Investor s Guide BANKING - INSURANCE - LEASING. Let s talk about your future

Transcription

1 Investor s Guide BANKING - INSURANCE - LEASING Let s talk about your future

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3 The aim of this brochure is to provide a brief introduction to the main product types tradable on financial markets and available from ING Luxembourg. Special emphasis shall be given to the different risks inherent in these financial instruments. When a customer decides to invest on financial markets, he takes a risk. Be they shares, bonds, options or investment funds, any investment can carry large risks. It may not be available on all financial markets, could prove illiquid or may not suit all investors. An investment s value or return can also suffer from volatility and/or be influenced by fluctuations in exchange rates. As for the past performance of a security, the customer should be aware that this offers no guarantee of future returns. For any investment decision, it is assumed the investor has at least the necessary general knowledge of related risks. However, the present guide aims to set out the characteristics of the main product types tradable on financial markets and available through ING Luxembourg, in order to ensure that the investor properly understands and recognises the risks inherent in these financial instruments. The main product categories covered here are: - bonds; - UCI vehicles; - equities. The brochure also describes warrants, rights certificates and allotment rights. It deliberately omits structured products and derivatives such as options and forward-based contracts, since these are subject to a specific agreement with ING Luxembourg. A user guide has been developed specifically for these, in order to set out certain agreements of this type. This is also available at our branches on request. The present guide does not in any case constitute investment advice. Moreover, the guide deliberately does not cover tax and legal aspects, since these depend on the personal situation of the client and are subject to certain changes. Customers seeking information on this subject are advised to contact a tax advisor or lawyer. The present information is also available on the Bank s internet site at the address: For more precise information on a product, customers are advised to ask their relationship manager. If there is any conflict between different language versions of the same document, the French version will prevail. 3

4 Contents Description of Main Financial Products I. Bonds 6 A. General Definition 6 B. Bond Characteristics 6 1. Face Value 6 2. Issue Price 6 3. Redemption Price 6 4. Forms of Redemption 6 5. Nominal Interest Rate 7 6. Yield 7 7. Rating 7 C. Main Bond Types 7 1. Zero-coupon Bond 7 2. Fixed-rate Bond 7 3. Floating-rate Bond 7 4. Warrant Bond 7 5. Indexed Bond 7 6. Step-up Bond 7 7. Step-down Bond 7 8. Subordinated Bond 7 9. Convertible Bond Equity Note Reverse Convertible Bond 8 D. Risks Relating to Bonds 8 1. Issuer Insolvency Risk 8 2. Interest-rate Risk 8 3. Inflation Risk 8 4. Exchange-rate Risk 9 5. Prepayment Risk 9 6. Specific Risks of Certain Bonds 9 II. Shares 9 A. General Definition 9 B. Share Types 9 1. Bearer and Registered Shares 9 2. Ordinary and Preferred Shares 9 C. Share Risks 9 1. Price Risk 9 2. Financial Risk 9 3. Market Liquidity Risk 9 4. Exchange-rate Risk Share Liquidity Risk Bankruptcy Risk Psychological Risk Risk of Shares Relative to Bonds 10 4

5 III. Undertakings for Collective Investment 10 A. General Definition 10 B. Legal Forms of UCI Contractual-type Fund (FCP) Open or Closed-end Investment Company (Sicav or Sicaf) 11 C. Distinction between EU UCI and Others 11 D. Sicav Types Money-market Sicav Bond Sicav Share Sicav Mixed Sicav Capital Guaranteed Sicav Funds of Funds Alternative or Hedge Funds 12 E. UCI Risks Investment Risk Management Risk Risk of Decline in Net Asset Value Liquidity Risk Risks Relating to Country of Domicile 13 IV. Other Products 13 A. Warrants Call / Put Premiums Underlying Asset Exercise Price Ratio Expiry Warrant Investment Summary 14 B. Rights Certificate (French Warrant) 14 C. Rights 14 D. Allotment Right 14 E. Depositary Receipt 15 F. Structured Products 15 G. Private Equity 15 V. Reminder of Main Product Risk Types 15 A. General 15 B. Liquidity 16 C. Credit Risk 16 D. Market Risk General Foreign Markets Emerging Markets 16 E. Clearing House Protections 16 F. Insolvency 16 G. Foreign-exchange Risk 17 H. Interest-rate Risk 17 I. Regulatory/Legal Risk 17 J. Operating Risk 17 5

