Description of Investment Instruments and Warning of Risks

Transcription

1 Description of Investment Instruments and Warning of Risks Effective as of 28 February 2013

2 Sberbank CZ, a.s. as the securities broker (hereinafter referred to as the Bank ) Introduction In this text, various investment instruments and risks related to them are described. Under the risk term is meant not reaching the expected return on an invested capital and/or loss of the invested capital up to its total loss, while different causes may be basis of this risk lying in investment instruments, markets or issuers according to the structure of investment instrument. Since these risks are not always foreseeable, the following description must not be considered as final. The risk arising from financial standing of the issuer of the investment instrument is dependent on individual case; the investor should therefore pay close attention to it. Description of investment instruments follows usual features of investment instruments. The decisive factor is the structure of a specific investment instrument. For that reason, the following description is no substitute for a thorough examination of the specific investment instrument by the investor. 1. General investment risks Currency risk If a trade in foreign currency is selected, then its yield, resp. value development of this trade, depends not only on the local yield of the security on the foreign market, but also heavily on the exchange rate development of the respective foreign currency in relation to the currency of the investor (e.g. CZK). This means that exchange rate fluctuations may increase or decrease the yield and value of the investment. Transfer risk When trading with incomes from abroad (e.g. foreign debtor) there exists depending on a relevant country an additional risk lying in prevention or difficulty to realize an investment project by political or currency-legal provisions. In addition, problems may also occur at proceeding an instruction. In case of trades in foreign currency such measures may obstruct the free convertibility of the currency. Under the financial standing risk term is meant the risk following from insolvency of a partner, i.e. potential inability to meet their obligations such as dividend payments, interest payments, installment payments, etc. on the appointed date or in full extent. The alternative terms for the financial standing risk are debtor s risk or issuer s risk. This kind of risk can be graded by means of rating. Rating is an evaluation scale used for appraisal of financial standing of emitters. Rating is compiled by rating agencies, particularly the financial standing risk and country risk is being estimated. The rating scale ranges from AAA evaluation (the best financial standing) to D (the worst financial standing). Interest rate risk Interest rate risk follows from the possibility of future changes of interest rate levels on the market. Rising level of market interest rates during maturity of fixed interest bonds leads to exchange rate losses, a fall in such interest rates leads to exchange rate gains. Exchange rate risk (volatility) Under the exchange rate risk term is meant potential variation (volatility) of value of individual investment or specific structure of cash flow. The exchange rate risk at trades with conditional obligations (e.g. currency forward deals, futures, option subscribing) can lead to necessity of increasing security (Margin), resp. to put up further margin, i.e. tying up liquidity. Risk of total loss Under the risk of total loss is meant a risk, that investment can become completely worthless. Total loss can occur, particularly, when the issuer of a security is no longer capable of meeting their payment obligations (insolvent), for economic or legal reasons. Securities purchase on credit The purchase of securities on credit poses an increased risk. The received credit must be paid independently of the success of the investment. Furthermore, the credit costs reduce the yield. Country risk The country risk is a financial standing risk of a given state. If the relevant state represents political or economic risk, it may have negative influence on all partners with registered office in this state. Liquidity risk Liquidity refers to the possibility of buying or selling a security or closing out a position at the current market price at any time. The market in a particular security is said to be liquid if an average sell instruction (measured by the usual trading volume) does not cause perceptible price fluctuations and if the instruction cannot be settled at all or only at a substantially changed rate level. Placing an instruction The instructions for the Bank to purchase or sell (placing an instruction) must minimally contain indication of the investment instrument, the quantity (number of pieces/nominal value), minimal/maximal price and period of time, during which the instruction is valid. Market order If buy or sell orders are placed with the instruction at best (no price limit), deals will be executed at the best possible price. In this way, the financial requirements purchase/gains remain uncertain. Effective as of 28 February 2013 Page 01 of 13

3 Price limit With a buy limit, you may limit the purchase price of a stock exchange instruction or of other market and thus limit the amount of the employed capital. No purchases will be made above the price limit. A sale limit stipulates the lowest acceptable selling price; no deals will be carried out below this price limit. Stop loss order A stop-loss order will not be executed until the price reaches the selected stop-limit. The price actually obtained may therefore differ from the selected stop-limit, especially in the case of a market with lower liquidity. Time limit You can set a time limit to determine the validity of your instruction. The period of validity of instruction without time limit depends on the practices of the respective exchange place. Your advisor will inform you on further additions of the instruction. Guarantees The term guarantee may have several meanings. On the one hand, under this term is meant a commitment of a third person other than the issuer, through whom the third person ensures fulfillment of the issuer s obligation. On the other hand, it can be a commitment of the issuer themselves to perform a certain performance regardless of the trend in certain indicators, that would be decisive for the extent of the issuer s obligation. Guarantees may also be related to various other circumstances. Capital guarantees are usually enforceable only until the end of term (repayment) that is why price fluctuations (price losses) are quite possible during the term. The quality of a capital guaranty depends to a significant extent on the guarantor s financial standing. Tax aspects Your advisor will provide you with information on the general tax aspects of the individual types of investment. The impact of an investment on your personal tax situation should be evaluated together with your tax advisor. Risks at stock exchanges, particularly on foreign markets There is no direct connection with most of the foreign stock exchanges, it means, that all instructions must be passed telephonically. This can lead to mistakes or time delays. In case of certain foreign share stock exchanges limited instructions for purchase and sale are generally not possible. The limited instructions cannot be given until the request has been made via telephone to the local broker, which can lead to time delays. In certain cases, such limits cannot be executed at all. At certain foreign share stock exchanges it is complicated to receive the current exchange rates, which makes it more difficult to assess the Client s existing positions. If a trading quotation is discontinued on stock exchange, it may no longer be possible to sell these securities through the relevant purchase stock exchange. A transfer to another stock exchange may also cause problems. At certain foreign stock exchanges, the trading hours still do not comply with European standards. Short trading hours of stock exchange of only three or four hours per day can lead to time pressure, resp. to not taking into account instructions concerning shares. 