«Structured products with reference bonds» Active management of debtor risk in portfolios. Vontobel Investment Banking

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1 «Structured products with reference bonds» Active management of debtor risk in portfolios Vontobel Investment Banking

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3 Table of contents 04 A new dimension in structured products with reference bonds What is a reference bond? 05 How does the structured product with reference bonds work? 06 New possibilities of using structured products thanks to reference bonds Optimising debtor risk in overall portfolio Exploiting additional yield opportunities 08 What happens on maturity with a structured product with a reference bond? 09 Opportunities and risks at a glance 10 Structured products with reference bonds: tailor-made with deritrade 12 Q&A concerning structured products with reference bonds 13 Your contact for structured products 3

4 A new dimension in structured products with reference bonds The market for structured products has seen a rapid development in recent years. Not least because structured products can be used very flexibly thanks to their varied design options. Investors have numerous redemption charts, such as capital protection or yield optimisation products at their disposal, to speculate on a corresponding market opinion in line with their risk appetite. Structured products are bearer bonds as a rule. Redemption ultimately depends on the solvency and therefore on the creditworthiness of the issuer. The risk is called counter party or debtor risk. While flexibility in designing the redemption chart is today very broad, the design options for managing the debtor risk in a portfolio are small. Although the Swiss derivatives sector came up with a solution in COSI in 2009, which eliminates the debtor risk almost entirely, it also involves a lower prospective yield. This is due to the costs related to the additional security that an investor obtains from collateralisation with COSI (hereinafter COSI ). After becoming the first issuer to launch COSI products, Vontobel is now presenting an expanded version: structured products that allow a debtor of choice with reference bonds and simultaneously virtually eliminate the counterparty risk against Vontobel with COSI. In doing so, the investor achieves two economic benefits 1. Yield optimisation thanks to reference bonds 2. Diversification of the debtor risk in the overall portfolio What is a reference bond? The reference bond is a bond which, it secures the redemp tion in the structured product with a reference bond. The reference debtor is the issuer of this bond and is therefore responsible for guaranteeing solvency. This, in turn, depends on the creditworthiness of the reference debtor. 4

5 How does the structured product with reference bonds work? Contrary to traditional structured products, a further element, i.e. the reference bond, is also added to structured products with a reference bond. The issuer (Vontobel), as well as the solvency of the reference debtor is therefore now decisive for the redemption of the structured product. To prevent the investor from bearing two debtor risks (issuer and reference debtor), the issuer risk is nearly eliminated with COSI collateralisation (see Important information on COSI collateralisation). Economically, a redemption chart therefore arises for the investor, which is secured by a reference bond. Traditional Structured product COSI Structured product COSI structured product with a reference bond Redemption Chart Redemption Chart Redemption Chart Capital protection Underlying Strike Capital protection Underlying Strike Capital protection Underlying Strike Issuer Vontobel COSI Issuer Vontobel COSI Issuer Vontobel Reference Issuer risk Vontobel Issuer risk minimised by COSI Issuer risk minimised by COSI Default risk of the debtor of the reference bond Traditional Structured product COSI Traditional Structured product COSI Traditional Structured product with a reference bond* Yield Risk Moderate Low High *Both the yield and risk depend on the creditworthiness of the reference debtor 5

