XIV. Additional risk information on forward transactions in CFDs

Transcription

1 XIV. Additional risk information on forward transactions in CFDs The following information is given in addition to the general risks associated with forward transactions. Please read the following information attentively. 1. DEFINITION A contract for difference (CFD) is a contract concluded between the bank and the customer on the sale or purchase of one or several underlying instruments without physical delivery and acquisition to refund and / or charge only the difference between purchasing and selling value of the corresponding underlying instrument at the corresponding date; depending on the context, it also includes cash contracts for difference. The smallest tradable unit is a CFD. Underlying instruments for CFDs include, among others, indexes, individual shares or a basket of shares (sector CFD). It is also possible to trade CFDs in currencies or commodities. The investor in CFDs speculates on the development of the price in the future. You can say he / she bets on the development of the CFDs. The possibilities of short sales of CFDs enable the trader not only to benefit from increasing prices, but also from falling prices. Depending on their features, CFDs generally have a term of two years. When concluding a CFD, the customer does not acquire the underlying instrument, but participates only in the price development of the underlying instrument concerned. The price development of a CFD is based on the price development of the underlying instrument concerned. When purchasing a CFD, the investor does not have to pay the entire price of the underlying instrument, but deposit a security (margin) for the transaction corresponding to a percentage (this percentage may vary for different products) of the traded volume fixed in the bank's list of prices and services. In this case, the volume and / or the value of the concluded transaction is covered only in the amount of the margin. Thus, transactions of a multiple of the value of the actual capital employed can be concluded (leverage effect). The purchase or sale of a CFD is executed by a so-called market maker at a market-relevant price. The price is fixed depending on the liquidity and the prices on the primary exchange of the underlying instrument. The purchaser of a CFD does not acquire the share and therefore does not have the rights of a shareholder either (e.g. voting right at general meeting). Dividends are paid in part with discounts to the holder of the CFD and / or charged in case of short positions. In most cases, other capital measures are reproduced as for the underlying instrument or by cash settlement. The customer has to pay funding charges for long positions in CFDs held over night (these funding charges arise for each night during which the long positions are held by the customer), in case of short positions, income is realised for the customer. The applicable funding rate of the corresponding trading currency is used as a basis of the interest rate. In most cases, a premium is charged and / or a discount is granted by the CFD provider. When trading CFDs the underlying instrument of which is quoted in a foreign currency, the margin generally is converted into the foreign currency automatically when opening the transaction. When the transaction is closed, the margin is converted automatically into the trading currency (e.g. EUR) of the account in most cases. However, profits and losses from foreign currency transactions generally remain as such and are accumulated until the customer places an order for the conversion into the trading currency (e.g. EUR). Interest at the respective funding interest rates of the currency has to be paid for negative balances in foreign currencies. In most cases, a premium is charged and / or a discount is granted by the CFD provider. CFDs count among the over-the-counter (OTC) products. OTC products are products that are not traded via a stock exchange, but off the floor, for example directly with an issuer (market maker). 2. POSSIBLE USES OF CFDS All strategies known from share trading can be used in CFD trading. An existing share portfolio can be protected against losses through offsetting positions in CFDs as well (hedging). 3. GENERAL RISKS ASSOCIATED WITH FORWARD TRANSACTIONS IN CFDS Risk of loss In contrast to other forward transactions, CFDs can only be settled in cash. The purchaser and the seller exchange the buying and the selling price of a contract of the underlying instrument and thus acquire the right to the difference in cash. The closing price of the underlying instrument on the business day concerned is decisive. When your expectations do not come true and the price of the CFD does not reach your fixed target price, you will have to pay the difference between the opening price and the closing price on close-out of the transaction multiplied with the number of traded CFD contracts when the CFD contract is closed out. 55