2. Bonds Bonds are securities that obligate the issuer (= debtor, issuer) to pay the bondholder (= creditor, buyer) interest on the capital invested and to repay it according to the bond terms. Besides such bonds in the strict sense of the term, there are also bonds that differ significantly from the above-mentioned characteristics and the description given below. We refer in particular to the bonds described in the Structured investment instruments paragraph. Especially in that area, it is not the definition as a bond that is decisive for the investment instrument risk but rather the specific structure of the investment instrument. The bond yield is composed of the interest on capital and potential difference between the purchase price and the price achieved at sale/redemption. Consequently, the yield can only be determined in advance if the bond is held until maturity. With variable interest rates of bonds, the yield cannot be specified in advance. As comparative/measuring value for the yield, yield up to maturity is used (final maturity), which is calculated according to usual international criteria. Bond yields which are significantly above the generally customary level of bond yields with comparable maturity should always be questioned, with an increased financial standing risk being a possible reason. The price achieved when selling a bond prior to redemption is not known in advance. Consequently, the yield may be higher or lower than the yield calculated initially. Thus when calculating the yield, the fees must be taken into account. There is always the risk that the debtor is unable to meet all or part of their obligations, e.g. in case of insolvency. Therefore, the financial standing risk of the debtor must be considered in your investment decision. A method of assessment of the debtor s financial standing risk may be the so called rating (= assessment of the debtor s financial standing risk by an independent rating agency). Rating AAA, resp. Aaa means the best financial standing risk; the worse rating is (e.g. rating B- or C), the risk of default (financial standing risk) is higher but by way of compensation the instrument generally pays a higher interest rate (risk premium). Investments with a rating comparable to BBB or higher are generally referred to as Investment grade. Exchange rate risk If a bond is held until the end of maturity, at its redemption you receive an amount, which you were promised in the bond terms. Please note if it is stated in the issue terms the risk of early calling-in by the issuer. If the bond is sold prior to its maturity, you shall receive the market price. This price is regulated by supply and demand, which among others depends on the current interest rate level. Effective as of 28 February 2013 Page 02 of 13

4 For example, the price of fixed interest bonds will fall, if the interest on bonds with comparable maturities rises, and reversely, bonds will gain in value, if the interest on bonds with comparable maturities falls. A change in the debtor s financial standing may also affect the bond price. In case of variable-interest bonds whose interest rate is indexed to the capital market rates, the interest rate risk is comparably higher than with bonds whose interest rate depends on the money market rates. The degree of change in the bond price in response to change in the interest level is described by the duration indicator. The duration depends on the bond s residual time to maturity. The bigger the duration, the greater the impact of changes of the general interest rate on the price, both in a positive and negative sense. Liquidity risk The tradability of bonds may depend on several factors, e.g. issuing volume, remaining time to maturity, stock exchange rules, market situation. Bonds which are difficult to sell or cannot be sold at all must be held until maturity. Trading with bonds Bonds are traded on a stock exchange, or over-the-counter. On the basis of your requirement, your bank may usually inform you on the selling and purchase price of certain bonds. However, there is no entitlement for negotiability. In case of bonds that are also traded on the stock exchange, the prices formed on the stock exchange may differ considerably from the off-the-market quotations. The risk of the worse price on the stock exchange may be reduced by placing a limit in the instruction. 3. Shares/Stocks Shares are securities, with which rights of a shareholder as a partner to participate on the company s management, its profit and liquidation balance at the company dissolution are connected and a right to vote at the general meeting. (Exception: priority shares) The yield from investment into shares is composed of dividend payment and exchange rate gains/losses and cannot be predicted with certainty. The dividend is a yield of a company paid on the basis of the general meeting decision. The dividend amount is expressed either as an absolute amount per share or as a percentage of the nominal value. The yield obtained from the dividend in relation to the exchange rate of shares is called dividend yield. It is usually considerably lower than the dividend indicated as a percentage of the nominal value. The greater part of yields from investments into shares follows regularly from development of value/share exchange rate (see exchange rate risk). Exchange rate risk Share is a security, which in most cases is tradable on a stock exchange. The exchange rate is usually established daily on the basis of supply and demand. Investments into shares may lead to considerable losses. In general, the share exchange rate depends on the economic development of a company, as well as the general economic and political frame conditions. Besides, irrational factors (investor sentiment, public opinions) may also influence the exchange rate and thus the yield on an investment. As a shareholder, you own participation on a company. Your participation may become valueless particularly by its insolvency Liquidity risk Tradability may be problematical in cases of titles seldom occurring on the market (mainly quotation on unregulated markets, over-the-counter trades). Also quotation of one share in several stock exchanges may lead to differences in tradability on different international stock exchanges (e.g. quotation of an American share in Frankfurt). Stock market Stocks are traded on a stock exchange, sometimes over-thecounter. In the case of stock exchange trading, the relevant stock exchange rules (trading volume, type of instructions, currency adjustment, etc.) must be observed. If a share is quoted at different stock exchanges in different currencies (e.g. an American share quoted in Euros at the stock exchange in Frankfurt) it entails an exchange rate risk, as well as a currency risk. Your advisor will inform you of further details. When purchasing a stock on a foreign stock exchange, please bear in mind that foreign stock exchanges always charge fees of third parties that accrue in addition to the bank s usual fees. You will be informed on their exact amount by your advisor. 4. Mutual funds I. Domestic mutual funds Generally The mutual funds of the domestic investment funds are securities which certify co-ownership in the mutual fund. Mutual funds invest money of owners in accordance with the principle of risk diversification. The three main types are bond funds, stock funds, as well as mixed funds investing both in bonds and stocks. Funds may invest in domestic and/or foreign securities. The investment spectrum of domestic mutual funds includes not only securities but also money market instruments, liquid financial investments, derivative investment instruments and mutual fund shares. Mutual funds may invest into domestic and foreign securities. Furthermore, we distinguish among distribution funds (paying dividends), growth funds (which do not pay dividends) and funds of funds. Unlike funds paying out dividends, growth funds do not pay out dividends but rather reinvest them in the fund. Funds of funds invest in other domestic and/or foreign funds. Guarantee funds are subject to a binding commitment by a guarantor commissioned by the fund with respect to distributions of dividends for a certain period, repayment of capital, or performance. Effective as of 28 February 2013 Page 03 of 13

