Steer the course with constant leverage

Transcription

1 Constant Leverage Certificates Steer the course with constant leverage rbsbank.ch/markets

2 Investing with constant leverage 3 The characteristics of Constant Leverage Certificates 4 at a glance The value of a Constant Leverage Certificate 7 What makes Constant Leverage Certificates special 8 Constant Leverage Certificates and Mini-Futures compared 10 Background knowledge: Understanding the structure 12 of Constant Leverage Certificates Disclaimer 14 The products do not constitute collective investment schemes within the meaning of the CISA. Accordingly, holders of the products do not benefit from protection under the CISA or the supervision by the Swiss Financial Market Supervisory Authority (FINMA). Investors in the products are exposed to the credit risk of the Issuer. 2

3 Investing with constant leverage Constant Leverage Certificates are exchange-traded financial products through which, depending on their features, investors can participate in an underlying s rising or falling prices. Their special character: a Constant Leverage Certificate provides constant leverage, also called the factor. The leverage is reset to the predetermined value on a daily basis. The leverage effect means that movements in the underlying are amplified. As a result, a Constant Leverage Long Certificate allows the investor to profit from rising prices, while a Constant Leverage Short Certificate rises in value when the prices are falling. The basic principle is quite simple: if, on a trading day, the price of the underlying rises by, for example, one per cent, a Constant Leverage 4x Long Certificate on this underlying climbs by a factor of four, i.e. 1% x Factor 4 = 4%. With Constant Leverage Certificates, there are no premiums, pricing is not affected by volatility and there are no fixed expiry dates. As soon as the underlying reaches the stop loss level (a level set individually for each product) during trading on the relevant market, the Constant Leverage Certificate terminates and a potential residual value is repaid to investors. Advantages at a glance: Constant leverage Optimal use of strongly trending markets Less danger of knock out - The stop loss level is reset daily so that it always has the same percentage margin relative to the price of the underlying Risk limitation thanks to the stop loss level Low capital outlay Focus on rising or falling prices Transparent pricing No volatility impact, as there is with warrants No premiums, as there are with warrants No fixed expiry (open ended) No margins or rollover risks, as there are with futures Easily recognised symbol - never again having to search for the right leveraged product Can be traded daily on Scoach Disadvantages: When markets are moving sideways, Constant Leverage Certificates can perform more poorly than the underlying or a comparable Mini-Future Certificate Early termination if the stop loss level is reached Substantial risks of losses including risk of total loss of the capital outlay, if the underlying does not move in the desired direction 3

4 The characteristics of Constant Leverage Certificates at a glance Particularly strong in trend following markets Constant Leverage Certificates unleash their full potential in clearly trending markets. In such a market environment, Constant Leverage Certificates can, thanks to their constant leverage, perform better than Mini-Future Certificates, whose leverage can change over time. At the same time losses can be smaller if market expectations do not materialise. How can this be explained? Here is an example: If a Constant Leverage 4x Long Certificate ends in positive territory on a given trading day, on the next trading day the previous day s value plus the previous day s gains are invested with a leverage factor of 4. If the Constant Leverage Certificate climbs again on the next trading day, then the previous day s value plus the previous day s gains are again invested with a leverage factor of 4. The effect of daily reinvestment is comparable to the compound interest effect. The resetting of the leverage factor basically corresponds to realising gains or losses on a daily basis and making a new investment with the set leverage factor on the next trading day. In our example scenario the leverage of a Mini-Future Certificate would, in contrast, decrease. In a clear trend-following market, a Constant leverage Certificate is therefore superior to a Mini-Future with an initially identical leverage. In sideways trending markets, Constant Leverage Certificates can, nonetheless, perform worse than the underlying or a comparable Mini-Future. Constant Leverage Certificate and underlying compared In what follows, let us look at a Constant Leverage 4x Long Certificate on a fictional underlying in various market phases and compare it with its underlying. To keep the figures in the example simple, financing costs are not included. This does not alter the basic proposition. The underlying in figure 1 is on a clear upward trend and climbs by 20 per cent from 100 to 120 over a period of 30 days. The Constant Leverage 4x Long Certificate on the underlying rises by about 99 per cent. This corresponds to over four times the performance (4 x 20% = 80%) of the underlying. This clearly shows how Constant Leverage Certificates can fulfil their potential in distinctly trend-following markets. The underlying is on a clear upward trend. The Constant Leverage Long Certificate climbs by more than four times the performance of the underlying. Figure 1 in percentage terms Underlying Constant Leverage 4x Long Certificate Source: RBS (hypothetical illustration) 4

