Risk Information for Expanded Investment Transactions and Forward Exchange Transactions

Transcription

1 Risk Information for Expanded Investment Transactions and Forward Exchange Transactions May 2010

2 TABLE OF CONTENTS Preliminary Remarks General Investment Risks Forward Exchange Transactions Foreign Exchange Swaps Interest Rate Swaps (IRS) Forward Rate Agreements (FRA) Over-The-Counter (OTC) Option Transactions Currency Option Transactions Interest Rate Options Cross Currency Swap (CCS) Commodity Swaps and Commodity Options with Cash Settlement ( Commodities Futures ): Credit Default Swaps (CDS) Credit Linked Notes (CLN) Total Return Swaps (TRS) Collateralised Debt Obligations (CDO)...12 Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 2 of 12

3 Preliminary Remarks Various investment products and the associated opportunities and risks are described below. Risk is regarded as the non-achievement of an anticipated return on invested capital and/or loss of the invested capital, up to its total loss, whereby this risk depending on the structure of the product can have different underlying causes with the product, the markets or the issuer. These risks are not always foreseeable in advance, so that the following description can also not be regarded as conclusive. In any case, the risk resulting from the creditworthiness of a product s issuer, which is always dependent on the individual case, is something that the investor must pay particular attention to. The description of the investment products is based on the most common product characteristics. However, the structuring of the concrete product is always crucial. Therefore, this description cannot replace a detailed review of the concrete product by the investor. 1. General Investment Risks Foreign exchange risk If a foreign currency transaction is selected, the income/performance of this transaction is not only dependent on the local return of the security in the foreign market, but also depends highly on the development of the exchange rate of the foreign currency in relation to the investor s base currency (e.g. euro). The change to the exchange rate can therefore increase or reduce the income and value of the investment. Transfer risk For transactions with a foreign dimension (e.g. foreign obligor) depending on the relevant country the additional risk exists that realisation of the investment may be hindered due to political or foreign exchange measures. Furthermore, problems can arise with the settlement of an order. With foreign currency transactions, such measures can also lead to the foreign currency no longer being freely convertible. Country risk The country risk is the creditworthiness risk of a state. If the relevant state poses a political or economic risk, this can have negative effects on all of the partners domiciled in this state. Liquidity risk The possibility of buying, selling/closing out an investment at market prices is called marketability (= liquidity). A liquid market can be spoken of when an investor can trade his securities without an average-sized order (measured on market turnover volume) leading to noticeable fluctuations and not be capable of being settled at all, or only at a changed price level. is regarded as the risk of the partner s insolvency, i.e. a possible inability to fulfil his obligations on time or at all, such as dividend payment, interest payment, principal repayment, etc. Alternative terms for creditworthiness risk are obligor or issuer risk. This risk can be assessed with the aid of so-called "ratings". A rating is an evaluation scale for assessing the creditworthiness of issuers. The rating is established by rating agencies, whereby creditworthiness risk and country risk are assessed. The rating scale ranges from AAA (best creditworthiness) to D (worst creditworthiness). ensues from the possibility of future changes to the market interest rate level. A rising market interest rate level leads to losses during the term of fixed-interest rate bonds, while a falling market interest rate level leads to gains. Price risk Price risk is regarded as possible value fluctuations of individual investments. With committed transactions (e.g. forward exchange transactions, futures, writing options), the price risk can make collateral security (margin) necessary/increase their amount, i.e. bind liquidity. Risk of total loss The risk of total loss is regarded as the risk that an investment can become worthless, e.g. on the basis of its structure as a temporary right. A total loss can particularly occur when the issuer of a security is no longer able to fulfil his payment obligations (insolvency) for economic or legal reasons. Buying securities on credit Buying securities on credit poses an increased risk. The loan taken up must be repaid, regardless of the performance of the investment. Furthermore, credit costs reduce the income. Order placement Buying or selling orders to the bank (order placement) must at least contain which investment is to be bought/sold in which quantity/nominal amount at which price over which time period. Price limit With the "best" (without a price limit) order code, you will accept any possible price; with this, a necessary capital investment/sales proceeds remain uncertain. With a buying limit, you can restrict the buying price of a stock exchange order, thereby limiting the capital investment; no purchases will occur above the price limit. With a selling limit, you define the lowest acceptable selling price for you; no sales will occur below the price limit. Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 3 of 12