5 The yield of investment fund is composed of the annual payment (provided they are distribution not growth funds) and the trend in the value of the fund assets. The yield cannot be established in advance. The trend in value of the fund assets depends on the investment policy specified in the fund terms, as well as the market trends of the individual parts of the fund. Depending on the composition of a fund portfolio, the relevant risk warning notices for bonds, stocks or warrants must be taken into account. Exchange rate risk/pricing risk Investment fund certificates can normally be returned at any time at the repurchase price. Under exceptional circumstances, the repurchase of certificates can be temporarily suspended until the sale proceeds. Your investment advisor will be pleased to inform you about any fees charged and the execution date of your buy and sell orders. The term of an investment fund depends on the fund conditions and is usually unlimited. Please keep in mind that investment fund certificates, unlike bonds, are not normally redeemed and, consequently, do not carry a fixed redemption price. The risk of investment fund certificates depends, as already mentioned, on the fund s stated investment objectives and the market trends. A loss cannot be ruled out. Although investment fund certificates can normally be returned at any time, they are instruments designed for investment over a prolonged period of time. Like stocks, funds can be traded on stock exchanges. The rates that are formed on the relevant stock exchange may differ from the redemption price. In that regard please see the information on risk related to stocks. Tax impacts The tax adjustment of yields is different depending on the type of the fund. II. Foreign investment funds Foreign investment funds are subject to the foreign legal provisions, which can noticeably differ from legal provisions valid in the Czech Republic. In particular, the power of supervisory body may be often less strict than as it is in inland. On the investment fund market, there are also closed-end funds and funds ruled by corporate law, whose prices are regulated by supply and demand, rather than the intrinsic value of the fund, which is roughly comparable to the establishment of stock prices. Please keep in account that the dividend payments and yields of the foreign capital investment funds amounting to the paid dividends (e.g. growth fund) regardless of their legal form are subject to other tax adjustments. III. Exchange Traded Funds (Index certificates) Exchange Traded Funds (ETFs index certificates) are fund shares that are traded like stocks on a stock exchange. An ETF is usually compound from a basket of securities (e.g. a basket of stocks) that reflects the composition of an index, i.e. that copies the index in one security by means of the securities contained in the index and their current weight, and so that ETFs are often referred to as index stocks. The yield depends on the trend of the underlying assets found in the securities basket. Risk The risk depends on values of the securities basket, which forms the basis of securities. 5. Structured investment instruments The structured investment instruments are investment instruments or treasury solutions for which the yields and/or repayment of capital are not generally fixed but rather depend on certain future events or market development. Such instruments may be, for example, structured in such a way that the issuer may call them in early if the investment instrument reaches the target value; in such cases, they would even be called in automatically. Subsequently, individual types of investment instruments will be described. For description of these types of investment instruments, common collective terms are used, that are not, however, used uniformly on the market. On the basis of various possibilities of connections, combinations and disbursements related to such investment instruments, various forms of investment instruments have developed; names selected for them do not always reflect the relevant forms uniformly. For that reason, it is always necessary to examine specific terms and conditions of the investment instrument. Your advisor will be happy to inform you of the forms of such investment instruments. Risk 1) When the interest and/or yield payments are agreed, such payments may depend on future events or development (indexes, baskets, individual stocks, specific prices, commodities, precious metals, etc.) and may therefore be reduced or even eliminated in the future. 2) Capital repayments may depend on future events or developments (indexes, baskets, individual stocks, specific prices, commodities, precious metals, etc.) and may therefore be reduced or even eliminated in the future. 3) In respect to the interest and/or yield payments as well as capital repayment, it is necessary to take into account mainly interest, currency, company, branch risks and country risk and financial standing risks (and possibly a lack of claims for separation and elimination) as well as tax risk. 4) The risks mentioned in sections 1) to 3), without regard to the potential interest, yield or capital guarantees, may lead to strong exchange fluctuations (exchange rate losses), resp. such risks may also make it difficult or impossible to sell the instrument before it reaches maturity. I. Guarantee certificates When guarantee certificates reach maturity, they pay out initial nominal value or a certain percentage rate independently of development of the underlying asset ( minimal paid amount ). The yield attainable from development of the underlying value may be limited by the highest paid amount or by other limitations of participation on development of the underlying asset Effective as of 28 February 2013 Page 04 of 13

6 Risk If the Knock-out limit is reached before maturity, either the certificate expires and becomes worthless or an estimated residual value is paid out (investment instrument will be due). In case of certain issuers, it suffices to knock out the certificate if the price reaches the Knock-out limit during the trading day (intraday). The closer the current stock market quotation is to the exercise price, the stronger the leverage effect is. At the same time, however, the risk that the price will fall below the Knockthat are stated in the certificate terms. The investor is not entitled to receive dividends and similar payments of the underlying asset. Risk The value of the certificate may fall below the agreed minimal paid amount during maturity. But at the end of maturity, the value will generally be at the amount of the minimal paid amount. However, the minimal paid amount depends on financial standing of the issuer. II. Discount certificates In the case of discount certificates, the investor receives the underlying asset (e.g. derived stocks or index) at a discount of the current price (safety buffer) but in exchange his interest in growth of the underlying security is limited to a certain ceiling (Cap or reference price). At maturity, the issuer has the option of either redeeming the certificate at the maximum value (Cap) or delivering stocks or, if an index is used as the underlying security, a cash settlement equal to the index value. The difference between the discounted purchase rate of the underlying security and the upper limit of the rate determined by Cap represents the possible yield. Risk If the price of the underlying asset falls sharply, shares will be delivered when the instrument reaches maturity (the equivalent value of the delivered shares will be below the purchase price at that moment). Since allocation of shares is possible, it is necessary to take into account the risk warnings concerning the shares. III. Bonus certificates Bonus certificates are bonds that, subject to certain requirements, pay out at maturity a bonus or appreciated price of an underlying asset (individual shares or indexes) in addition to the nominal value. Bonus certificates have fixed given maturity. The terms and conditions of the certificate stipulate regular payment of the financial amount or provision of the underlying assets at the end of maturity. The type and amount of sum paid at the end of maturity depend on development of the value of the underlying assets. For a bonus certificate there is set a starting level, a barrier being underneath the starting level, and a bonus level being above the starting level. If the underlying security falls down to the barrier, or below, the bonus is forfeited and the paid sum will be in the amount of the underlying security. Otherwise, the minimal paid amount results from the bonus level. When the certificate reaches maturity, the bonus is paid out along with the amount initially invested capital for the nominal value of the certificate. With a bonus certificate, the investor acquires a claim against the issuer for payment of a money amount depending on the value of the underlying security. The yield depends on development of the derived underlying security. Risk The risk depends on the