6 New possibilities of using structured products thanks to reference bonds This product solution provides investors with the possibility of managing the debtor risk in the portfolio with a bond of choice, thereby taking additional yield opportunities in addition to diversifying without having to forego the product and service quality of Vontobel. Diversifying the debtor risk in the overall portfolio Although the investor can already choose between various issuers today and thereby diversify the debtor risk in the portfolio, some issuers even offer defacto almost complete elimination of the issuer risk through the COSI collateralisation. However, this involves yield reduction and investors should consider three aspects: 1. Products of several issuers also mean a different standard for the product and service quality (e.g. trading quality, documentation quality, etc.) 2. Because banks are issuers as a rule, the investor achieves a diversification in the portfolio in the area of individual stocks, but not in the area of sectors. So why not buy a structured product with the debtor risk of an industrial company? 3. COSI collateralisation is always a suitable instrument when a debtor risk is to be reduced for structured products. For increased security, however, a price must be paid, which normally results in a lower possible yield. Exploiting additional yield opportunities A reference bond in the product means a change to the debtor profile, which has an impact on the possible yield. This impact depends, in particular, on the creditworthiness of the reference debtor. As a rule, the higher the creditworthiness of a reference debtor is rated by the market, the lower the yield contribution that the reference bond makes to the structured product. The yield contribution depends on the amount of the credit spreads (see credit spread definition). Conversely, the lower the credit wor thiness of the reference debtor is rated, the greater the yield contribution made in the structured product. Importation information on COSI collateralisation To reduce the issuer s default risk, collateralisation is provided by depositing collateral in the form of securities in the collateral pool of the SIX Swiss Exchange. Both collateralised products and collateral deposited are valued every banking day. The collateral provider undertakes to adjust the amount of collateralisation to any value adjustments. The collateral is credited to an account of SIX Swiss Exchange at SIX SIS. No assignment of collateral to individual issues of collateralised products takes place. The collateralisation must be maintained over the entire term of a collateralised product. The collateral must fulfil the prescribed quality criteria at all times. During the day-to-day valuation of the collateral, a so-called haircut must also be taken into account in addition to the market value. Haircuts serve to hedge against the collaterals price risk. They are 2% for SNB-enabled collaterals, 5% with ECB-enabled collaterals, 10% with equities (only from a recognised index and sufficient liquidity) and 0% with deposit money. Depending on the stock category of the collateral, this collateral buffer can therefore result in a significant excess collateralisation of the COSI - collateralised products, an effect that is in the interests of security-oriented investors and which they should also consider in their investment decision. COSI Collateral Secured Instruments Investor Protection engineered by SIX Group. 6

7 Therein lies is the opportunity: there are numerous reference bonds which are rated by the market with higher credit spreads but are by all means investable for an investor and are therefore feasible as reference bonds. There are, for example, many industrial companies, which are regarded as very sound, but are traded with a higher yield contribution (credit spreads) in relation to the financial sector. If the investor is willing to accept such a company as a commercial collateral provider for the redemption chart, he can thereby take more attractive yield opportunities than with the same redemption chart of a traditional structured product. It is important that the investor is convinced of the reference debtor s ability to redeem. Credit spread definition? An indicator of a debtor s default probability. A credit spread is the difference between the risk-free interest rate and the market rate that a debtor must pay for taking out a loan. This value implies the market s current assessment of the debtor s creditworthiness. The poorer a debtor s creditworthiness, the higher the credit spread, which is stated in base points. A high credit spread therefore means that a debtor must pay its lenders a high risk premium. As help for the assessment of the reference debtor s creditworthiness, the credit ratings of official rating agencies, which can be applied as good indicators, are used in addition to the credit spread. Here, the following rating categories are used as an example of Standard & Poor s (source: SSPA Association): The market assessment of creditworthiness can change during the term of the product and have an impact on the price in the secondary market. The credit rating applicable for the reference bonds on issue is available at or in the corresponding term sheet; rating changes made later are published under Product history, where possible. Current credit spreads can be downloaded via finance and information systems. The additional possible yield can be seen, for instance, with a Defender Vonti product (Barrier Reverse Convertible) in a higher coupon, for example, or with a Unit (capital protection) in the form of a higher participation in the performance of the underlying. Large selection of reference bonds at Vontobel Vontobel provides investors with a defined choice of reference bonds, which consists of a universe of corporate bonds or government bonds from various sectors or countries. In doing so, Vontobel remains the issuer, market maker, ensures product quality and provides the investor the accustomed, comprehensively high service quality. Whether the reference bond suits the corresponding structured product, depends on the term of the structured product. It must comply to a major extent with the remaining term of the reference bond. However, the currency has no impact on the product. AAA Reliable and stable debtor of top quality. AA+ to AA Good debtor, slightly higher risk than AAA. A+ to A Overall economic situation must be taken into account. BBB+ to BBB Medium-quality debtor, who is currently acting satisfactorily. BB+ to BB Very dependent on overall economic situation. B+ to B Financial situation is notoriously inconsistent. CCC+ to C Speculative bonds, low income of the debtor. D In default. 7