5 With Constant Leverage Long Certificates, the daily resetting of the lever works like an additional accelerator in bull markets, while, in bear markets, losses will be slightly slowed (cf. also comparison with Mini-Futures). In figure 2, the underlying is on a clear downward trend and falls by 20 per cent from 100 to 80 over a period of 30 days. Due to the daily resetting of the lever, the Constant Leverage 4x Long Certificate on this underlying falls, therefore, not by 4 x 20% = 80%, but by only about 62 per cent. Figure 2 in percentage terms The underlying is on a clear downward trend. The value of the Constant Leverage Long Certificate decreases by less than four times the performance of the underlying Underlying Constant Leverage 4x Long Certificate Source: RBS (hypothetical illustration) 5

6 Figure 3 illustrates the weakness of Constant Leverage Certificates in markets that are trending sideways. At the start of the observation period the underlying is at 100 and 30 days later closes unchanged at the initial level. In this case too, the Constant Leverage 4x Long Certificate locks in daily performances with a leverage factor of 4, but after 30 days posts a value of 88 instead of 100. How is this explained? As already mentioned, the Certificate leverages the daily performance by a factor of 4 and not the performance over 30 days. The longer the Certificate is held, and where the underlying is very volatile, this difference can be amplified and lead to substantial losses. For this reason, Constant Leverage Certificates should not be used in markets moving sideways and should be used only for short-term commitments. If the underlying moves sideways, losses can ensue, even though the underlying s value is unchanged at the end of the period. Figure 3 in percentage terms Underlying Constant Leverage 4x Long Certificate Source: RBS (hypothetical illustration) 6

7 The value of a Constant Leverage Certificate The value of a Constant Leverage Certificate focuses on intrinsic value. Constant Leverage Certificates directly comprehend the daily performance of the underlying whilst taking the ratio into account. Because, unlike warrants, there is no premium and volatility has no direct impact on pricing, the value of a Constant Leverage Certificate is transparent and easy to understand. Financing level With Constant Leverage Certificates, the lever is based on a lower capital requirement when compared to a direct investment in the underlying. The remaining amount needed to buy the underlying is financed by RBS and is referred to as the financing level. With Constant Leverage Long Certificates, the financing level is less than the price of the underlying and with Constant Leverage Short Certificates, higher. As with all leveraged products, investors also need to meet the financing costs. With Constant Leverage Certificates, the financing costs are accounted for through the daily adjustment of the financing level. The financing costs consist of an interest rate component (LIBOR, EURIBOR) and an interest margin, fixed by RBS, of 0.65% per annum. With Constant Leverage Long Certificates, the Certificate s interest rate component and the interest margin are debited daily, with Constant Leverage Short Certificates, only the interest margin is charged and the interest rate component is credited to the Certificate. Settlement of the financing costs is carried out only overnight, so for intraday traders, the leverage is free of charge. Stop loss level Constant Leverage Certificates have no fixed expiry but are redeemed early as soon as the stop loss level is reached. With a Constant Leverage 4x Long Certificate, the stop loss level margin is reset at 20% below the previous day s closing price of the underlying every day anew. In other words: The SMI would have to decline by 20% or more in one day for a SMI Constant Leverage 4x Long Certificate to be terminated. Even if the SMI collapses by 10% in one trading day, the stop loss level margin on the next trading day will again be 20%. In this way the K.O. risk decreases accordingly. Residual value If a Constant Leverage Certificate terminates, investors automatically receive the residual value within five bank working days. The residual value corresponds to the remaining value of the Constant Leverage Certificate after a stop loss event has occurred. For a Constant Leverage Long Certificate, this can approximately be calculated as the difference between the stop loss level and the financing level, divided by the ratio. For a SMI Constant Leverage 4x Long Certificate, with a financing level of 4500, a stop loss level at 4800 and a ratio of 150, the theoretical residual value would be ( )/150 = CHF The residual value can, however, be higher or lower, depending on how the underlying continues to develop after the stop loss level is reached. Upon the occurrence of a stop loss event, the market conditions under which RBS is able to unwind its hedging positions are decisive. Value of a Constant Leverage Long Certificate = (Underlying - Financing level) Ratio Value of a Constant Leverage Short Certificate = (Financing level - Underlying) Ratio The value of a Constant Leverage Certificate is transparent and easy to understand. 7