derived underlying security. If the issuer goes bankrupt, the investor has no rights or claim for separation and recovery with respect to the underlying security. IV. Index certificates Index certificates are bonds (usually quoted in the stock exchange) that offer investors the possibility to participate on a certain index, without having to own the values contained in the given index. Changes in the underlying security (index) and index certificate are in 1:1 ratio. With an index certificate, the investor acquires a claim against the issuer for payment of a sum that depends on the state of the derived index. The yield depends on development of the derived index. Risk The risk depends on the derived values of the index. If the issuer goes bankrupt, the investor has no right or claim for separation or recovery of the underlying securities. V. Knock-out-certificates (turbo-certificates) Under the Knock-out-certificates term are meant certificates that guarantee the right to buy, event. to sell a certain underlying security at a certain exchange rate, if the underlying security fails to reach the specified limit of the exchange rate (Knock-out-limit) before maturity. If it does reach the specified limit, the certificate will expire early and most of the investment will generally be lost. Depending on the expected development of the exchange rate with respect to the relevant underlying security, a distinction is made between Knock-out long certificates and Knock-out short certificates. Besides normal Knockout certificates, leveraged Knock-out certificates are issued, usually under the name of Turbo certificates (or leverage certificates). When the value of the underlying security rises, the increase in the value of the Turbo certificates will be disproportionately greater due to the level (Turbo) effect; the same effect occurs in the opposite direction when prices fall, however. Thus, high yields can be earned through small investments, but the risk of loss is increased, as well. A positive yield can be earned if there is a favorable difference between the acquisition price or market price and the exercise price (making it possible to buy the underlying security at the lower exercise price or to sell it at the higher exercise price). 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7 out limit increases and either the certificate will become worthless or the estimated residual value will be paid out. 6. Money market instruments s Money instruments include short-term investments in the financial market, as for example certificates of deposit (CDs), treasury bills, and all short-term bonds with maturity of the capital approximately up to five years and fixed interest rates approximately up to one year. Parts of yield and risk The parts of yield and risk of money market instruments are largely equivalent to those of bonds. Differences relate mainly to the liquidity risk. Liquidity risk There are no organized secondary markets for money market instruments. Consequently, it cannot be guaranteed that the instrument can be sold at any time. Liquidity risk becomes of secondary importance, if the issuer guarantees payment of the invested capital at any time and his financial standing is for such purposes sufficient. Instruments of the financial market elementary explanation Certificates of Deposit securities of the financial market issued by banks, generally with a maturity from 30 to 360 days. Treasury Bills securities of the financial market with a maturity up to 1 year. Commercial Papers instruments of the financial market, short-term bonds issued by big companies, with a maturity from 5 to 270 days. Short-term bonds short-term securities of the capital market, generally with a maturity from 1 year to 5 years. 7. Security derivatives (options and futures contracts) When trading in options and futures, the high chances of gain are counterbalanced by high chances of loss. As your bank, we believe it is our duty to inform you of the risks of options or futures contracts before you make such transactions. Sale of option contracts and purchase or sale of futures contracts Sale of Calls This means the sale (Opening = sale when opening, short position) of a Call (option to buy), by which you assume the obligation of delivering the underlying security at a specified price at any time before the expiration date (in the case of American type call options) or on the expiration date (in the case of European-type call options). In exchange for assuming that obligation, you receive the option price. If the price of the underlying security rises, you must accept the risk of delivering the underlying security at the agreed price even if the market price is significantly higher than that price. That price difference constitutes your risk of loss, which cannot be determined in advance and in principle is unlimited. If the underlying securities are not in your possession (uncovered short position), you will have to purchase them through a cash transaction (replacement transaction) and your risk of loss in that case cannot be determined in advance. If the underlying securities are in your possession, you are protected against replacement losses and you will also be able to make timely delivery. Since such securities must be kept blocked until the expiration date of your option transaction, however, you will not be able to dispose of them during that time, which means that you cannot sell them to protect yourself against falling prices. Sale of Puts This refers to the sale (Opening = sale when opening, short position) of a Put (short position), by which you assume the obligation of purchasing the underlying security at a specified price at any time before the expiration date (in the case of American-type call options) or on the expiration date (in the case of European-type call option). In exchange for assuming that obligation, you receive the option price. If the price of the underlying security falls, you must accept the risk of buying the underlying security at the agreed price even if the market price is significantly lower than that price. That price difference, which is calculated on the basis of the exercise price minus the option premium, constitutes your risk of loss, which cannot be determined in advance and is in principle unlimited. An immediate sale of the underlying securities will be possible only at a loss. If you do not wish to sell the underlying securities immediately, however, and want to retain possession of them, you will have to take into consideration costs of needed funds. Option purchase This means the purchase (Opening = purchase when opening, long position) of Calls (options to buy) or Puts (options to sell), which entitles you to demand delivery or acceptance of the underlying security or, if that is possible, as in the case of index options, you are entitled to demand payment of an amount of cash equal to the positive difference between the price of the underlying security at the time of purchase of the option and market price at the time of exercise of the option. In the case of American-type options, the option may be exercised at any time before the agreed expiration date; in the case of European- -type options, they can be exercised only on the agreed expiration date. In exchange for the grant of the option, you pay the option price (option premium). If the price changes in the opposite direction from what you hoped when you bought the option, your option may lose all its value by the expiration date. Your risk of loss is therefore the price you paid for the option. Sale or purchase of futures contracts This refers to the purchase or sale at a specified date, by which you assume the obligation to accept or deliver the underlying asset at the specified price at the end of the agreed term. If prices rise, you must accept the risk of having to deliver the underlying securities at the agreed price, even if the market price is significantly higher than that price. If prices fall, you will have to accept the risk of purchasing the underlying securities at the agreed price even if the market price is considerably lower. That price difference constitutes your risk of loss. In the case of an obligation to purchase, you must have all the necessary cash available at maturity. If the underlying securities are not in your possession (uncovered short position), you will have to purchase them through a cash transaction (replacement transaction) and your risk of loss in that case cannot be determined in advance. If the underlying securities are in your possession, you are protected against replacement losses and will also be able to make timely delivery. Effective as of 28 February 2013 Page 06 of 13