6 I. Bonds A. General Definition A bond is a transferable security issued by a company or public authority (hereinafter the «issuer») representing an amount receivable by the lender (hereinafter the «bondholder») from the issuer. It is issued carrying a fixed or variable coupon and usually with a fixed term (apart from perpetual bonds) and redemption of the principle on maturity. Coupons are payable on a fixed date based on a predefined frequency. A bond issue can be private (reserved for a restricted number of institutional investors) or public (when the subscription offer is made to the general public). B. Bond Characteristics 1. Face Value The face value is the amount of the bond issue divided by the number of bonds issued. The coupons are calculated based on this value. Thus, a bond with a EUR 5,000 face value and 5% coupon shall generate a EUR 250 coupon for the holder (5,000 x 5%). 2. Issue Price This is the price at which the bond is issued. It can differ from the face value or redemption price of the bond. When the issue price is at a premium against the face value of the bond, the difference is called the «issue premium». This is paid by the bondholder on issuance, in addition to the face value of the bond subscribed. 3. Redemption Price The redemption price is the value of the bond at the end of its term. It can be less than, equal to or more than the issue price. When the redemption price exceeds that of issuance, the difference is called the «redemption premium», which is repaid to the bondholder on redemption of the bond in addition to the amount paid when subscribing. 4. Forms of Redemption A bond is generally redeemed on maturity but possibly earlier through annual redemptions or by drawing of lots. Certain bonds present specific forms of redemption, at the discretion of the bond s issuer or holder and under certain conditions. As examples, here are two methods used by issuers to redeem bonds: - redemption by equal instalments: in each period, the bondholder receives an identical portion of the principal, that is, the amount initially subscribed. Assuming a term of five years, 20% of the principal would be repaid each year. In practice, the amount of coupon payments shall decrease each year as the table below shows. Period Principal Coupons Repayment Principal Annuities at beginning of period (7%) by equal instalments at end of period redemption on maturity: this form of redemption guarantees the bondholder steady interest payments throughout the term of the bond. In fact, the principal is repaid on maturity, that is, in full on the last due date. Meanwhile, the interest is paid throughout the term of the bond. Period Principal Coupons Repayment Principal Annuities at beginning of period (7%) by equal instalments at end of period

7 5. Nominal Interest Rate The interest rate for the bond, which is applied to its face value to enable coupon payments to be calculated. A 7% interest rate and EUR 1,000 face value should generate coupons equalling 7% x EUR 1,000 = EUR Yield The yield to maturity of the bond expresses its average annual return. 7. Rating A rating is an assessment made by a specialised agency, independent of ING Luxembourg (such as Standard & Poor s or Moody s), on the probability of an issuer fully meeting a bond issue s principal repayment and interest payments on the forecast due dates. The rating is an assessment by this agency of the issuer s solvency in relation to a particular issue. ING Luxembourg is not responsible for this assessment. The long-term ratings are classified from AAA (at S&P) or Aaa (Moody s) for the best-quality bonds to D for those for which the issuer is in default on payments. The different categories generally indicate the following: A: good quality; B: speculative, payment sensitive to the economic context; C: risk of payment default; and D: payment default. C. Main Bond Types 1. Zero-coupon Bond This is a bond with no interest payments and a coupon rate thus equalling 0%. It is generally issued at a very low price but therefore offers a large redemption premium. For example, it is issued at 63% of value and redeemed at 100%. 2. Fixed-rate Bond A bond with an annual interest rate fixed on issuance and constant to maturity, being paid with a predefined frequency. 3. Floating-rate Bond A bond with an interest rate varying over its term in accordance with money or bond market rates. 4. Warrant Bond An ordinary bond giving the right to subscribe to a given number of shares or bonds at a fixed price (strike price) for a certain period (the exercise period). The warrant bond includes two clear components: firstly the bond and secondly the warrant, that is, a subscription right. 5. Indexed Bond A bond giving the right to redemption of the face value on maturity and a potential return calculated based on an underlying asset s percentage stock market performance during the bond s term. The return on the bond is capped at a rate calculated as a proportion of face value. 6. Step-up Bond A bond of which the interest rate increases over its term. The rates and their applicable periods are determined on issuance. 7. Step-down Bond A bond of which the interest rate decreases over its term. The rates and their applicable periods are determined on issuance. 8. Subordinated Bond In the event of liquidation or bankruptcy of the issuing company, a subordinated bond is repaid after the other bonds and liabilities of the company but before its shares. It is thus a type of lower-priority bond with larger risk. It is possible that such bonds are subordinated only to certain well-defined liabilities like bank loans. 9. Convertible Bond A bond that can be converted into shares by its holder in conditions and on the conversion basis determined on issuance, either in certain predefined periods or at any time in the bond issue. Its return, however, is less than that of a traditional bond. The interest-rate difference arises from the conversion right the bond carries, enabling the investor to: 7