4 Caution: A stop market order is only activated as soon as the price formed on the stock exchange corresponds to the selected stop limit. The order is valid as of its activation as a best order, i.e. without a limit. The actual price achieved can therefore deviate significantly from the selected stop limit, particularly with illiquid securities. Time limit You can restrict the validity of your order with a time limit. The validity of orders without a time limit is based on the standard practices of the relevant stock exchange. Your account manager will inform you about other order codes. Guarantees The term "guarantee" can be used in various meanings. On the one hand, it is regarded as the commitment by a third party other than the issuer, with which the third party secures the fulfilment of the issuer's liabilities. On the other hand, it can involve a commitment by the issuer himself to provide a specific service, regardless of the development of specific indicators, which would be crucial to the amount of the issuer s commitment. Guarantees can also relate to other diverse circumstances. Capital guarantees are usually only valid at the end of a term (maturity), which is why price fluctuations (losses) can, by all means, occur during the term. The quality of a capital guarantee is significantly dependent on the guarantor s creditworthiness. Tax aspects Upon request, your account manager will be pleased to inform you about the general tax aspects of the different investments. You should carry out the assessment of an investment on your personal tax situation together with your tax advisor. Risks on stock exchanges, particularly on secondary markets (e.g. Eastern Europe, Latin America, ) With the majority of secondary market stock exchanges, there is no direct link, i.e. all orders must be forwarded by telephone. This can result in errors/delays. At several secondary equity markets, limited buying and selling orders are generally not possible. Therefore, limited orders can only be placed after enquiring with the local broker by telephone, which can cause delays. It could also occur that these limits are not implemented at all. With several secondary equity markets, it is difficult to obtain up-to-date prices, which makes a current valuation of the existing client positions difficult. If a listing is discontinued on a stock exchange, it could be the case that it is no longer possible to sell these securities through the relevant stock exchange. A transfer to another stock exchange can also entail problems. With several secondary market stock exchanges, the opening hours are still far from corresponding to the Western European standards. Short stock exchange opening hours of around three or four hours per day can lead to bottlenecks/non-consideration of share orders. Information requests by foreign joint-stock companies Foreign shares that a client leaves in the custody of domestic or foreign banks are subject to the legal system of the state in which the joint-stock company is domiciled. The rights and duties of the shareholders are therefore determined by this legal system. According to this, the joint-stock company is frequently entitled or even obligated to obtain information about its shareholders. The same can also apply to other securities. 2. Forward Exchange Transactions A forward exchange transaction comprises the firm commitment to buy or sell a specific foreign currency amount at a later point in time or during a time period, at a price defined upon conclusion. The delivery/receipt of the counter currency occurs with the same value date. The income (profit/loss) for the speculative user of forward exchange transactions results from the difference between the foreign exchange parities during or at maturity of the forward transaction, under the conditions of this forward transaction. Use for hedging purposes means the definition of an exchange rate, so that the cost or income of the hedged transaction is neither increased nor reduced by exchange rate changes in the interim. Foreign exchange risk With hedging transactions, the foreign exchange risk of forward exchange transactions is that the buyer/seller could buy/sell the foreign currency more favourably during or at maturity of the forward exchange transaction than upon conclusion of the transaction, or with open transactions, the risk is that he must buy/sell less favourably. The risk of loss can significantly exceed the original contract value. The creditworthiness risk of forward exchange transactions is the risk of the partner's insolvency, i.e. a possible, temporary or ultimate inability to fulfil the forward exchange transaction and therefore the necessity to obtain possibly expensive, subsequent cover on the market. Transfer risk The transfer options for individual currencies can be specifically limited by the relevant home state of the currency. This would jeopardise the proper settlement of the forward exchange transaction. Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 4 of 12