2 You have to be aware that the amount of your loss can account for the entire capital paid in by you (total loss). The risk of loss in forward transactions is not calculable! Market price risk The market price risk is the risk of changes in the price of CFDs. It results from a change in price of the underlying instrument. Today, the short reaction times made possible by modern communication technologies and the large number of market operations sometimes result in large price fluctuations on a single day that were possible in the past only over rather large periods of time. It is this fact that makes the CFD trade extraordinarily interesting, but also involves a special risk. The relevant exchange rates in spot transactions are defined by the bid price and the ask price. The bid price is the price at which a CFD can be sold, while the ask price is the price at which a CFD is purchased. The difference between bid price and ask price is called spread. The bid price and the ask price are not fixed, but vary in particular depending on the volume of the transaction and the type of the customer. In addition to economic laws for changes in prices, the market participants psychology plays an important role: The prices may represent many different considerations, assessments and decisions of the individual market participants in figures. Political and economical news, moods and rumours have an influence on price-making. It is absolutely possible that the same facts are assessed or interpreted differently. This is why it may be very difficult to separate rational and irrational influencing factors and to determine the immediate effect of these factors on the price movement direction and intensity of the underlying instrument and thus of the CFD. Risk of leverage effect Since CFDs are traded on a margin basis, you are able to conclude transactions of a multiple of the value of the capital you have paid in. In case of an account presenting a strong leverage effect, a small movement of the price against your position often already results in a large loss. As a general rule, the providers of CFDs have the right and the possibility to liquidate positions that put at risk the existence of the account after sending a margin call (call for the provision of further capital). However, the providers are generally not obliged to provoke liquidation. Thus, it may happen that no liquidation takes place or an account is liquidated only when it has a large negative balance. You can lose your entire paid-up capital (total loss). The risk of loss in forward transactions in CFDs is not calculable! In the following, you will find an example that illustrates the leverage effect and the associated consequences for your account: Example (purchase of CFDs) Available capital on the trading account EUR 10,000 Required margin 1% Max. possible trading volume with the present margin (1% of EUR 1,000,000 = EUR 10,000) Quantity of CFDs purchased EUR 1,000,000 10,000 pieces Purchase price per CFD EUR Profit situation Purchasing price CFD price x quantity of CFDs = trading volume EUR x 10,000 = EUR 400,000 = trading volume CFD price at the date of sale: EUR (+ 2.50% compared to the initial purchasing price of EUR 40.00) EUR x 10,000 = EUR 410,000 = trading volume Profit: EUR 410,000 EUR 400,000 = EUR 10,000 56

3 In this case, you made a profit of EUR 10,000 for a capital employed of EUR 4,000 (= margin 1% of EUR 400,000). The available capital / margin on your trading account increases from EUR 10,000 to EUR 20,000. You have doubled your capital initially paid in (profit 100%). Loss situation Purchasing price CFD price x quantity of CFDs = trading volume EUR x 10,000 = EUR 400,000 = trading volume CFD price at the date of sale: = (- 2.50% compared to the initial purchasing price of EUR) EUR x 10,000 = EUR 390,000 = trading volume Loss: EUR 400,000 EUR 390,000 = EUR 10,000 In this case, you sustained a loss of EUR 10,000 for a capital employed of EUR 4,000 (= margin 1% of EUR 400,000). Your capital paid in or the available margin decreases from in all EUR 10,000 to EUR You have sustained a total loss. Please note that, in these examples, we are just assuming a trading volume amounting to EUR 400,000 which represents only 40% of the possible maximum trading volume. When looking at this example, please realise that, both in case of profit and loss, the leverage effect may result in extreme outcomes including a total loss of your account balance and even beyond. Liquidity risk The liquidity risk is caused by the fact that it might not be possible to liquidate positions at a fair market price or to liquidate them at all or only in part. Reasons include the fact that no corresponding counterparty can be found, the number of market participants is too small or the traded volume is not sufficient or that general market disturbances occur. Liquidity risks may occur in particular in OTC transactions. However, exchange-traded products may involve these risks as well. This risk may exist in particular if illiquid markets presenting a relatively great difference between purchase and selling price (high bid-ask spread) are involved or large transactions have a sustainable influence on the market. Furthermore, you are subject to restrictions with respect to time on account of the fixed trading times. Therefore, it is not possible to open new and close existing positions at any time. This involves the risk that you might not be able to react to more recent interim developments and therefore sustain losses. Finally, technical problems may occur during the placing or execution of orders. For example, problems may occur during the transmission of your order on account of system failure. The execution of the order might not be possible for a certain time on account of technical problems. Risks of transactions on foreign stock exchanges In case of transactions concluded in a foreign currency, the currency risk adds to the risks associated with the respective transaction. Furthermore, an assessment of the individual risks abroad is more difficult. Risks of loss / failure of intended risk limitations Even if, in general, the risks can be limited to a certain extent by stop limit orders and / or stop market orders (for example stop loss order), these measures taken by the principal may fail completely if the orders can only be executed at losing prices, not at the intended prices or cannot be executed at all. The risk limitation intended by these orders may fail in particular in highly volatile market phases involving the typical large and extremely quick market phases and / or changes in prices and, as the case may be, extended spreads and result in a total loss. Risk associated with forward transactions with borrowed funds Your risk increases when you fund your investment amount through a credit. In this case, if the market develops against your expectations, you will not only have to cope with the sustained loss, but also to pay interest and repay the credit. So never bank on being able to pay the interest and repay the credit with profits from trading, but check before concluding the transaction, whether you will also be able to pay the interest and, as the case may be, repay the credit at short term if losses instead of the expected profits occur. Please ensure to employ only capital which you can do without if the worst comes to the worst. 57