8 - either convert the bond into a share determined on bond issuance. He or she would then benefit from increases in the underlying asset s price, while enjoying a guarantee against a decline in this by being able to request redemption in cash or - wait till maturity and redeem the bond in cash if the underlying underperforms. The loss to the bondholder would then equal the difference between the coupons paid on a traditional bond higher than on a convertible bond and the coupons he or she has received. 10. Equity Note Bonds that must be redeemed in shares on maturity. The interest rate on this type of bond is generally less than on a standard bond, even if the issuing company s growth prospects are bright when issued. The risk for this type of security is that redemption could take place at a time when the share price has fallen sharply. The basic amount invested could thus be sharply reduced. 11. Reverse Convertible Bond The redemption on maturity of a reverse convertible bond is determined by the issuer, in accordance with conditions established at the time of the bond s issuance. On maturity, the bondholder receives: - either 100% of the bond s face value (redemption at par) or - a number of shares established on the issue date, based on the face value of the bond and the reference price of the underlying share. In both cases, the holder receives a guaranteed coupon. If the share price is less than the reference level on maturity, the bondholder risks being repaid in shares worth less than the bond s face value. He or she is thus exposed to the possibility of losing all or part of the principal invested. The product does not therefore offer a capital guarantee. This is why it pays a larger coupon than the return on a traditional bond. D. Risks Relating to Bonds 1. Issuer Insolvency Risk The issuer could become temporarily or permanently insolvent. This could result in the risk of default for one or more coupons or even the bankruptcy of the issuer, in which case the bond loan may not be redeemed either in full or in part. The bondholder is indeed regarded as a simple ordinary creditor and has no payment priority or privilege. The issuer s solvency may in particular depend on its management quality, general developments in its economy or economic sector and political changes that have economic effects. Logically, a deterioration in the financial situation of an issuer influences the trading price of the bond. Certain bonds enjoy guarantees (for example, given by the state); default risk in this case is decreased in accordance with the quality of the guarantee provided. Ratings represent information that can give a good idea of the issuer s ability to meet its commitments. 2. Interest-rate Risk The bond s price is mathematically linked to the interest rate. Uncertainty over market interest-rate developments exposes the bondholder to the risk of a falling bond price if interest rates increase. Meanwhile, this is only the case during the term of the bond and not on maturity. Furthermore, in the event of an interest-rate decrease, the expected return on maturity may not be achieved, due to reinvestment of coupons at smaller rates. 3. Inflation Risk A deterioration in the value of money, known as inflation, reduces the purchasing power of the total coupons received. The result is that the value of the purchasing power paid out on maturity no longer corresponds to that on issuance. This risk is all the greater when maturity is far away and the intervening payments (coupons) are small. 4. Exchange-rate Risk Currency fluctuations affect the value of foreign investments when the return on these is converted into local currency. The risk can be reduced by diversifying between local and foreign-currency bonds. 8

9 5. Prepayment Risk A bond s issuer can include a clause allowing it to repay the bondholder early in the event of a decrease in market rates. In this case, the expected return to maturity may not be achieved. 6. Specific Risks of Certain Bonds Another type of risk relates to certain bonds of which the return or redemption methods are linked to another instrument. This is particularly the case for floating-rate bonds, convertibles, callable bonds, indexed and subordinated bonds and so on. II. Shares A. General Definition A share is a security representing part of the capital in a company. It also represents a set of shareholder rights, such as to the ability to vote in general meetings, to information, to dividends and in the event of liquidation to net assets. On issuance, a share sometimes has a given face value. This face value relates to the portion of share capital that the share represents. B. Share Types 1. Bearer and Registered Shares The share is said to be «bearer» when its owner is not recorded in the company s register, unlike for a registered share. 2. Ordinary and Preferred Shares A share is described as «preferred» if its holder is granted any benefit in addition to those enjoyed by ordinary shareholders. This is often the right to receive a fixed sum in the event of liquidation and a fixed dividend before the ordinary shareholders. The benefits granted for preferred shares are included in the articles of association of the company. C. Share Risks 1. Price Risk Since the price of a share factors in different aspects influencing the supply and demand for it, changes in this price are the main risk the investor faces. Yet since upside movements are generally welcome, the risk is more of downward asset price movements, which are liable to result in short-term losses. The risk factors affecting the share price can be of a general market nature or more specific aspects concerning the company itself. Examples of aspects affecting general market prices are political, social and economic changes that investors can both factor in and amplify plus economic cycles, of which the impacts can vary from one economic sector or region to another. Instances of features affecting the price of a specific share are a failure to achieve expected results, an incapacity to pay dividends or an inability to withstand competition. 2. Financial Risk It may happen that the issuing company does not distribute any profits, even if it has made them, or does not report profits for one or more years. It could also end one or more years with losses, see its financial situation go downhill and ultimately be declared bankrupt. 3. Market Liquidity Risk A lack of liquidity could arise when the supply or demand for a security is very limited or nonexistent at a certain price. In these circumstances, sale and purchase order execution may not be immediate or possible only partially or on unfavourable terms. Moreover, there could be large transaction costs. Liquidity risk is larger for shares of small companies or emerging markets, due to small trading volumes on such markets. 4. Exchange-rate Risk Currency fluctuations affect the value of foreign investments or returns on these when converted into local currency. The risk can be reduced by diversifying between local and foreign-currency shares. 9