5 3. Foreign Exchange Swaps A foreign exchange swap is the exchange of two currencies over a specific period of time. The interest rate difference between both of the currencies involved is taken into consideration with a surcharge or discount on the re-exchange price. The delivery/receipt of the counter currency occurs with the same value date. The income (profit/loss) for the user of foreign exchange swaps ensues from the positive/negative development of the interest rate difference and can be generated during the term of the foreign exchange swap, in case of a counter transaction. The creditworthiness risk of foreign exchange swaps is the risk of the partner's insolvency, i.e. a possible, temporary or ultimate inability to fulfil the foreign exchange swap and therefore the necessity to obtain possibly expensive, subsequent cover on the market. Transfer risk The transfer options for individual currencies can be specifically limited by the relevant home state of the currency. This would jeopardise the proper settlement of the foreign exchange swap. 4. Interest Rate Swaps (IRS) An interest rate swap regulates the exchange of differently defined interest liabilities on a fixed, nominal amount between two contracting parties. This generally involves the exchange of fixed against variable interest payments. Therefore, an exchange of interest payments occurs, however, no flow of capital. The buyer of the IRS (fixed interest payer) gains his income in the case of a rise in the market interest rate level. The seller of the IRS (fixed interest recipient) gains his income in case of a falling interest rate level. The income from an IRS cannot be defined in advance. The interest rate risk ensues from the uncertainty of future changes to the market interest rate level. The buyer/seller of an IRS is exposed to a risk of loss if the market interest rate level falls/rises. The creditworthiness risk of IRS is the risk of losing positive cash values in case of default by the business partner, or being forced to obtain subsequent cover in the market at a worse price. Special conditions for IRS IRS are not standardised. The settlement details must be contractually regulated in advance. These are customised products. Therefore, it is particularly important to find out about the precise conditions, especially regarding: Nominal amount Term Interest rate definitions Special form: Constant Maturity Swap (CMS) A constant maturity swap regulates the exchange of differently defined interest liabilities on a fixed, nominal amount between two contracting parties. This generally involves exchanging a variable money market interest rate (e.g. 3-month EURIBOR) against a capital market interest rate (e.g. 10-year EUR-IRS). However, this capital market interest rate does not remain fixed for the entire term, but rather, it is adjusted at regular intervals. The buyer of the CMS (payer of the capital market interest rate) gains his income in the case of a flattening yield curve, i.e. if e.g. the capital market interest rates fall and the money market interest rates rise. The income from a CMS cannot be defined in advance. The interest rate ensues from the uncertainty regarding future changes to the interest rate level of the capital market and the money market. The buyer/seller of a CMS is exposed to a risk of loss if the yield curve becomes steeper/flatter. Special form: CMS Spread Linked Swap With a CMS spread linked swap, differently defined interest rate liabilities are again exchanged. On the one hand, these are generally a money market interest rate (e.g. 3-month EURIBOR; however, as an alternative, it could also be a fixed interest rate over the entire term) and on the other side, the difference between two CMS - e.g. 10-year EUR CMS minus 2-year CMS, also often with a factor x (e.g. 2 times). The CMS spread is frequently provided with a fixed coupon for a specific, initial term. Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 5 of 12

6 The buyer of the CMS spread linked swap (payer of the CMS difference) gains his income in the case of a flattening of both capital market interest rate curves involved (e.g. 10-year EUR IRS and 2-year EUR IRS). The income from a CMS spread linked swap cannot be defined in advance. The interest rate risk ensues from the uncertainty regarding future changes to the interest rate level of the shorter-term capital market to the long-term capital market, in relation to the interest rate level of the money market (or the amount of the fixed interest rate). 5. Forward Rate Agreements (FRA) The purpose of the forward rate agreement is to agree on interest rates for future interest rate periods in advance. As trading occurs on the interbank market and not on the stock exchange, no standardisation exists. Therefore, in contrast to the closelyrelated interest rate futures, a FRA involves customised products, according to amount, currency and interest rate period. The buyer/seller of the FRA has fixed the interest rate by buying/selling. If the reference interest rate on the maturity date is above the agreed interest rate (FRA price), the buyer receives a settlement payment. If the reference interest rate on the maturity date is below the agreed interest rate (FRA price), the seller receives a settlement payment. The interest rate risk ensues from the uncertainty of future changes to the market interest rate level. This risk generally has a stronger effect, the more the market interest rate rises/falls. The creditworthiness risk of FRAs is the risk of losing positive cash values in case of default by the business partner, or being forced to obtain expensive, subsequent cover in the market at a worse price. Special conditions for FRAs FRAs are not standardised. These are customised products. Therefore, it is particularly important to find out about the precise conditions, especially regarding: Nominal amount Term Interest rate definitions 6. Over-The-Counter (OTC) Option Transactions Standard Option Plain Vanilla Option The buyer of the option acquires the temporary right to buy (call) or sell (put) the underlying asset (e.g. securities, foreign currencies, etc.) at a fixed exercise price, and resp. (e.g. with interest rate options) the