.⁵

Key Takeaways

• Point to point calculation measures the change in value between two specific dates, the start and end of a period.
• It is widely used in assessing the return of structured products and fixed indexed annuities.
• This method ignores interim volatility and the path of the underlying asset's performance.
• While simple, it can mask significant price swings or short-term gains/losses within the measurement period.
• The final return often depends on other factors like participation rates, cap rates, and floor rates.

Formula and Calculation

The formula for a basic point-to-point return is straightforward, representing the percentage change between an initial value and a final value.

Let:
(V_1) = Value at the beginning of the period
(V_2) = Value at the end of the period

The formula for the point-to-point return is:

This basic formula calculates a simple return over a defined period. In products like indexed annuities, additional terms like a participation rate, cap rate, or floor rate are applied to this raw point-to-point gain.

Interpreting the Point to Point

Interpreting a point-to-point calculation requires understanding that it offers a snapshot of total change over a period, without revealing the journey. For an investment like a structured note or an annuity indexed to a stock market, a positive point-to-point return indicates growth in the underlying index or underlying asset from the start to the end of the contract term. Conversely, a negative result means a decline.

However, this simplicity can be deceptive. A product might offer significant upside participation, but if the market experiences a substantial decline then recovers by the end of the period, a modest point-to-point gain might mask significant interim volatility that would have affected other types of investments. Investors need to consider the specific terms of the product, such as how often the point-to-point return is calculated (e.g., annually, or at the end of the full term) and any caps or floors that limit or protect the return.

Hypothetical Example

Consider an investor who purchases a structured product linked to the S&P 500 index with a two-year term. The product uses a point-to-point calculation for its return, subject to a 75% participation rate and a 12% cap over the two-year period.

• Initial Index Value (Start of Year 1): 4,000 points
• Final Index Value (End of Year 2): 4,600 points

First, calculate the raw point-to-point return of the index:

Next, apply the participation rate:

Finally, apply the cap rate:
Since the calculated participated return of 11.25% is less than the 12% cap, the investor's return will be 11.25% for the two-year term. If the participated return had been, say, 14%, the investor's return would have been limited to the 12% cap rate. This example illustrates how the point-to-point calculation forms the basis, which is then adjusted by the specific terms of the financial instrument.

Practical Applications

Point-to-point calculations are central to several financial instruments and analyses. They are most notably applied in:

• Fixed Indexed Annuities (FIAs): These insurance products credit interest based on the performance of a market index, often using a point-to-point method. For instance, a common design will compare the index value on the contract's anniversary date to its value on the previous anniversary date.⁴
• Structured Products/Notes: These complex debt instruments issued by financial institutions often link their return to the performance of an equity index, commodity, or currency, with the payoff determined by the change from the initial observation point to the final observation point. The SEC issues guidance on these products due to their complexity.³
• Economic Data Analysis: Governments and economists often use point-to-point changes to describe shifts in economic indicators. For example, the Bureau of Labor Statistics (BLS) reports changes in the Consumer Price Index (CPI) over specific periods (e.g., month-to-month, year-over-year), which are inherently point-to-point measurements of inflation.²
• Simple Investment Performance: For basic performance measurement of a single asset or portfolio over a specific, non-compounding period, a simple point-to-point calculation suffices. This is often seen in short-term trading or when evaluating the profit/loss of a single trade.
• Hedging Strategies: Some derivative strategies or hedging instruments are designed to protect against or profit from a specific price change between two points, rather than continuous exposure.

Limitations and Criticisms

While useful for its simplicity, the point-to-point method has notable limitations. The primary criticism is its disregard for the "path" taken by the underlying asset or index between the two points. An asset could experience extreme volatility, including significant gains or losses, during the measurement period, but if its value returns to or near its starting point, the point-to-point calculation would suggest little to no change.

This can be problematic in products like fixed indexed annuities, where significant gains achieved mid-period might be entirely missed if the market declines before the calculation date. It also means that investors might miss out on potential dividends or interest payments that are not factored into the index's price return. Furthermore, while products often offer principal protection, this protection is typically only valid if the product is held until maturity, and it relies on the creditworthiness of the issuer. Investors who need to exit early may face substantial losses in the secondary market due to limited liquidity and complex valuation. FINRA has issued alerts warning investors about the risks associated with structured products, highlighting their complexity and potential for illiquidity.¹

Point to Point vs. Compound Annual Growth Rate (CAGR)

Point to point measures the total percentage change between two values without considering the time duration or compounding effects. It simply shows the direct start-to-end performance.

In contrast, Compound Annual Growth Rate (CAGR) provides a smoothed, annualized rate of return over multiple periods, assuming that the profits are reinvested (compounded). While point to point gives a single figure for a period, CAGR presents the geometric mean of annual growth rates, making it suitable for comparing the performance of different investments over varying timeframes. CAGR accounts for the time value of money and the effect of compounding, whereas point to point does not. Therefore, point to point is often used for products with specific maturity dates or reset periods (like many structured products), while CAGR is preferred for analyzing long-term growth of traditional investments like stocks or mutual funds in financial markets.

FAQs

What does "point to point" mean in finance?

In finance, "point to point" refers to the calculation of a change in value from one specific date (the starting point) to another specific date (the ending point), ignoring any values or fluctuations that occurred in between.

Is point to point the same as simple return?

Yes, a basic point-to-point calculation is essentially a simple percentage return over a specified period. However, in complex financial products, this basic return is often modified by other terms like participation rates or caps.

Why is point to point used in structured products?

Point-to-point calculations are used in structured products because they allow for precise definition of the gain or loss on which the product's payout is based. This aligns with the structured nature of these instruments, where the payoff is determined by the difference between two clearly defined observation dates.

Does point to point account for dividends?

Typically, a pure point-to-point calculation based on an index's price movement does not account for dividends. The index value itself usually reflects only price changes, not total return which includes dividend reinvestment. Products that track total return indices would implicitly include dividends.

What are the risks of investments that use point-to-point calculations?

The main risks include missing out on significant market gains that occur and then reverse before the end point, lack of liquidity if you need to sell before maturity, and credit risk of the issuer. The simplified calculation can also mask the true volatility experienced during the holding period.