10 5. Share Liquidity Risk Liquidity risk may be linked to a security s characteristics, for example, slowness in a transaction procedure for registered shares, or practices on certain markets. 6. Bankruptcy Risk In the event of bankruptcy or liquidation shareholders are repaid after payment of all creditors, with a larger risk of losing all the initial investment. 7. Psychological Risk Irrational factors such as rumours, opinions and trends can affect the overall performance of shares on stock markets. These may directly influence the stock market price even when the company s outlook is not negative. 8. Risk of Shares Relative to Bonds Shares carry larger risk than bonds, as can be seen from share price volatility against that of bonds. However, the long-term performance of share prices and dividends has on most occasions been more favourable than that of bonds. The larger equity risk is thus remunerated by better overall performance or return. III. Undertakings for Collective Investment A. General Definition An undertaking for collective investment (UCI) is an entity collecting funds from the public for investment in assets (shares, bonds and others), complying with the principle of risk diversification. It manages these assets in the sole interest of its investors, based on the UCI investment policy established on its creation, and the legal framework determined by its country of domicile. UCI vehicles apply the principle of diversification, which consists of not putting all one s eggs in the same basket, and so enabling an investment to be distributed over several types of financial asset. The Net Asset Value (NAV) is the amount obtained from dividing the UCI s overall asset value by the number of units or shares it has in circulation on the same date. Apart from closed UCI vehicles that is, with a fixed number of shares or units and for which the acquisition or redemption price of shares and units is not necessarily linked to the NAV but instead determined by supply and demand the issue or redemption price of a UCI share or unit equals the NAV. The frequency of the NAV calculation varies from one UCI to another; for an open-end investment company (Société d Investissement à Capital Variable, or Sicav) or closed-end investment company (Société d Investissement à Capital Fixe, or Sicaf) this is set out in the prospectus and for a contractual-type investment fund (Fonds Commun de Placement, or «FCP») in the management rules. It should be noted that the expenses and fees paid by the UCI can be passed on via the NAV and so indirectly attributed to the investor. B. Legal Forms of UCI The UCI can have two legal forms: - the contractual form: the mutual investment fund (FCP); - the company form: the open-end investment company (Sicav) or closed-end investment company (Sicaf). This distinction is valid for Luxembourg UCI vehicles. The legal form of a UCI from another country can be found by consulting its prospectus. 1. Contractual-type fund The FCP consists of a set of assets invested and held in indivision by the investors: unit holders in the co-ownership of this entirety in the amount of their investment. The FCP does not have a legal personality and so is run by a management company in the sole interest of the unit holders. This is in accordance with the management rules drawn up by the management company, which in particular include the investment policy, distribution policy and methods of issuing and redeeming the FCP units. When subscribing to FCP units, the investor is considered to have accepted the management rules in their current and future form. In principle, the unit holder has no ability to amend these, with only the management company being authorised to do so. 10