8 Cash Settlement transactions If delivery or acceptance of the underlying securities is not possible in a futures transaction (e.g. in the case of index options or index futures), you will be required to pay a cash amount (Cash Settlement) if the market did not move in the direction you anticipated. The amount of that difference between the price of the underlying security at the time you signed the option or futures contract and the market price at the time of exercise or maturity. That constitutes your risk of loss, which cannot be determined in advance and is in principle unlimited. In that case, you must ensure that you have sufficient liquid assets to cover the transaction. Provision of security (Margins) In the case of uncovered sale of options (Opening = sale when opening, uncovered short position) or purchase or sale of futures (future transactions), it is necessary to post security in the form of a Margin. You are required to post such security at the time of opening and whenever needed (if the price moves contrary to your expectations) at any time before the expiration of the option or futures contract. If you are not capable of posting the additional security that is required, we will be unfortunately forced to close out your position immediately and use the hitherto posted security to cover the transaction (see article 3 section 2 of the General contract on Closing Deals with Investment Instruments ). The yield (profit/loss) achieved by speculative investors is the difference between the foreign exchange rates during or at the end of maturity of the futures transaction in line with the contract specifications. The use of currency futures for hedging purposes means locking in an exchange rate so that the costs of the hedged transaction as well as its yield will neither increase nor decrease as a result of any exchange rate fluctuations. Currency risk The currency risk inherent in currency futures transactions is, in the case of hedging transactions, the possibility that the buyer/seller could buy/sell the foreign currency at a more favorable price during or at the end of maturity. In the case of uncovered transactions, there is possibility that the buyer/seller must buy/sell the currency at a less favorable price. The potential loss may substantially exceed the original contract value. in connection with currency futures transactions derives from the possibility of counterparty default due to insolvency, i.e. one party s temporary or permanent inability to complete the currency futures transaction, making more expensive covering transactions in the market necessary. Liquidation of positions When trading in American-type options and futures contracts, you have the possibility of liquidating your position before the expiration date (Closing). You cannot always be sure that that it will be possible at any time, however. It always depends very strongly on the market situation; based on complicated market conditions, you may have to perform trades at an unfavorable market price, so that losses may incur. Other risks Options entail both rights and obligations futures contracts entail obligations only with a short maturity and predetermined expiration or delivery dates. For those reasons, and because of the rapidity of such transactions, the following additional risks arise, in particular: Options that are not exercised in timely manner will expire and become worthless. If you are unable to post the required additional security in a timely manner, we will liquidate your position and draw upon your previously posted security, without prejudice to your obligation to cover the outstanding balance. If you perform futures transactions in foreign currency, an unfavorable trend in the foreign exchange market may increase your risk of loss. 8. Currency futures transactions (currency derivatives) Currency future transaction is the firm undertaking to buy or to sell a certain foreign currency amount at a specified date in the future or over a specified period of time at a price agreed upon conclusion of the contract. Provision or acceptance of foreign currency equivalent is exercised with the same value date. Transfer risk The transfer of some foreign currencies may be restricted, in particular by the country issuing that currency. The orderly execution of the currency futures transaction would then be at risk. 9. Currency swaps (currency derivatives) A transaction in which specified amounts of one currency are exchanged for another currency over a certain period of time. The interest rate differential between the two currencies is reflected in a premium/discount to the re-exchange price. The yield (profit/loss) for anyone trading in currency swaps results from the positive/negative development of the interest rate differential and can be made in the case of a countertrade during the maturity of the currency swap. The financial standing risk in connection with currency swaps derives from the possibility of counterparty default due to insolvency, i.e. one party s temporary or permanent inability to complete the currency swap, making more expensive covering transactions in the market necessary. Transfer risk The transfer of some foreign currencies may be restricted, in particular by the country issuing that currency. The orderly execution of the currency futures transaction would then be at risk. Effective as of 28 February 2013 Page 07 of 13

9 10. Interest Rate Swap (IRS) (interest rate derivative) Interest rate swap manages the exchange of variously defined interest rate obligations to fixed nominal amount between two contractual parties. In general, it is exchange of fixed payments of interests for variable ones. This means that only interest payments are swapped, whereas no exchange of the capital flow takes place. The buyer of IRS (pays fixed interest rates) benefits from a rise in interest rates. The seller of IRS (receives fixed interest rates) benefits from a fall in interest rates. The yield on an interest rate swap cannot be determined in advance. Interest rate risk The interest rate risk results from the uncertainty over future changes in market interest rates. The buyer/seller of interest rate swap is exposed to loss if market interest rates fall/rise. The financial standing risk encountered with IRS is derived from the possibility of counterparty default, causing the loss of positive cash values or making more expensive covering transactions in the market necessary. Special terms and conditions of interest rate swaps IRS do not have standardized terms. The processing details must be contractually agreed upon in advance. It is therefore imperative to obtain full information on exact terms and conditions of interest rate swaps, in particular: nominal amount, term, interest rates definition. 11. Forward Rate Agreements (FRA) (interest rate derivative) Forward Rate Agreements are used to agree on interest rates to be paid at the specified time in the future. Since FRAs are dealt in on the interbank market and not on a stock exchange, they do not have standardized terms. Unlike interest-rate futures, FRAs are customized investments instruments in terms of nominal amount, currency and interest period. Through buying/selling an FRA, the buyer/seller fixes the interest rate for the period in question. If the reference interest rate is higher that the agreed interest rate (FRA price) at the maturity date, the buyer of the FRA will be compensated for the movement in interest rates. If the reference rate is lower than the agreed interest rate (FRA price) at the maturity date, the seller of the FRA will receive a compensation payment. Interest rate risk The interest rate risk results from the uncertainty over future changes in interest rates. Generally, this risk is all the higher, the more pronounced the increase/decrease in interest rates is. The financial standing risk with FRAs derives from the possibility of counterparty default, causing the loss of positive cash values or making more expensive covering transactions at a lower price in the market necessary. Special features of FRAs FRAs do not have standardized terms, but are customized investment instruments. It is therefore imperative to obtain full information on the exact terms and condition, in particular: nominal amount, term, interest rates definition. 