entitlement to a settlement payment, which is calculated from the positive difference between the exercise price and market price at the time of exercising. With the writing (opening) of options, you commit to fulfil the rights of the option buyer. Options can envisage various exercising conditions: American type: during the entire term. European type: at maturity. Exotic options Exotic options are financial derivatives that are derived from standard options (plain vanilla options). Special form - barrier option In addition to the exercise price, a threshold value (barrier) exists, which activates (knock-in option) or deactivates (knock-out option) the option when reached. Special form - digital (payout) option Options with a defined disbursement amount (payout), which the buyer of the option receives in exchange for payment of a premium when the price (interest rate) of the underlying asset is below or above (depending on the option) the threshold value (barrier). The holder of options receives the income if the price of the underlying value rises above the exercise price of the call/falls below the exercise price and he exercises his option or can sell it (plain vanilla option, activated knock-in option, nondeactivated knock-out option). With a non-activated knock-in option/a deactivated knock-out option, the warrant lapses and the option becomes worthless. The holder of digital (payout) options receives the income when the threshold value is reached during the term/upon maturity, so that the payout occurs. General risks The value (price) of options depends on the exercise price, the development and volatility of the underlying value, the term, the interest rate structure and the market situation. The capital investment (option premium) can therefore reduce as far as Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 6 of 12

7 complete worthlessness. If the price of the underlying asset should not develop according to the expectations of the option buyer, the resulting potential loss can theoretically be unlimited (plain vanilla option, barrier option)/be in the amount of the agreed payout (digital option). It should particularly be noted that rights from options that are not exercised on time will lapse when the exercise period expires and are therefore written off without value. Note: Please note that the bank will not exercise your warrants without your explicit instruction. Specific risks with over-the-counter option transactions Over-the-counter options are generally not standardised. These are primarily customised instruments. It is therefore particularly important to find out about the precise details (exercising type, exercising and lapse). The creditworthiness risk when buying over-the-counter options lies in the risk of losing the premium already paid if the business partner defaults and thereby being indirectly forced to obtain expensive subsequent cover on the market. For over-the-counter options as customised products, a regulated (secondary) market typically does not exist. Therefore, availability cannot be ensured at all times. 7. Currency Option Transactions The buyer of a currency option acquires the right, but not the obligation, to buy/sell a specific amount of currency at a price and point in time/time period that is defined in advance. The seller (writer) of the option guarantees the relevant right. The buyer pays the seller a premium for this option right. The following types of options exist: With the purchase of an option on a call basis, the buyer acquires a right to buy a defined amount of a specific currency at a delivery price defined in advance (base price or exercise price), as of/prior to a specific date (delivery date). With the sale of an option on a call basis, at the request of the option buyer, the seller commits to deliver/sell a defined amount of a specific currency at a base price as of/prior to a specific date. With the purchase of an option on a put basis, the buyer acquires the right to sell a defined amount of a specific currency at a base price as of/prior to a specific date. With the sale of an option on a put basis, at the request of the option buyer, the seller commits to buy a defined amount of a specific currency at a base price on/prior to a specific date. The income from a call option can result from the market price of the currency becoming higher than the exercise price to be paid by the buyer, whereby the purchase price (=premium) is deducted. The buyer then has the possibility of buying the foreign currency at the exercise price and immediately selling it again at the market price. The seller of the call option receives a premium for selling the option. The same applies analogously to put options, with contrasting currency developments. Risks of buying an option Risk of total loss of the premium The risk of selling currency options lies in the total loss of the premium, which must be paid, regardless of whether the option is exercised in the future. The creditworthiness risk when buying currency options lies in the risk of losing the premium already paid if the business partner defaults and thereby being indirectly forced to obtain expensive subsequent cover on the market. Foreign exchange risk The risk of currency options is that the currency parity does not develop in the manner that you have based your buying decision on, by the time of the option expiring. In an extreme case, this can lead to total loss of the premium. Risks of selling an option Foreign exchange risk The risk of selling currency options is that the market price of the foreign currency does not develop in the manner that you have based your decision on, by the time of the option expiry. The resulting potential loss is not limited for written options. The premium for the currency option depends on the following factors: volatility of the underlying foreign exchange rate (measurement for the fluctuation margin of the market price) the selected exercise price term of the option current rate of exchange interest rate of both currencies liquidity Transfer risk The transfer options for individual currencies can be specifically limited by the relevant home state of the currency. This would jeopardise the proper settlement of the transaction. Liquidity risk Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 7 of 12