11 The unit holders thus have no influence over the management of the FCP s assets. Furthermore, unless envisaged otherwise in the management rules, they cannot terminate the appointment of the management company nor cause the co-ownership constituted by the FCP to be divided. 2. Open or Closed-end Investment Company (Sicav or Sicaf) Unlike other UCI types, investment companies have a legal personality. These companies are in principle managed by a board of directors, appointed by the investors in their capacity as shareholders. The board of directors defines the company s management policy but can delegate management to managers approved by Luxembourg s Financial Sector Supervisory Commission (Commission de Surveillance du Secteur Financier). Investors have voting rights and can participate in the general shareholders meetings. Among the investment companies, one can highlight: - The Sicav, of which the capital can vary in accordance with subscriptions and redemptions of shares as well as the valuations of its assets. For this type of company, no specific formality is required in case of increasing or decreasing capital. The capital of the Sicav is at all times equal to the net assets of the company, that is, its assets minus its liabilities. - The Sicaf, meanwhile, has capital that equals the amount of contributions by its investors and that in principle varies only by virtue of a decision by the general meeting. The entry of new shareholders therefore requires a resolution by the general shareholders meeting and compliance with certain formalities. C. Distinction between EU UCI and Others Part one of the Luxembourg UCI act (the Act) implements European guidelines defining the framework of an open UCI investing in securities that benefits from the European passport and so can be marketed freely throughout the EU. Such a UCI can only invest in securities and other instruments authorised by the guidelines. These are called coordinated UCITS. A UCI covered by part two of the Act does not benefit from a European passport and so can only be marketed in other EU countries after meeting specific conditions established by the authorities of the country concerned. However, they can invest in securities other than those authorised for the coordinated UCITS. D. Sicav Types The Act allows a UCI to split its net assets into various portfolios called sub-funds that can in particular follow different investment policies or be denominated in various currencies. For example, therefore, the sub-funds can invest in different geographical regions or business sectors. As from subscribing to the UCI, each investor choose the sub-fund in which he or she would like to buy shares; they only participate in the profits or losses of this sub-fund and not those of the UCI as a whole. The advantage for the investor is that switches between sub-funds are generally cheaper since the costs of redeeming shares in one UCI and subscribing to those in another are avoided. The UCI can also issue different types of security, depending on the expected appropriation of returns. Depending on its legal form, we can talk of: - distribution shares or units when the UCI regularly pays the holder a dividend; - capitalisation shares or units when these revenues are fully reinvested by the UCI and the holder only receives the return on investment when selling the unit or share. The net asset values reflect this difference. A typology is presented below for information purposes. It is a classification by type of investment corresponding to the product types distributed by ING Luxembourg but not necessarily the UCI vehicle types marketed by third parties. Such a classification does not suffice to provide precise information on the investment policy of these funds. The prospectuses and financial reports can provide more complete information on a UCI s investment policy. 1. Money-market Sicav A money-market Sicav invests mostly in cash and assets with a very short term to maturity, such as term deposits, treasury bills, bonds with a near-term maturity, certificates of deposit and commercial paper. 11

12 This type of Sicav exists in many currencies. It represents an ideal investment when an investor would like to allocate money for the very short term while waiting to use it for something else. The return offered by a money-market Sicav is closely related to short-term interest rates. 2. Bond Sicav A bond Sicav invests mainly in fixed-income securities such as government and corporate bonds. It can invest in one or more currencies. The rate offered can be fixed or variable. 3. Share Sicav A share Sicav invests mostly in equities. A share Sicav can specialise, for example, by geographical region or sector. 4. Mixed Sicav A mixed Sicav is one that invests in both shares and bonds. This type of Sicav actively manages the allocation between both different investment categories and markets, individual shares and bonds, in order to benefit from changing conditions in the investment world. 5. Capital Guaranteed Sicav This Sicav offers its subscribers a commitment of a minimum return linked to the performance of an underlying asset, or a guarantee to repay a minimum amount of capital on a given due date. A Sicav allowing full participation over six years in gains by the CAC 40, a benchmark made up of 40 securities from the monthly settlement market belonging to all economic sectors and among the top 100 market capitalisations. During this period, the index advances by 150%. On maturity, the investor receives 150% more than the initial investment. If the CAC 40 does not advance, or even declines, the investor shall still recover the initial capital. It should be noted that this protection is usually conditional and is obtained by buying a type of insurance, also known as a hedge, for example on the options market. 6. Funds of Funds This is a fund investing in other funds. 7. Alternative or Hedge Funds A hedge fund is an investment fund characterised by much more active management than a standard fund investing in shares or bonds. Hedge funds aim to generate what is known as absolute return, that is, independent of developments on standard financial markets. For this reason, they use management methods that differ from those used in managing traditional funds. They buy and sell numerous asset types, invest in long and short positions and use leverage or derivatives to benefit from both rising and declining markets. They thus enjoy more flexible management rules than traditional funds. Meanwhile, subscription and redemption conditions are generally more restrictive than for traditional funds. E. UCI Risks 1. Investment Risk Firstly, a UCI is exposed to all the risks incurred by shares, bonds and other transferable securities used in its portfolio management. Then the risk depends on the nature of the investments it makes (kinds of securities, issuer types, economic sector, geographical area, currency, etc.). The investor has no control over the UCI investment decisions and sometimes the investment policies give the manager the ability to use derivatives or leverage effects in managing the portfolio, in parallel to the main investment in for example equities or bonds. Furthermore, the currency used for subscriptions and redemptions of shares or units is not necessarily representative of the UCI investment positions. 2. Management Risk Among other factors, the revenue generated by the UCI parts or shares depends on the capabilities and decisions of the managers. Accordingly, bad management decisions can give rise to losses. 12