12. Over-the-counter (OTC) options (derivatives) Standard options Plain Vanilla Option The buyer of an option has the right, on or before a specified date, to buy (Call option) or sell (Put option) the underlying asset (securities, currency, etc.) at a fixed (strike) price or (e.g. in the case of interest-rate options) to receive a compensation payment resulting from the positive difference between strike price and market value at the time the option is exercised. The option writer (seller) is obliged to fulfill the rights of the option buyer. Options may differ according to the manner of exercise: American type: during whole period of maturity European type: at the end of maturity Exotic options Exotic options are financial derivatives derived from standard options (Plain Vanilla Options). Special form Barrier options In addition to the strike price, there is a threshold value (barrier). When that barrier is reached, the option is either activated (Knock-In Option) or deactivated (Knock-Out Option). Special form - Digital (Payout) option Option with a specified Payout, which the buyer of the option receives in exchange for paying a premium, if the price (interest rate) of the underlying asset is below or above (depending on the option) the threshold value (barrier). The buyer of an option will make a profit if the price of the underlying asset rises above the strike price (in the case of a Call option) or falls below the strike price (in the case of a Put option). The option holder may either exercise the option or sell it (Plain Vanilla Option, activate Knock-In Option, non-deactivated Knock-Out Option). If a Knock-In Option is not activated or Knock-Out Option is deactivated, the option expires and becomes worthless. Effective as of 28 February 2013 Page 08 of 13

10 The holder of digital (Payout) options receives a yield if the threshold value is reached before maturity or at maturity, which means he/she receives the Payout. General risks The value (price) of an option depends on the strike, the performance and volatility of the underlying instrument, the option life, the level of interest rates and the market situation. In the worst case, therefore, the capital invested (option premium) may become completely worthless. If the price of the underlying asset moves contrary to the expectation of the option writer, the potential loss will be virtually unlimited (Plain Vanilla Option, barrier option) or in the amount of the agreed Payout (digital option). Please note, in particular, that options not exercised in a timely manner will expire on the expiration date and will therefore be erased from the accounts as worthless. Important: The bank will not exercise your option without your express instructions. Special risks of over-the-counter option transactions The over-the-counter options do not have standardized terms, but they are customized investments. It is therefore imperative to obtain full information on the exact terms and conditions of a option (style of exercise, expiry, etc.). The financial standing risk encountered by the buyer of an overthe-counter option derives from the possibility of losing the premium due to counterparty default, making more expensive covering transactions in the market necessary. Being customized products, over-the-counter options are usually not traded on organized markets. Consequently, the tradability of such options cannot be guaranteed at any time. 13. Currency option transactions (currency derivatives) The buyer of a currency option acquires the right, but not the obligation, to buy or sell a fixed quantity of currency at a particular price on a specified date in the future or within a specified period of time. The seller of the option grants this right. The buyer pays the seller a premium. The following possibilities exist: The buyer of a Call option acquires the right to buy a fixed amount in a specified currency at a particular price (exercise price or strike price) on or before a particular date (expiry date). The seller of a Call option guarantees to deliver/sell, at the option holder s request, a defined amount in a particular currency at the agreed strike price on or before a particular date. The buyer of a Put option acquires the right to sell a fixed amount in a specified currency at a particular price (exercise price or strike price) on or before a particular date. The seller of a Put option guarantees to buy, at the option holder s request, a defined amount in a particular currency at the agreed strike price on or before a particular date. The buyer of a Call option will make a profit if the market price of the currency rises above the agreed strike price, with the option premium to be deducted from the gain. The buyer may then buy the foreign currency at the strike price and re-sell it immediately in the market. The seller of a Call option receives a premium in exchange for selling the option. The same applies, in the opposite direction, to put options, which are purchased in the expectation of rising currency rates. Risks when purchasing options Risk of forfeited premium The buyer of an option incurs the risk of losing the entire amount of the premium, which must be paid irrespective of whether the option is exercised or not. The financial standing risk in connection with the purchase of currency options results from the possibility of counterparty default. This will lead to the loss of the premium already paid and make more expensive covering transactions in the market necessary. Currency risk The currency risk is derived from the possibility of adverse moves in the value of the respective currency during the life of the option. In the worst case, the premium may be forfeited. Risk when selling options Currency risk The risk at sale of options results from the possibility of adverse moves in the value of the respective currency during the life o the option. The resulting risk of loss is unlimited for the options being sold. The premium of a currency option depends on the following factors: volatility of the underlying currency exchange rate (measure of the expected fluctuation margin in the exchange rate), the agreed strike price, the amount of time remaining until expiration of the option, the current exchange rate, the interests rate level in both currencies, liquidity. Transfer risk The transfer of certain currencies may be restricted, in particular by the country issuing that currency. The orderly execution of the trade would then be at risk. Liquidity risk Being largely customized products, there are usually no organized secondary markets for that currency options. Consequently, it cannot be guaranteed that a currency option can be sold at any time. Effective as of 28 February 2013 Page 09 of 13

11 Special features of currency options Currency options do not have standardized terms. It is therefore imperative to obtain full information on the exact terms and conditions of the option, in particular: Manner of exercise: Is the option exercisable at any time during its life (American option) or only at its expiry (European option). Expiry: When does the option right expire? Please note that your bank will not exercise an option unless specifically instructed to do so. 14. Interest Rate Options (interest rate derivative) Interest rate options are agreements on an upper or lower limit to interest rates or an option for interest rate swaps. They are used either a) for hedging purposes or b) for speculative trading to realize a gain. Interest rate options are either Calls or Puts. Common variants are Caps, Floors, Swaptions, etc. Through buying a Cap, the buyer secures for himself/herself an upper interest rate limit (=strike price) for future borrowings. In speculative trading, the value of a Cap increases with rising interest rates. Selling a Cap can be used as a speculative instrument only. The seller receives the premium and undertakes to compensate the buyer for any difference in interest rates. Floors secure the buyer a certain minimum interest rate on a future investment. In speculative trading, the Floor value increases with falling interest rates. ad a) hedging purposes Depending on the agreed reference periods, the current threemonth or six-month interest rate is compared with the agreed Strike price. If the market price is higher than the Strike price, the holder of the Cap will be compensated for the difference. ad b) speculative trading to realize a gain The value of a Cap increases as interest rates rise. In this case, however, the forward rates (future interest rates traded today) are more