4 Since trading in CFDs is carried out on a margin basis and you can thus use a leverage effect for your account, so you make use of a credit for speculation on securities, the above-mentioned risks would increase strongly if you funded your investment amount through a credit. Influence of additional charges on the expected profits for trading in CFDs When purchasing and selling CFDs, various additional charges arise in addition to the required margin (e. g. transaction charges, spread). Besides these expenses that are directly associated with the transaction (direct expenses), you also have to take into account consequential charges (e.g. funding charges in case of overnight positions). Inform yourself of all charges that may arise before placing an order. This is the only way to calculate under which conditions your position will reach the profit wedge. Please note: The higher the charges, the later the breakeven point will be reached if the expected price development occurs, since these charges first have to be covered, before a profit can be made. If the expected price development does not occur, the additional charges increase the resulting loss. The more transactions you conclude or have concluded in your account, the higher the burden of transaction charges on your investment. This may result in the fact that your entire investment is consumed nearly completely by the total amount of the transaction charges without any market changes or losses. Risks of day trading When carrying out such transactions, you have to take into account that day trading may result in immediate losses when surprising developments result in the fact that the instrument purchased by you falls on the same day and you are forced to sell the purchased instrument before the closing of the trading day at a price lower than the purchasing price in order to avoid further risks (e.g. overnight risks). This risk increases when investing in instruments for which high price fluctuations are expected within a trading day. The entire capital employed by you for day trading might get lost. Moreover, when attempting to make profits in day trading, you will also compete with professional and well-financed market participants. Therefore, you should absolutely have in-depth knowledge with respect to securities markets, methods of trading in securities and strategies of trading in securities. Regular day trading also creates an excessively high number of transactions in your account. The associated charges (e.g. transaction charges) may be unreasonably high compared with the capital employed and a possible profit. If special premises are provided for handling day trading transactions, the vicinity to other investors in these premises may have an influence on your behaviour. Tax risks Tax risks may be associated with forward transactions in CFDs as well. Therefore, you should also take into account the tax treatment of the transactions concluded by you. In the end, the important thing for you is the net amount, i.e. the return after deduction of taxes. The legislator, the judiciary and the fiscal authorities have developed principles for the taxation of forward transactions. Those forms of contracts that provide the taxpayer with a cash settlement or a certain amount of money or advantage defined by the value of a variable reference parameter are considered to be forward transactions. In Germany, those transactions are subject to tax. In part, the treatment of new forms of investments such as CFDs with respect to income tax has not been conclusively established by the legislator, the judiciary or the fiscal authorities. When you conclude such innovative forward transactions or derivatives, you will therefore bear the risk that you will not achieve the expected rate of return in case of a unfavourable development of tax law during the term of the contract. Inform yourself of the tax treatment of the transaction intended by you before concluding a forward transaction and make sure that the transaction can come up to your personal expectation under this individual point of view as well. As the case may be, consult experts such as e.g. tax advisers. Information risk Missing, incomplete or incorrect information may result in wrong decisions in any conclusion of a transaction. Incorrect information may result from access to unreliable sources of information, wrong interpretation when evaluating initially correct information or on account of transmission errors. An excess or shortage of information or outdated information may also present an information risk. Transmission risk Orders for conclusion of a forward transaction CFDs have to be clear and unambiguous in order to avoid misunderstandings and delays. Therefore, each order of an investor to the bank has to state certain absolutely required information. This information includes in particular the instruction to purchase or sell, the number of pieces and the exact designation of the CFDs. 58

5 The extent to which the transmission risk can be limited or excluded strongly depends on you the more precise your order, the lower the risk of a mistake. Risk of counterparty default This means the risk that a contracting party does not meet their obligations and is in default, for example in case of insolvency. This results in a financial damage to the other contracting party since they have to conclude replacement transactions at unfavourable prices. This risk may occur at any time and does not depend on market activity. This risk is particularly high in case of CFD spot transactions since, when placing their payment orders, no party can be sure that the other party meets their obligations. 59