8 What happens on maturity with a structured product with a reference bond? As a rule, the structured product with a reference bond is redeemed in the same way as traditional structured products in accordance with the redemption terms in the term sheet. As long as the reference debtor has not applied for insolvency or, for instance, does not repay the reference bond early, any change to the reference debtor s credit rating has no relevance for the redemption of the product. If Vontobel determines a corresponding default/ redemption event during the term (see default/redemption event), an early redemption ensues. As the reference bond secures the redemption chart economically, the investor may sustain a significant loss in the structured product with a reference bond regardless of the market value of the redemption chart. The possible amount of the loss in such an event depends on the residual value of the reference bond and the market value of the redemption chart. Default/redemption event As the calculation agent, it is Vontobel s task to monitor whether a default or redemption event occurs for the reference bond during the structured product s term. Default events are, for instance, deemed to be bankruptcy or declaration of insolvency of the reference bond s issuer, payment default or restructuring of the reference bond, etc. Any partial or full early redemption of the reference bond is carried out by the reference bond s issuer, for instance by exercising a redemption option or a redemption right. Redemption is calculated on the basis of the market value of the redemption chart multiplied by the percentage residual value of the reference bond For details on the redemption scenarios, please refer to the authoritative term sheets at ReferenceBonds «It is important for the investor that he gets a clear idea of the credit rating or creditworthiness of the reference bond s debtor. Depending on the choice of the reference debtor, the investor assumes a greater risk». 8

9 Opportunities and risks at a glance Benefits Additional yield opportunities with the choice of reference bonds New options for debtor diversification in the overall portfolio Broad selection of reference bonds consisting of various corporate and government bonds from various sectors or countries Vontobel guarantees the product and service quality as a top-quality issuer Risks Early redemption may arise to the detriment of the investor Depending on the choice of the reference debtor, the investor assumes a greater risk. The redemption amount can therefore be considerably lower than the issue price or, in extreme cases, can even be zero Traditional risks, such as the market or currency risk, influence the value of structured products The collateralisation of COSI eliminates the default risk of the issuer only to the extent that the revenues from the sale of the securities can cover the claims of the investors on occurrence of a sale event (less the costs for the sale and redemption). Product overview of the structured products with reference bonds from Vontobel At you can find in the navigation «Reference bonds quick access» an overview of all products with reference bonds (marked with ) and the current prices. You can also find all relevant product information there, such as function, current key figures or performance of the relevant products. The term sheet with the final terms contains the legally authoritative product terms, in particular also the information on the corresponding reference bonds. 9

10 Structured products with reference bonds: tailor-made with deritrade Investment requirements and market expectations, risk profiles and expected yields are as individual as investors. At derinet.ch investors are provided with a broad range of products already structured by fixed parameters. To fulfil the individual requirements, Bank Vontobel provides professional financial service providers and their clients with deritrade, the interactive trading platform for structured products. With deritrade investment advisers can them selves structure investment products and attend to the individual wishes of their clients and react to market events quickly. As the first provider in the market, Vontobel opened Open deritrade, its electronic trading platform, in September Ever since, deritrade has incorporated global participants in the pricing process electronically and provided deritrade users with access to the inter-banking market. As such, investors have more pricing power and the investment universe of underlyings increases significantly. On the basis of Open deritrade, Vontobel now offers a further innovation in reference bonds. With the new selection option, deritrade users now, in addition to the determination of the usual market parameters, have the globally unique option to also select a tailor-made reference debtor for the structured product from the universe defined by Vontobel. Facts and figures on deritrade About 6 years ago, deritrade, the interactive trading platform, was developed by Vontobel Financial Engineering, initially for internal use. In 2008 the platform was also opened to financial intermediaries, banks and independent asset managers, who can simulate and trade tailor-made structured products for their clients online. In the meantime this platform has become an integral part in issue trading. deritrade users have a host of options at their disposal as regards equities, precious metals, indices and various currency pairs. With 15 different product structures in the categories of capital protection, participation and yield optimisation and more than 40 currency pairs, a broad range is provided. The number of underlyings avai lable recently exceeded the threshold of 600. In addition, deritrade users can also issue all products as collateralised certificates (COSI ) for their clients. With VONCASH on foreign currencies or on the precious metal gold as a currency (XAU), interesting alternatives to a money market investment are also offered. As a private investor, you have the option of creating tailor-made investment solutions via your investment adviser. Contact your investment adviser directly or download further information from our website 10