important than the current interest rates. The same applies, in the opposite direction, to the purchase/ sale of a Floor. The buyer of a Floor secures for himself/herself a lower limit to interest rates, while the seller holds a speculative position. A Swaption is an option on an Interest Rate Swap (IRS = agreement to exchange interest payments). There are two basic types of swaptions: Payers-Swaptions (right to pay fixed interest rates) and Receivers-Swaptions (right to receive fixed interest rates). Both variants can be either bought or sold. Furthermore, a distinction is made between two different types of performance with different risk profiles: Swaption with Swap Settlement The purchaser becomes a party to the swap at the time of exercise of the swaption. The buyer of a Payers-Swaption acquires the right to make fixed interest payments at the strike price at the agreed nominal amount and at the delivery date and to receive variable interest payments in return. The seller of a Payers-Swaption undertakes to receive fixed interest payments at the agreed strike price at the agreed nominal amount and at the delivery date and make variable interest payments in return. The buyer of a Receivers-Swaption acquires the right to receive fixed interest payments at the agreed strike price at the agreed nominal amount and at the delivery date and to make variable interest payments in return. The seller of a Receivers-Swaption undertakes to make fixed interest payments at the agreed strike price at the agreed nominal amount and at delivery date and to receive variable interest payments in return. Swaption with Cash Settlement At the time of exercise of the Swaption, the purchaser receives the difference between the values of the Swaps and Swaption interest rate or current market interest rate. The holder of an interest rate option will realize a yield if on the exercise date the interest rate in the market is higher than the price of the Strike Cap lower than the price of the Floor. In the case of Swaptions, a yield can be achieved if on the exercise date the interest rate in the market is above the agreed strike price (with Payers-Swaption) or below the agreed strike price (with Receivers-Swaptions). In any case, the premium must be deduced from the return. The option premium received stays with the seller, no matter whether the option is exercised or not. Interest rate risk The interest rate risk results from the possibility of future interest rate changes. The buyer/seller of an interest-rate option may incur a price loss if interest rates rise/fall. This risk is all the higher, the more pronounced the increase/decrease in interest rates is. This results in an unlimited potential of loss. The premium of the interest-rate option depends on the following factors: volatility of interest rates (interest difference), agreed strike price, the amount of time remaining until expiration, level of interest rates in the market, current financing costs, liquidity. This means that the price of an option may remain unchanged or decrease even though investor s expectations as to the movement of interest rates have been met. The financial standing risk encountered by the buyer of an interest-rate option derives from the possibility of counterparty default, causing the loss of positive cash values or making more expensive covering transactions in the market necessary. Risk of total loss at purchase The maximal loss in the case of buying an interest-rate option is the amount of the premium, which must be paid irrespective of whether the option is exercised or not. Effective as of 28 February 2013 Page 10 of 13

12 Special features of interest-rate options Interest-rate options do not have standardized terms, but are customized investment instruments. It is therefore imperative to obtain full information on the exact terms and conditions, in particular: Manner of exercise: Is the option exercisable at any time during its life (American option) or only at expiry (European option) Payment: Delivery of the underlying asset or cash settlement? Expiry: When does the option right expire? Please note that your bank will not exercise an option unless specifically instructed to do so. 15. Cross Currency Swap (CCS) (interest rate derivative) A Cross Currency Swap is an exchange of differently defined interest rate payables and different currencies on a fixed nominal value between two contractual partners. It is generally an exchange of fixed interest payments in two different currencies. Both interest payments may also be in variable interest rates payable. The flow of payments occurs in different currencies based on the same amount of capital, which is fixed on the basis of the current exchange rate valid on the trade date. Besides the exchange of interest rates payables or interest rates receivables, there is an exchange of capital both at the beginning (Initial Exchange) and at the end of maturity (Final Exchange). Depending on the needs of the individual trading partners, the Initial Exchange may be omitted. The yield from a CCS cannot be determined in advance. In the case of a positive trend in the exchange rate and in the difference between the interest rates, a yield may be realized from early liquidation of the CCSs. If the CCS is concluded with an improvement of the difference in interest rates, a yield may be realized from lower interest rates of another currency. That yield may be neutralized in turn by exchange losses, however. If the currency ratio develops in a positive manner, the yield may further increase. Interest rate risk The interest rate risk results from uncertainty concerning the future change in the market interest rate level. The buyer/seller of a CCS is exposed to a risk of loss if the market interest level falls/rises. Currency risk The currency risk results from uncertainty concerning the future change in the relevant exchange relationship of the currencies involved. In the case of a CCS with Final Exchange, it is especially important to note that currency risk exists not only in the case of the default of a contracting partner but also during the whole period of maturity. Special terms and conditions for CCSs CCSs are not standardized. They are customized investment instruments. It is therefore very important to get accurate information about them, especially with respect to: nominal amount, term, definition of the interest rate, definition of the currency, definition of the exchange rate, Initial Exchange (yes or no?). 16. Commodity futures transactions (commodity derivative) Commodity futures transactions are special contracts that involve rights or obligations to buy or sell certain commodities at a predetermined price and time or during a specified period of time. Commodity futures transactions are involved in the instruments described below, among others. Basic information about the individual instruments Commodity Swaps A Commodity Swap is an agreement involving the exchange of a series of commodity price payments goods ( fixed amount ) against variable commodity price payments ( market price ) resulting exclusively in a cash settlement ( settlement amount ). The buyer of a Commodity Swap acquires the right to be paid a settlement amount if the market price rises above the fixed amount. On the contrary, the buyer of a Commodity Swap is obligated to pay the settlement amount if the market price falls below the fixed amount. The seller of Commodity Swap acquires the right to be paid a settlement amount if the market price falls below the fixed amount. On the contrary, the seller of a Commodity Swap is obligated to pay the settlement amount if the market price rises above the fixed amount. Both payment flows (fixed/variable) are in the same currency and based on the same nominal amount. Whereas the fixed side of the swap is of the nature of a benchmark, the variable side is related to the trading price of the relevant commodities quoted on a stock exchange or otherwise published on the commodities future market on the relevant fixing day or to a commodity price index. Commodity options with cash settlement The buyer of a Commodity Put option pays a premium for the right to receive the financial difference between the strike price and the market price in relation to the nominal value if the market price falls below the fixed amount. The buyer of a Commodity Call option pays a premium for the right to receive the financial difference between the strike price and the market price if the market price rises above the fixed amount. The financial standing risk in the case of buying/selling a CCS is the danger that the default of the transaction partner will result in an obligation to provide additional cover. Effective as of 28 February 2013 Page 11 of 13