8 For currency options as customised products, a regulated secondary market typically does not exist. Therefore, marketability cannot be ensured at all times. Special conditions for currency options Currency options are not standardised. Therefore, it is particularly important to find out about the precise details, especially regarding: Type of exercising: Can the warrant constantly be exercised (American option) or only on the day of exercising (European option)? Lapse: When does the right expire? Please note that the bank will not exercise your warrants without your explicit instruction. 8. Interest Rate Options Interest rate options represent an agreement for an interest rate maximum limit, interest rate minimum limit or options on interest rate swap transactions. They are either a) for hedging purposes or b) for gaining income on a speculative basis. A distinction is made between calls and puts. Common special forms are: caps, floors or swaptions, etc. The buyer of a cap hedges a fixed maximum interest rate ceiling for future borrowings through the exercise price. In a speculative case, the value of the cap increases with rising interest rates. The sale of a cap can only be used as a speculative instrument, whereby the seller receives the premium and commits to make settlement payments. With floors, the buyer secures a minimum interest rate on a future investment. In a speculative case, the value of the floor increases with falling interest rates. ad a) for hedging purposes Depending on the selected reference term, every three or six months, the current three-month or six-month interest rate is compared to the hedged strike. If the market price should be higher than exercise price, the settlement payment is made to the cap holder. ad b) for gaining income on a speculative basis The value of the cap increases with rising interest rates, whereby the forward interest rates (currently traded future interest rates) are relevant, rather than the current interest rates. The same applies analogously to buying/selling a floor. With this, the buyer secures a minimum interest rate ceiling, while the seller holds a speculative position. A swaption is an option on an interest rate swap (IRS = agreement regarding swapping interest rate payments). A basic distinction is made between payers (=fixed payer) and receivers swaption (receiver of the fixed side with IRS). Both forms of options can be bought and sold. A further distinction is made between types of fulfilment with different risk profiles: Swaption with swap settlement The buyer enters into the swap when utilising the swaption. With the purchase of a payer's swaption, the buyer acquires the right to pay a fixed interest rate agreed in the exercise price, on the basis of a specific nominal amount and receive variable interest rate payments in exchange for this, on the delivery date. With the sale of a payer's swaption, the seller commits to pay a fixed interest rate agreed in the exercise price, on the basis of a specific nominal amount, and receive variable interest rate payments in exchange for this, on the delivery date. With the purchase of a receiver's swaption, the buyer acquires the right to receive a fixed interest rate agreed in the exercise price, on the basis of a specific nominal amount, and receive variable interest rate amounts in exchange for this, on the delivery date. With the sale of a receiver's swaption, the seller commits to pay a fixed interest rate agreed in the exercise price, on the basis of a specific nominal amount, and receive variable interest rate payments in exchange for this, on the delivery date. Swaption with cash settlement When utilising the swaption, the buyer receives the difference between the present values of the swaps and the swaption interest rate/current market interest rate. The holder of interest rate options receives the income when the market interest rate level on the exercise date is above the exercise price of the cap/below the exercise price of the floor. With swaptions, the income is available when the market interest rate level on the exercise date is above the agreed exercise price for payers swaptions/below the agreed exercise price for receivers' swaptions. The received option premium remains with the seller, regardless of whether the option is exercised or not. ensues from the possibility of future changes to the market interest rate level. The buyer/seller of an interest rate option is exposed to an interest rate risk in the form of a loss, when the market interest rate level rises/falls. This risk Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 8 of 12