13 3. Risk of Decline in Net Asset Value (NAV) A decline in the NAV or in the currencies making up the fund portfolio shall be reflected in the prices of the UCI shares or units. 4. Liquidity Risk It is not always possible to obtain redemption of shares on a daily basis. Certain UCI vehicles only allow for redemption once weekly or monthly. Moreover, there are UCI vehicles that are completely closed until maturity or have postponement clauses if redemption orders exceed a certain threshold. In practice, this results in very little order liquidity. Open funds, however, generally present little liquidity risk. 5. Risks Relating to Country of Domicile The funds domiciled in Luxembourg benefit from a legal framework with appropriate prudential supervision, unlike certain funds domiciled in other countries. Furthermore, the money-laundering and investor protection legislation is stricter in certain countries in particular Luxembourg than in others. IV. Other Products A. Warrants Warrants are more modest equivalents of options and one of the easiest derivative products to access. Understanding them can then allow the investor to access option markets more confidently. The investor must be aware that with warrants, he or she can suffer losses of up to the amount of capital initially invested. Developments in the warrant s value do not depend solely on the performance of that of the underlying asset. It is therefore important to take note of the different factors influencing the value of the warrant, as described in the prospectus. Unlike shares or bonds, which respectively represent a portion of capital or debts, warrants are only an entitlement to buy a security and so are valued based on the right they grant the holder. Depending on the case, a warrant allows a given quantity of securities (called the underlying) to be bought (call warrant) or sold (put warrant) at a predetermined price (exercise or strike price) during a given period. The holder of a call warrant is free to exercise the subscription right or not. The right can be sold on the market before the expiry date. Example Name Call X Strike price: EUR Ratio: 100 / 1 Amount: 1,000 Price on 14 April: EUR Call / Put On the stock market an investor can either buy or sell shares. In practice, with shares, the investor s exposure is the full amount of the investment. In contrast, with call warrants which offer a right but not an obligation the initial investment is limited accordingly. In our example, this is a call (or purchase option). The investor shall thus be able to buy X shares at the rate of EUR In the opposite case, we talk of a put warrant (or sale option). 2. Premiums The premium corresponds to the initial amount payable to buy the put or call warrants. To calculate this, in addition to the purchase price, we need to know the trading quantity. Indeed, given quantities must be used in warrant market transactions. In our example, the quantity is 1,000 warrants with a latest price of EUR 0.14 on 14 April. The minimum premium therefore corresponds to: - Quantity x purchase price = total premium - 1,000 x 0.14 = EUR 140, for 1,000 call warrants 3. Underlying Asset The underlying is the asset to which the warrant relates, on which the subscription right shall be exercised. Here the underlying is X. 13

14 4.. Exercise Price The exercise or strike price is the value at which the right attached to the warrant can be exercised, that is, at which the underlying may be bought or sold. In our case, the exercise price equals EUR The holder of the call warrants can thus buy shares in X at EUR If the exercise price is less than the X share s latest price (EUR 100), the call warrant can be called «in the money». For a call warrant: «in the money» indicates that underlying s price exceeds the exercise price of the warrant; «out of the money» indicates the underlying s price is less than the warrant s strike price; and if it is in the money, the price of the warrant s exercise and the underlying are equal. 5. Ratio A 100/1 ratio means 100 warrants provide entitlement to one underlying security. 6. Expiry If purchasing shares, these can in principle be held indefinitely, unless the company goes bankrupt or is bought. With a warrant, an expiry date is fixed from the outset. After the expiry date the right attached to the warrant is no longer valid: the warrant is then worthless. 7. Warrant Investment Summary In EUR Explanations Purchase of call warrants ,000 x 0.14 Purchase of stock X at (1,000 / 100) (1) x Total 1, equals EUR / security X (1) The question is in knowing how many shares in X 1,000 share warrants can buy. The answer lies in the ratio. The ratio is 100 warrants for one share. Therefore, 1,000 / 100 = 10 X shares can be bought at EUR B. Rights Certificate (French Warrant) A rights certificate is an instrument giving the holder the right to subscribe to a share or bond at a predefined price and up to a certain date. It may happen that the certificate is not exercised but resold before maturity. The rights certificate can be attached to a share or bond, or instead be independent. The issue of rights certificates is linked to the issuance of new shares. Unlike rights, which have a very short term, rights certificates are generally valid for more than a year. It is a financial instrument with a strong leverage effect. Indeed, its price is usually less than that of the underlying and generally fluctuates in accordance with this. Thus, any increase of the underlying s price results in a larger increase in that of the rights certificate. Conversely, any reduction in the underlying s price incurs all the greater a loss. These are often used in capital increases and in this case concern shares with rights certificates. C. Rights A right is a share strip giving an ordinary shareholder the right to subscribe to new shares for a given period at a predetermined price. It is a financial instrument with a strong leverage effect. Indeed, its price is usually less than that of the share envisaged and generally fluctuates in accordance with this. Thus, any increase in the share price results in a larger gain in the right s price. Conversely, any decrease in the share price results in all the greater a loss. Until expiry, the right s holder may exercise his or her option at any time particularly if the share price has exceeded the right s exercise price or sell it on the rights market if one exists. D. Allotment Right The allotment right is a tradable right stripped from a share and giving the holder to receive new shares free of charge. This right is stripped on the day the operation begins and can be traded on the market as if it were a separate security. 14