8 What makes Constant Leverage Certificates special To determine the performance of a stock over a given time frame, all you need to know is the initial price and the closing price and then work out the difference (disregarding dividend payments). To put it more simply: it is immaterial how the stock arrived at its final price at the end of the period. This is known as a non path-dependent financial instrument. Constant Leverage Certificates are described as path-dependent instruments. With path-dependent financial instruments, the performance of the instruments depends on the path taken by the underlying. Accordingly, the way an instrument reaches its closing price at the end of the observation period plays a role. The reason for the path-dependency is that the daily performance of the underlying is leveraged. This means that the performance on any single day is relevant. not. In this case, the Constant Leverage Certificate performs more poorly in scenario 2 than in scenario 1. With a Constant Leverage 4x Long Certificate, the factor of 4 must not be confused with a fourfold multiplication over the investment period. In actual fact, a Constant Leverage Certificate leverages the performance by a factor of 4 over the investment period only in the rarest of cases, because Constant Leverage Certificates leverage the performance of the underlying by a factor of 4 on each trading day. In contrast, a Mini-Future with a leverage factor of 4 leverages the underlying s performance by a factor of 4 over the investment period. Scenario 3 again shows that a Constant Leverage Certificate can lose value even though the underlying is again at its initial level at the end of the investment period. Constant Leverage Certificates are pathdependent financial instruments. The same performance of the underlying can result in a varying performance by a Constant Leverage Certificate. In the following scenarios 1 and 2, the underlying reaches the same level of after three days - however, on different paths. The Constant Leverage Certificate performs differently in each scenario. In scenario 1, the underlying is on a clear upward trend, whereas in scenario 2 it is 8

9 Scenario 1 Underlying Constant Leverage 4x Long Certificate Scenario 2 Underlying Constant Leverage 4x Long Certificate The same performance of the underlying can result in varying performances of a Constant Leverage Certificate. Losses can arise in trendless markets. +1% +4% +2% +8% Day Day % +8% -4% -16% Day Day % +4% +6,26% +25,04% Day Day ,05% +16,81% Performance over a three-day observation period. (The fourfold performance would amount to 16.2 per cent) +4,05% +13,44% Performance over a three-day observation period. (The fourfold performance would amount to 16.2 per cent) Scenario 3 Underlying Constant Leverage 4x Long Certificate % +4% Day % -8% Day ,03% +4,12% Day ,00% -0,38% Performance over a three-day observation period. Source: RBS (hypothetical illustration) 9