11 Functions via deritrade 1. Selection of the product structure desired 2. Selection of the reference debtor desired 3. Setting of underlying, investment currency, term, etc. 4. Simulation and trade deritrade your benefit Participants can access deritrade via the internet and structure and complete products themselves. Thanks to the tailor-made product solutions, you can cater to your clients needs and requirements individually You are more flexible, as you yourself can determine the time of issue You can react to investment opportunities quickly You enjoy comprehensive after sales service at with up-to-date prices, term sheets, fact sheets and much more And not least, you can strengthen client loyalty, as you can easily and quickly reinvest capital that has matured. 11

12 Q&A concerning structured products with reference bonds For which investors are structured products with reference bonds suitable? They are suitable for investors who wish to consciously manage the debtor profile in their portfolio. Here, in addition to debtor diversification in a portfolio, an additional yield opportunity can also be the focus. Interview with Georg von Wattenwyl Head Financial Products, Advisory & Distribution Bank Vontobel AG What is the added value for investors with structured products with reference bonds? While investors today already have endless design options as regards the redemption chart, their options in respect of managing the debtor risk in the portfolio are only limited. We wish to address this with the new dimension of struc tured products with reference bonds. How did you come up with the idea of launching structured products with reference bonds? Bank Vontobel is continuously developing structured products. While some years ago the focus of investors was on the optimisation of yield targets, in 2008 the default event of Lehman Brothers showed painfully how the debtor risk was not only a theoretical value, but can actually really occur. In particular professional investors have increasingly started to manage the credit risk of their investments more actively in addition to the market risk. After COSI, the structured product with a reference bond is a further milestone. With COSI, the aim is to minimise the debtor risk. What is the difference to the reference bond? A reduction of risk always comes at a price. In the case of a collateralised structured product, this results in a smaller possible yield. If the investor is prepared to choose Holcim as the reference debtor, for instance, this opens up an additional yield option in the current market environment. An investor aiming to simply minimise the issuer risk will continue to opt for traditional COSI products. From what universe can reference bonds be selected? A selection opens up to the investor from a universe defined by Vontobel consisting of various corporate and government bonds from various sectors or countries, which originate not only from the finance sector, but also from the industrial sector. Whether the reference bond then suits the corresponding structured product depends in particular on the remaining term. However, the currencies of both elements do not have to match, which in turn expands the alternatives. Here, the currency of the reference bond can be freely selected without this having an impact on the redemption amount of the product. For what product types does Vontobel offer structured products with reference bonds? In a first phase, Vontobel launches structured products with reference bonds for product structures of the yield optimisation and capital protection categories. To achieve a yield which is higher than for traditional products, the product should have a longer term, because there, the possible yield is likely to be at its highest. 12

13 Your contact for structured products All key information and a product overview of all Vontobel structured products with reference bonds is available on our website Contact our advisory team for questions or advice: Your Advisory Financial Products Team Zurich Dreikönigstrasse Zurich Phone Fax advisoryderivatives@vontobel.ch 13

14 Legal notice This publication is for information purposes only and does not represent an investment recommendation or advice and contains neither an offer nor an invitation to make an offer. It does not replace the qualified advice necessary before any purchase decision, in particular as regards all associated risks. The Guidelines for Guaranteeing the Independence of Financial Analyses of the Swiss Bankers Association shall not apply. The legally applicable product documentation (listing prospectus) consists of the definitive term sheet with the final terms and the issue programme registered with SIX Swiss Exchange. This and the brochure Special Risks in Securities Trading can be obtained free of charge at or from Bank Vontobel AG, Financial Products, CH-8022 Zurich (tel. +41 (0) ). Past results must not be regarded as an indication or guarantee of future performance. Structured products are not regarded as collective capital investments within the meaning of the Federal Act on Collective Investment Schemes (KAG), and are therefore not subject to the approval or supervision of the Swiss Financial Market Authority (FINMA). The value of structured products may depend not only on the performance of the underlying asset, but also on the credit rating of the issuer. The investor is exposed to the risk of default of the issuer/guarantor. This publication and the financial products outlined therein are not intended for persons subject to a jurisdiction which limits or prohibits the sale of financial products or the dissemination of this publication and/or the information contained therein. All data is provided without warranty. COSI Collateral Secured Instruments Investor Protection engineered by SIX Group. 5 May 2011 Bank Vontobel AG. All rights reserved. 14

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