15 In the aim of strengthening shareholder loyalty, some companies make free share grants. It should be noted that these shares do not in any way improve the net worth of the shareholder. Indeed, let us assume the capital of a company consists of 50,000 shares with a EUR 10 face value and that the firm also has EUR 500,000 in reserves. It is entirely foreseeable that these reserves could be included in the capital. The new capital would thus be 100,000 shares. Every shareholder shall then receive one new share for each old one. Basically, the shareholder is no better off but has twice as many shares at half the price, since the market price shall be adjusted accordingly. At the time of such operations, each existing shareholder fulfilling its conditions shall receive an allotment right allowing him or her to benefit from the entitlement to the future shares. This allotment right is freely transferable, particularly for shareholders not wishing to receive additional shares. Before operation After operation Number of shares 50, ,000 Face value EUR 10 EUR 10 Share capital EUR 500,000 EUR 1,000,000 Reserves EUR 500,000 EUR 0 Total equity EUR 1,000,000 EUR 1,000,000 (+0%) E. Depositary Receipt The share depositary receipt is issued by financial firms on the request of the share issuer and is intended, for example, for circulation abroad. A receipt represents a certain number of shares. It is a bearer instrument. It can happen that the receipt is tradable in the country where the share it represents is issued. F. Structured Products Structured products are investment assets combining money market or bond market investments with operations on derivatives. These themselves are more specifically options or swaps of which the value depends on an underlying in order to guarantee either a coupon or principal based on well-defined characteristics. Different types of underlying are possible such as shares, equity benchmarks, exchange rates, interest rates, raw materials, inflation and UCI vehicles. The risks of structured product relate to the underlying and to whether the principal is guaranteed on maturity or not. Meanwhile, if the investor wants to redeem the product before maturity, the capital guarantee does not apply and the underlying s performance shall affect the redemption price. G. Private Equity Private equity is a broad term referring to any type of investment in equity not listed on a public market. Private equity companies are not quoted on a stock exchange but can hold listed companies in their portfolios. Since they are not quoted, these companies must find a buyer without a traditional market quotation. The liquidity of such products is therefore limited and the risk of capital losses generally greater than for a direct investment in listed company shares. Private equity funds combine capital invested by private equity companies. A private equity fund works as follows: the funds regularly obtain «capital commitments» to invest a given amount from well-informed or «qualified investors» such as pension funds, financial institutions and wealthy individuals. Whenever an investment opportunity appears in a predetermined period (for example seven years) in the life of the funds, these investors are invited to pay in the capital required in proportion to their commitment. A commitment is understood to be the total amount of investment each investor has irrevocably decided to make. A commitment shall be used as from when it is called. The commitment period differs from one sub-fund to another. V. Reminder of Main Product Risk Types A. General The price or value of an investment shall depend on fluctuations in the financial markets outside anyone s control. Past performance is no indicator of future performance. 15