10 Constant Leverage Certificates and Mini-Futures compared Like Mini-Futures, but with constant leverage Focusing on rising or falling prices, with leverage but without fixed expiry, no volatility impact or premiums, as is the case with warrants, and with transparent pricing - these are the features investors appreciate in Mini-Future Certificates. If the market moves in the desired direction, the leverage means investors can multiply their returns when compared with a direct investment in the underlying. However, the leverage of a Mini-Future Certificate in this scenario constantly reduces. With Constant Leverage Certificates, RBS enhances the proven features of Mini-Futures by adding that of constant leverage (the factor). How they compare In order to visualise the differences between Constant Leverage Certificates and Mini-Futures, let us again consider a Constant Leverage 4x Long Certificate on a fictional underlying and a Mini-Future with an initial leverage of 4 on the same underlying. In this example too, for the sake of simplicity, financing costs have not been considered, which does not, however, alter the basic principles. The difference in the performance of the Constant Leverage Certificate and the Mini-Future results from the fact that with the Constant Leverage Certificate, the leverage is reset daily to the target leverage of 4, whereas this is not the case with Mini-Futures. In figure 4 the underlying climbs from 100 to 120, and the Mini-Long leverages the evolution of the value over the 30-day period by 4 and closes at exactly (20 x 4) = 180. As the underlying has consistently trended upwards over the period, the Constant Leverage 4x Long Certificate can, in this example, perform better and posts a value of 199 after 30 days. Also if the underlying falls in value, a better performance is achieved (figure 5). In this scenario, the Mini-Future loses 80 per cent, while the Constant Leverage Certificate loses only 62 per cent. Figure 6 shows the scenario of a market trending sideways. After 30 days, the underlying returns to its initial level of 100. In this environment, the Constant Leverage Certificate loses 12 per cent, while the Mini-Future closes at 100, like the underlying. In a clearly positive trend, the Constant Leverage Certificate performs better than a comparable Mini-Future. Figure 4 in percentage terms Underlying Constant Leverage 4x Long Certificate Mini-Long with leverage 4 Source: RBS (hypothetical illustration) 10

11 Figure 5 in percentage terms 120 In a clearly downward trend, the Constant Leverage Certificate loses less than a comparable Mini-Future Underlying Constant Leverage 4x Long Certificate Mini-Long with leverage 4 Source: RBS (hypothetical illustration) Figure 6 in percentage terms 160 If the underlying moves sideways, Mini-Futures perform better than comparable Constant Leverage Certificates Underlying Constant Leverage 4x Long Certificate Mini-Long with leverage 4 Source: RBS (hypothetical illustration) 11

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13 Background knowledge: Understanding the structure of Constant Leverage Certificates The relationship with Mini-Future Certificates has already been mentioned. The structure of both products, with financing level and stop loss level is actually the same. There are, however, differences in how these values are adjusted. While with Mini-Futures the financing level changes only slightly each day as the financing costs are taken into account, with Constant Leverage Certificates the financing level together with the stop loss level and the ratio are adjusted daily in order to enable constant leveraging of the underlying s performance. In order to start the investment with the same leverage on each trading day, the leverage factor of a Constant Leverage Certificate is reset daily to the target leverage for the particular product after market close. A Constant Leverage 4x Long Certificate on the SMI, for example, starts with a factor of 4 on any given trading day. During the day the leverage can rise or fall. At the end of the day the leverage is reset so that on the next trading day the leverage starts again at 4. A Constant Leverage 4x Long Certificate on the SMI participates accordingly on each trading day in the percentage development of the SMI with a factor of 4. If the SMI rises by one per cent on a given trading day, then a Constant Leverage 4x Long Certificate on the SMI rises by four per cent. If the SMI falls by one per cent on a given trading day, then a Constant Leverage 4x Long Certificate on the SMI loses four per cent. Since the leverage can change over a trading day, investors buying this instrument during the day do not get a leverage of exactly 4, but will do so on the next trading day. For an up-to-date overview of RBS s Constant Leverage Certificates, please visit our website: The leverage of a Constant Leverage Certificate is reset daily after market close to the target leverage factor. 13

