Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments

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1 Rigensis Bank AS Information on the Characteristics of Financial Instruments and the Risks Connected with Financial Instruments Contents 1. Risks connected with the type of financial instrument... 2 Credit risk of the financial instrument issuer... 2 Risk of Market Prices... 2 Liquidity risk... 2 Currency Risk... 2 Interest Rate Risk Risks connected with trading in financial instruments... 3 Operational risk... 3 Counterpart credit risk... 3 Other risks Types of financial instruments... 3 Shares... 3 Bonds... 4 Shares of investment funds... 4 Security selling with repurchase (REPO transactions)... 5 Currency exchange (SPOT, TOM, TOD transactions)... 5 Currency transactions with a future term of settlement (FORWARD transactions)... 5 Currency SWAP transactions... 6 Riga,

2 Investments in financial instruments are always connected with assuming a risk. The funds invested in financial instruments may increase or decrease, and there is no guarantee that the customer will not lose the entire amount or part of his/her invested capital. In the process of trading in financial instruments, the investments of customers are exposed to different types of risks. There are such risks that are typical of specific kinds of financial instruments and different financial instruments are subject to different degrees of these risks. There are risks that exist in the process of trading in financial instruments irrespective of the characteristics of the financial instruments. A description of the main risk groups that may arise during transactions with the financial instruments with which Rigensis Bank AS operates along with a description of these financial instruments follows. 1. Risks connected with the type of financial instrument Credit risk of the financial instrument issuer There is a risk of suffering losses in these cases: The financial instrument issuer is unable or unwilling to settle liabilities against the holder of the financial instrument, The solvency assessment (credit rating) of the financial instrument issuer decreases, which affects the fall of the price of the financial instrument. Risk of Market Prices This is a risk that involves the possibility of suffering losses in the event of changing financial instrument prices, the result of which the value of the investment decreases. This may arise: Due to the changed attitudes of market participants (in a situation of market instability, the members of the market may ask for a larger premium for risks), Due to changes in the market situation (when global factors change, for example, interest rate base, sovereign debt yield, etc.), Due to changes in the assessment of financial instrument yield (for instance, poor financial performance of the financial instrument issuer, reduced payments in dividends for shares, etc.). Liquidity risk This is a risk that involves the possibility of suffering losses in the event where the intended amount of financial instruments cannot be sold unless substantial additional costs are incurred with an impact on market prices. Liquidity risk pertains to financial instruments that are issued in small amounts, large positions of financial instruments, and high-risk financial instruments in periods of market crises. Currency Risk This is a risk that involves the possibility of suffering losses in the event when the financial instrument has been issued in a foreign currency (i.e., a currency other than the portfolio base currency) and there is an adverse trend in the change of the foreign currency rate. 2

3 Interest Rate Risk This is a risk that involves the possibility of suffering losses due to adverse changes in interest rates. Pertaining to debt securities, this is one of the market risks. The interest rate risk also arises in the event of borrowing funds for the purchase of financial instruments at a variable interest rate. 2. Risks connected with trading in financial instruments All the transactions with financial instruments are exposed, to a greater or lesser extent, to the risks of this risk group. Operational risk This is a risk that involves the possibility of suffering losses due to the consequences of inadequate or failing processes, human or system errors, or the impact of external circumstances including force majeure. Counterpart credit risk This is a risk that involves the possibility of suffering losses arising in the event that the counterpart who has concluded an agreement with the customer is unable or unwilling to settle its liabilities with the investor. Other risks This is a risk that involves the possibility of suffering losses due to other reasons: legal risk, state regulation risk, tax risk, specific sector risk and other. Shares 3. Types of financial instruments Shares are securities without a defined term of maturity issued by a joint-stock company. A share certifies its owner s part in the share capital of the joint-stock company. Shares provide its holder with these rights: Receive dividends as part of the profit, Sell shares on the financial instrument market, Participate in the management of the joint-stock company (except for shares without the right to vote), Obtain part of the joint-stock company holdings in the event of its liquidation. The degree of risk sensitivity Issuer s credit risk High sensitivity issuer s insolvency may lead to the loss of issuer s capital value and this usually leads to a sharp decline of the share price. Risk of Market Prices High sensitivity the price of shares frequently fluctuates and sharply responds to any changes in the market situation. 3