16 The nature and extent of investment risks varies between countries and from investment to investment. These investment risks shall vary with, inter alia, the type of investment being made, including how the financial products have been created or their terms drafted, the needs and objectives of particular investors, the manner in which a particular investment is made or offered, sold or traded, the location or domicile of the issuer, the diversification or concentration in a portfolio (e.g. the amount invested in any one currency, security, country or issuer), the complexity of the transaction and the use of leverage. The risk types set out below could have an impact on each type of investment. B. Liquidity The liquidity of an instrument is directly affected by the supply and demand for it. Under certain trading conditions it may be difficult or impossible to liquidate a position. This may occur, for example, at times of rapid price movement if the price increases or declines to such an extent that under the rules of the relevant exchange trading is suspended or restricted. Placing a stop-loss order shall not necessarily limit your losses to intended amounts, while market conditions may make it impossible to execute such an order at the stipulated price. In addition, with the off-exchange products, unless the contract terms so provide, the counterparty does not have to terminate the contract early or buy back the product. C. Credit Risk Credit risk is the risk of loss caused by borrowers, bond obligors, or counterparties failing to fulfil their obligations or the risk of such parties credit quality deteriorating. D. Market Risk 1.. General The price of investments goes up and down depending on market supply and demand, investor perception and the prices of any underlying or allied investments or, indeed, sectoral and economic factors. These can be totally unpredictable. 2. Foreign Markets Any foreign investment or investment with a foreign element can be subject to the risks of foreign markets which may involve different risks from the local markets. In some cases the risks shall be greater. The potential for profit or loss from transactions on foreign markets or in foreign denominated contracts shall be affected by fluctuations in foreign exchange rates. 3. Emerging Markets Price volatility in emerging markets, in particular, can be extreme. Price discrepancies can be common and market dislocation is not uncommon. Additionally, as news about a country becomes available, the financial markets may react with dramatic upswings and/or downswings in prices during a very short period of time. Emerging markets generally lack the level of transparency, liquidity, efficiency and regulation found in more developed markets. For example, these markets might not have regulations governing manipulation and insider trading or other provisions designed to level the playing field with respect to the availability of information and the use or misuse thereof in such markets. They may also be affected by political risk. It may be difficult to employ certain risk management practices for emerging markets investments, such as forward currency exchange contracts or derivatives. E. Clearing House Protections On many exchanges, the performance of a transaction is guaranteed by the exchange or clearing house. However, this guarantee is usually in favour of the exchange or clearing house member and cannot be enforced by this client who may, therefore, be subject to the credit and insolvency risks of the firm through whom the transaction was executed. There is, in any event, no clearing house for traditional options, nor normally for off-exchange instruments which are not traded under the rules of an exchange. F. Insolvency The insolvency or default of the firm with which you are dealing, or of any brokers involved with your transaction, may lead to positions being liquidated or closed out without your consent or, indeed, investments not being reimbursed to you. There is also insolvency risk in relation to the investment itself, for example of the company that issued the bond or of the counterparty to the off-exchange derivatives (where the risk relates to the derivative itself and to any collateral or margin held by the counterparty). 16

17 G. Foreign-exchange Risk In respect of any foreign exchange operations and transactions in derivatives and securities denominated in a currency other than that of your account, a movement in exchange rates may have a favourable or an unfavourable effect on the gain or loss obtained on such transactions. The weakening of a country s currency relative to a benchmark currency or the currency of your portfolio shall negatively affect the value of an investment denominated in that currency. Currency valuations are linked to a host of economic, social and political factors and can fluctuate greatly, even during intra-day trading. Some countries have foreign exchange controls that may include the suspension of the ability to exchange or transfer currency, or the devaluation of the currency. Hedging can increase or decrease the exposure to any one currency, but may not completely eliminate exposure to changing currency values. H. Interest-rate Risk Interest rates can rise as well as fall. A risk exists with interest rates that the relative value of a security, especially a bond, shall worsen due to an interest rate increase. This could impact negatively on other products. I. Regulatory/Legal Risk All investments could be exposed to regulatory or legal risk. Returns on all, and particularly new, investments are at risk from regulatory or legal actions and changes which can, amongst other issues, alter the profit potential of an investment. Legal changes could even have the effect that a previously acceptable investment becomes illegal. Changes to related issues such as tax may also occur and could have a large impact on profitability. Such risk is unpredictable and can depend on numerous political, economic and other factors. For this reason, this risk is greater in emerging markets but does apply everywhere. In emerging markets, there is generally less government supervision and regulation of business and industry practices, stock exchanges and over-the-counter markets. The laws and regulations governing investments in securities may not exist in some places, and where they do, may be subject to inconsistent or arbitrary application or interpretation and may be changed with retroactive effect. Both the independence of judicial systems and their immunity from economic, political or nationalistic influences remain largely untested in many countries. Judges and courts in many countries are generally inexperienced in the areas of business and corporate law. Companies are exposed to the risk that legislatures shall revise established law solely in response to economic or political pressure or popular discontent. There is no guarantee that a foreign investor would obtain a satisfactory remedy in local courts in the case of a breach of local laws or regulations or a dispute over ownership of assets. An investor may also encounter difficulties in pursuing legal remedies or in obtaining and enforcing judgments in foreign courts. J. Operating Risk Operational risk, such as of the breakdown or malfunctioning of essential systems and controls, including IT systems, can impact on all financial products, but could have particular effects for holders of shares, which equate to a part of the ownership of the company. Business risk, especially the risk that the business is run incompetently or poorly, could also impact on this. Personnel and organisational changes can severely influence such risks and, in general, operational risk may not be apparent from outside the organisation. 17

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20 CL 07065/03