9 generally has a stronger effect, the more the market interest rate rises/falls. The resulting potential loss is not limited for the seller. The premium for the interest rate option depends on the following factors: interest rate volatility (fluctuation margin of the interest rates) the selected exercise price term of the option market interest rate level current financing costs liquidity These factors can cause the price of the option to remain the same or fall, although your expectations have been realised with regard to the interest rate development of the options. The creditworthiness risk when buying interest rate options is the risk of losing positive cash values in case of default by the business partner, or being forced to obtain subsequent cover in the market at a worse price. Risk of total loss from purchase The risk of buying interest rate options lies in the total loss of the premium, which must be paid, regardless of whether the option is exercised in the future. Special conditions for interest rate options Interest rate options are not standardised. These are exclusively customised products. Therefore, it is particularly important to find out about the precise details, especially regarding: Type of exercising: Can the warrant constantly be exercised (American option) or only on the exercise date (European option)? Exercising: Delivery of the underlying asset or cash settlement? Lapse: When does the right expire? Please note that the bank will not exercise your warrants without your explicit instruction. 9. Cross Currency Swap (CCS) A cross currency swap regulates the swapping of differently defined interest rate liabilities, as well as of different currencies on a fixed nominal amount between two contracting parties. This generally involves the exchange of fixed interest payments in two different currencies. Both interest rate payments can, of course, also take place in variable interest rate commitments. The payment flows occur in different currencies on the basis of the same capital amount, which is fixed with the relevant spot rate on the closing date. In addition to swapping interest rate commitments/interest rate claims, a swap of capital occurs at the beginning (initial exchange) and end of the term (final exchange) According to the requirements of the individual business partners, the initial exchange can be omitted. The income from a CCS cannot be defined in advance. With a positive development of the exchange rate and the interest rate difference, income can be generated in the case of early cancellation of the CCS. If the CCS should be concluded to improve the interest rate difference, income can be generated from the lower interest rates of a different currency. This can, however, be balanced again through possible currency losses. If the currency ratio should develop positively, the income can even be improved. The interest rate risk ensues from the uncertainty of future changes to the market interest rate level. The buyer/seller of a CCS is exposed to a risk of loss if the market interest rate level falls/rises. Foreign exchange risk The foreign exchange risk ensues from uncertainty about the future changes to the relevant price ratio of the currencies involved. It is particularly important that with a CCS with final exchange, the foreign exchange risks not only exists if a contracting party defaults, but also during the entire term. The creditworthiness risk with buying/selling CCS lies in the risk of being forced to obtain subsequent cover on the market in case of default by the business partner. Special conditions for CCS CCS are not standardised. These are customised products. Therefore, it is particularly important to find out about the precise conditions, especially regarding: Nominal amount Term Interest rate definition Currency definition Price definition Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 9 of 12

10 Initial exchange yes or no 10. Commodity Swaps and Commodity Options with Cash Settlement ( Commodities Futures ): Commodities futures are special contracts containing rights or obligations to buy or sell specific commodities at a price and point in time defined in advance or during a defined time period. Commodities futures exist, inter alia, in the different instruments described below. Basic information about the individual instruments Commodity swaps: A commodity swap is an agreement regarding the exchange of a series of fixed commodity price payments ( fixed amount ) against variable commodity price payments ( market price ), whereby only cash settlement ( settlement amount ) takes place. The buyer of a commodity swap acquires the right to payment of the settlement amount if the market price is above the fixed amount. In contrast, the buyer of a commodity swap is obligated to pay the settlement amount if the market price lies below the fixed amount. The seller of a commodity swap acquires the right to payment of the settlement amount if the market price is below the fixed amount. In contrast, the seller of a commodity swap is obligated to pay the settlement amount if the market price lies above the fixed amount. Both payment flows (fixed/variable) occur in the same currency and on the basis of the same nominal amount. While the fixed side of the swap has the character of the benchmark, the variable side relates to the trading price of the relevant commodities or a commodity price index that is quoted at a stock exchange or otherwise published in the commodity futures market on the relevant fixing date. Commodity options with cash settlement: The buyer of a commodity put option acquires the right to receive the difference between the exercise price and the market price in relation to the nominal amount on any exercise date, if the market price is below the fixed amount. The buyer of a commodity call option acquires the right to receive the difference between the exercise price and the