4 Liquidity risk Medium sensitivity trading in shares generally takes place on a regulated market (stock-exchange) with a sufficient number of participants and sufficient demand and offer. However, there exist low liquidity shares that are not actively traded. The liquidity of shares may be influenced by periods of financial crisis. The liquidity risk may create additional expenses as is the case when buying/selling transactions take place with large amounts of share packages. Currency risk The sensitivity of currency risk depends on the currency of the shares and the portfolio base currency. Interest rate risk Low sensitivity does not directly influence the price of shares. Bonds A bond is an issued debt security that certifies the obligation of its issuer to pay to its owner (creditor) the nominal value of the debt security after a definite date of maturity and to make regular payments of the interest rate. States, local government institutions as well as private companies issue bonds at a fixed or variable interest rate or at a zero interest rate (discounted bonds). The degree of risk sensitivity: Issuer s credit risk High sensitivity the issuer s insolvency means a refusal of the issuer to pay for the bonds it has issued. In addition, a decline of the issuer s credit quality may lead to the fall of the bond price. Risk of Market Prices Medium sensitivity the price of the bond depends on the changes in interest rates and they usually change on a relatively small scale. In the case of ordinary bonds, the longer their term of maturity, the more they are exposed to the change of interest rates. Liquidity risk High sensitivity depending on the type of bonds. Debt securities that are traded on stock exchanges are less exposed to the liquidity risk. At the same time, the bonds that are not quoted on the stock exchange and are traded on less transparent markets (over the counter) are more exposed to liquidity risk. Liquidity risk may cause additional expenses when a big package of bonds is purchased or sold. Currency risk The influence of the currency risk on bonds depends on the currency of the bond and the portfolio base currency. Interest rate risk High sensitivity it directly affects the bond value. Shares of investment funds The investment fund shares is a type of issued securities of investment funds that reflects the effectiveness of investment operations and the price of the financial instruments that are included in the funds. The fund assets are created by the resources of collective investors. There are several types of investment funds which differ by their way of operation there are open-end funds and closed-end funds, funds on and off the stock exchange quotation listings, funds with a set time limit and permanent, etc. The funds may differ depending on in what kind of instruments the funds invest their resources in shares, bonds, financial derivatives, real estate, commodity contracts, term deposits or other. 4

5 Before acquiring an investment fund shares, it is important to clearly understand the peculiarities and characteristic indicators of the fund. The risk sensitivity degree of funds depends on the type of the investment fund and on its investment strategy entailing risks from low to very high degrees of sensitivity. Security selling with repurchase (REPO transactions) REPO transaction is an agreement between parties according to which the customer sells securities to the bank on the condition of repurchase after a definite period of time and at a fixed price. REPO transactions may be regarded as a short-term loan with securities as collateral although, formally, the REPO transaction is carried out as a purchase and selling, not a loan. The securities owned by the customer are used as the object of transaction. In case the price of securities falls below the fixed level, the bank may demand from the customer an additional security for this particular transaction. The sum of the transaction will usually be smaller than the market value of the securities (the sales price is below the market price) with the aim to prevent a situation that in case the market prices of the securities go down an urgent need for an additional collateral arises; the bank s interest rate is included in the price of securities repurchased from the bank in REPO transactions. The degree of risk sensitivity: Bank s credit risk Medium sensitivity in the event of a bank s insolvency, the customer risks the difference between the current market value of the securities and the price at which the securities were sold to the bank. The other risks are identical with the risks common to the transactions with customerowned securities. Currency exchange (SPOT, TOM, TOD transactions) SPOT is a transaction of the currency exchange undertaken by the customer and the bank ensures its settlement by the end of the second working day after the date of transaction; in TOM the transaction is performed before the end of the next working day but in TOD the conversion is performed on the date of the transaction. Currency exchange transactions take place outside the stock exchange and the transactions are directly concluded with the bank. Currency transactions with a future term of settlement (FORWARD transactions) Currency transaction with a future date of settling or FORWARD transaction is an agreement between the customer and bank on buying or selling currency on a fixed date in the future at a fixed exchange rate as set by the contract or agreement. In order to carry out this transaction, the customer needs to deposit in the bank the necessary collateral in accordance with the deal currency, term, and amount set in the agreement. In the event of fluctuations of the currency rates which create losses, the deposit must be supplemented in order to reach a definite amount that depends on the total amount of the FORWARD transaction and the negative result of currency revaluation. The degree of risk sensitivity: Bank s credit risk Medium sensitivity in the case of a bank s insolvency, the customer risks the deposited sum and in the event when the currency rate fluctuations are beneficial for the customer he/she loses the calculated increase of the sum in the result of revaluation. 5

6 Currency risk High sensitivity the currency risk depends on the currency used in the transaction and the transaction time limits. The more often the currency rates change and the longer the position of the transaction is, the greater the risk. Currency SWAP transactions Currency SWAP transactions consist of two transactions in opposite directions that are concluded at the same time and are mutually connected a currency exchange SPOT (TOM, TOD) transaction and a simultaneously concluded agreement on a FORWARD transaction with the same currencies but in the reverse direction. Thus, this type of transaction is fully exposed to the transaction risks of both deals. *** 6

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