13 Risks details on the various instruments Risk of Commodity Swaps and Commodity Options with Cash Settlement: If the trend does not live up to your expectations, difference coming out from exchange rate used at trade conclusion and current market exchange rate at trade maturity must be paid. This difference represents loss. Maximal height of loss cannot be determined in advance. It can exceed potential provided security. Risk when buying Commodity Options loss of value A price change in the underlying asset (e.g. of a raw material) that underlies the option as the subject matter of the contract may reduce the value of the option. A loss of value may occur in the case of a purchase option (Call) at exchange rate losses, in case of sale option (Put) at exchange rate gains, of a subject of contract, which is a base of the contract. A loss in the value of the options may occur even if the price of the underlying assets does not change because the value of the option is also influenced by other price formation factors (e.g. the term or frequency and intensity of the underlying asset). Your risk when selling Commodity Options leverage effect The risk in the case of selling Commodity Options is that the value of the underlying asset will not have moved in the direction originally anticipated by the seller by the time that the option expires. The resulting potential loss is unlimited for the options being sold. Risks of Commodity futures transactions Price fluctuations The amount of the payment obligation arising out of commodity futures transactions is determined by the prices on a certain commodity futures market. Commodity futures markets may depend on strong price fluctuations. Many factors related to supply and demand for commodities may influence the prices. It is not easy to forecast or predict such pricing factors. Prices may be significantly influenced by unforeseen events, such as natural disasters, illnesses, epidemics, or orders given by the public authorities, as well as unpredictable developments, e.g. the effects of weather, variations in harvests, or risks connected with delivery, storage or transport. Currency risk Commodity prices are often quoted in foreign currency. You will also be exposed to currency market risk if you enter into a commodity transaction in which your obligation or right to counter-performance is denominated in foreign currency or a foreign accounting unit or the value of the subject matter of the contract is determined thereby. Liquidation / liquidity Number of commodity futures markets is generally smaller than financial futures markets and may therefore be less liquid. You may be wholly or partially unable to liquidate a commodity futures position at the desired time because of insufficient market liquidity. Moreover, the spread between the bid and ask prices in a contract may be relatively wide. It may be difficult or impossible to liquidate positions under certain market conditions. Most commodity futures exchanges are authorized to set limits on price fluctuations, for example. Such limits prohibit asks or bids outside beyond certain limits during a certain period. This may make it difficult or impossible to liquidate certain positions. Limit- /Stop-Orders Limit-Orders or Stop Loss-Order are instructions that limit trading losses in the event of certain market movements. Although such possibilities of limiting risk are permitted on most commodity futures exchanges, Limit-Orders or Stop Loss-Orders are not generally set for OTC commodities. Futures and prompt transactions It is especially important to understand the relationship between futures contract prices and prompt transactions. Although market forces may equalize the differences between the futures contract price and the prompt transactions price (Spot) of the commodities in question to such an extent that the price difference on the delivery date is practically null, a variety of market factors, including supply and demand, may still result in differences between the contract price and prompt transaction price Spot) of the commodities in question. Determination of the market price Market prices are quoted either on the commodity futures exchanges or according to the usual market practices. Due to system failures, system malfunctions on the exchanges or other causes; it sometimes happens that no market price can be determined for the agreed fixing date. If no arrangement is made for a substitute method of price determination, the calculation agent is usually authorized to set the market price according to his own reasonably exercised discretion. 17. Other information Security (margin) The Client must have provided a guarantee to the selected types of the investment instruments (mentioned in the chapters 7, 8, 9, 10, 11, 12, 13, 14, 15, 16) in the amount of certain per cent from the volume of the relevant transaction, which will be determined by the bank before the business is agreed, according to the total volume of business in CZK in dependence on the maturity and rate of movement of the investment instrument price in CZK or another currency, which will be determined by the bank, in one of the following forms or their combinations. Deposit of collateral blocked on an account, possibly of limit, which the bank shall determine to the Client, or other values accepted by the bank (e.g. blocking of finances on a current account for purposes of foreign payments, etc.) Other financial liabilities When trading with the investment instruments, the Client, as a consequence of the transactions, may take over except the costs for such investment instruments also other financial and other liabilities including potential conditional obligations. Effective as of 28 February 2013 Page 12 of 13

14 Leverage effect In the case of futures transactions, the leverage effect may also be used. The derivative transactions, in the case of collateral deposit or guarantee provision, enable the Client to trade with multiple higher volume of money than the collateral or limit height. In the same way as the Client may multiply their profit through leverage effect, there also exists a risk that leverage effect also multiplies losses, if the trade does not develop for the Client s benefit. In case of fluctuations by a percentage higher than the collateral or limit, the Client may lose the whole investment. Guarantee or obligation of a third party In case that the bank offers an investment instrument including is a guarantee of a third person or another obligation of a third person to settle a claim of a creditor if not settled by the debtor or if another condition specified in advance shall be fulfilled, the Client shall receive information on this guarantee or another obligation of a third person and data about the warrantor and guarantee or about the undertaking of the third person and obligation of the third person needed so that an unprofessional Client or potentional unprofessional Client is able to adequately assess the guarantee or obligation of the third person. Risk interaction Investment instruments may also arise as combination of investment instruments; this may lead then to increase of risk. In case of such investment instrument supply, if the risks connected with investment instrument consisting of two or several investment instruments or services could be higher than the risks connected only with one of these investment instruments or services, the Client shall be informed accordingly. Information Since the investment instruments are subject to the market and other changes, further information on description of the investment instruments and risks connected with them shall be continuously published on the bank s internet page. Selection of the trading venues designated for execution of the Client s instructions under fulfilling the best conditions is described in Rules for Best Execution of Client Instructions. Public offer on an investment instrument In case that at the time of providing information by the bank, the investment instrument is a subject of a public offer and in the connection with the public offer, the published booklet will be in compliance with law, the bank fulfils its obligation to inform by stating the fact, where the booklet is publicly available. Effective as of 28 February 2013 Page 13 of 13