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15 Disclaimer This document has been prepared by The Royal Bank of Scotland plc or one of its affiliates ( RBS ) for information and discussion purposes only and is aimed at informing its readers of the main characteristics of the products described herein, although it is not intended to specify all possible risks or characteristics of the same. It shall not be construed as, and does not form part of an offer, nor invitation to offer, nor a solicitation or recommendation to enter into any transaction, nor is it an official or unofficial confirmation of terms. This document does not replace the essential advice given by your advisors before entering into any derivative activity and does not constitute an offering document or prospectus and is not intended to provide the sole basis for any evaluation of transactions in products or financial interests mentioned herein. Potential investors are, therefore, urged to seek adequate information, before investing in the products, on the nature of these products and the risks to which they will be exposed. An offer or invitation to offer, solicitation or recommendation to enter into any transaction will solely be made on the basis of an offering document or where applicable a prospectus which can be obtained free of charge from The Royal Bank of Scotland plc, Edinburgh, Zurich Branch by calling +41 (0) Calls maybe recorded. Please note that you shall be deemed to consent to such recording if you call us on the above line. This document is neither a prospectus pursuant to article 652a or article 1156 of the Swiss Code of Obligations nor a simplified prospectus within the meaning of Art. 5 of the Swiss Federal Act on Collective Investment Schemes ( CISA ). The products do not constitute collective investment schemes within the meaning of the CISA. Accordingly, holders of the products do not benefit from protection under the CISA or the supervision by the Swiss Financial Market Supervisory Authority (FINMA). Investors in the products are exposed to the credit risk of the Issuer. The contents of this document have not been reviewed by any regulatory authority in the countries in which this document is distributed. If you are in any doubt about any contents of this document, you should obtain independent professional advice. United States of America This document is intended for distribution only to major institutional investors as defined in Rule 15a-6 under the U.S. Exchange Act of 1934 as amended (the Exchange Act ), and may not be furnished to any other person in the United States. Each U.S. major institutional investor that receives these materials by its acceptance hereof represents and agrees that it shall not distribute or provide these materials to any other person. Any U.S. recipient of these materials that wishes further information regarding, or to effect any transaction in, any of the products discussed in this document, should contact and place orders solely through a registered representative of RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: RBS Securities Inc. Is an affiliated broker-dealer registered with the U.S. Securities and Exchange Commission under the Exchange Act, and a member of the Securities Investor Protection Corporation (SIPC) and the Financial Industry Regulatory Authority (FINRA). Further, please be advised that the products referred to herein have not been and will not be registered under the U.S. Securities Act of 1933, as amended (the Securities Act ) and may not be offered or sold in the United States except to qualified institutional buyers ( QIBs ) in reliance on Rule 144A or another exemption from, or transactions not subject to, the registration requirements of the Securities Act. The offer or sale of products or the transactions contemplated herein may be further restricted by U.S. federal and state securities law. Potential investors are required to inform themselves of and to observe any legal restrictions on their involvement in the transactions. Please be advised that the products may not be appropriate or suitable for all investors. Special risks The leverage effect of Constant Leverage Certificates means that you can lose a far greater percentage of your capital outlay than with a direct investment in the underlying. Constant Leverage Certificates carry an increased risk of losing the full amount of your capital outlay. If the underlying reaches the stop loss level, Constant Leverage Certificates terminate early, and investors receive the residual value, which is determined after the stop loss level has been reached. The residual value may be zero if the underlying performs very unfavourably after reaching the stop loss level. If the underlying moves sideways, Constant Leverage Certificates can lose value for holding periods longer than one day even though the underlying is again at its initial level at the end of the investment period. Constant Leverage Certificates should be used only for shortterm commitments. When determining the price during the life of the Constant Leverage Certificate, the bid/ask spread of the underlying must be taken into consideration, along with the liquidity of the underlying and (as appropriate) the liquidity of the corresponding futures market. With Constant Leverage Certificates on major equity indices in particular, trading is heavily geared to the futures market, which can lead to deviations from the underlying spot market. The reference price of the underlying is determined by RBS at its sole discretion, if that the underlying can only be traded to a limited extent or not at all in Switzerland. Currency risk In case the underlying is quoted in a foreign currency, investors in the products are exposed to the currency risk. SMI is a registered trademark of SIX Swiss Exchange. This brochure is not intended for distribution in the United States nor in the Netherlands, nor to US persons or individuals in the Netherlands or the United Kingdom. RBS is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland plc. All rights, save as expressly granted, are reserved. The Daisy Device logo, RBS, THE ROYAL BANK OF SCOTLAND and BUILDING TOMORROW are trade marks of The Royal Bank of Scotland Group plc. Reproduction in any form of any part of the contents of this factsheet without our prior written consent is prohibited unless for personal use only. Registered address: The Royal Bank of Scotland plc, 36 St Andrew Square, Edinburgh EH2 2YB. Dated: 30 September 2013 This document is issued by The Royal Bank of Scotland plc, Edinburgh, Zurich Branch, Lerchenstrasse 24, P.O. Box 2921, 8022 Zurich 15

16 Further information regarding interesting products from RBS Online Phone rbsbank.ch/markets