market price in relation to the nominal amount on any exercise date, if the market price is above the fixed amount. Risks Details on the different instruments Risk of Commodity Swaps and Commodity Options with Cash Compensation: If the expectations are not realised, the difference is payable, which exists between the price used as a basis upon closing and the current market price on maturity of the transaction. This difference comprises the loss. The maximum amount of the loss cannot be determined in advance. It can exceed possible collateral that has been provided. Risk for purchased commodity options loss of value A price change of the underlying asset (e.g. a commodity), which is the basis of the contract subject matter of the option, can reduce the value of the option. A value reduction occurs in the case of a purchase option (call) with price losses, in the case of a sales option (put), with price gains from the underlying contract subject matter. However, a value reduction of the options can also occur when the price of the underlying asset does not change, because the value of the option is co-determined by additional pricing factors (e.g. term or frequency and intensity of the price fluctuations of the underlying asset). Your risk with sold commodity options leverage effect The risk of selling commodity options is that the value of the underlying asset does not develop in the manner that seller has based his decision on, by the time of the option expiring. The resulting potential loss is not limited for written options. General risks of commodities futures Price fluctuations The amount of the payment obligation from commodities futures is calculated from the prices on a specific commodities futures market. Commodities futures markets can be strongly dependent on price fluctuations. Many factors related to supply and demand of the commodities can influence the prices. It is not easy to forecast or foresee these pricing factors. Unforeseen events, e.g. natural catastrophes, diseases, epidemics and acts of authorities can influence the price just as significantly as incalculable developments, e.g. weather influences, harvest fluctuations or delivery, storage and transportation risks. Foreign exchange risk Commodities prices are frequently quoted in foreign currency. When you enter into a commodity transaction, where your obligation or your consideration to be claimed is issued in foreign currency or a unit of account, or the value of the contract subject matter is determined according to this, you are also exposed to foreign exchange market risk. Closing out / liquidity Commodities futures markets are generally tighter than financial futures markets and can therefore be less liquid. It is possible that you cannot, or can only partially, close out a commodities futures position at the time you require, due to insufficient market liquidity. Furthermore, the spread between buying and selling offers (bid and ask) in a contract can be relatively large. The Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 10 of 12

11 liquidation of positions can also be difficult or impossible under certain market conditions. Most of the commodities futures exchanges are e.g. authorised to define price fluctuation limits, which do not permit buying or selling offers outside of specific limits, for a certain time period. This can limit or entirely prevent the liquidation of individual positions. Limit order/stop order Limit orders or stop loss orders are orders, which are intended to limit trading losses in case of certain market movements. Although such risk limitation options are admissible at most commodities futures markets, limit orders or stop loss orders are generally not arranged with OTC commodities. Forward and spot market It is particularly important to understand the relationship between the forward contract prices and spot market prices. Although market forces can approximate the differences between the forward contract price and the spot market price for the commodities in question such that the price difference can virtually be zero on the delivery date, numerous market factors, including supply and demand, can cause differences to still exist between the forward contract price and the spot market price of the relevant commodity. Defining the market price Market prices are either quoted on commodities futures exchanges or are published according to normal market practice. Due to system failures, system disruptions at the exchange or other causes, it can occur that no market prices can be determined for the agreed fixing day. If no regulations are agreed for substitute determination of the market price, the settlement centre is usually authorised to set a market price at its discretion. 11. Credit Default Swaps (CDS) A CDS is a bilateral, time-limited agreement that specifies the transfer of defined credit risks from one contracting party to another. Compulsory contract components are term, currency and amount, defined credit events and the periodic premium payable. The seller of the CDS (security provider) generally receives a periodic premium calculated on the nominal amount for assuming the defined risk from the buyer (secured party). This premium is based, inter alia, on the quality of the credit risk underlying the secured party. As long as no credit event occurs, the security provider does not need to perform. The conventional credit events include, inter alia, bankruptcy, restructuring (e.g. capital reduction), refusal to pay, With the occurrence of the previously defined credit events, the security provider either accepts a security (delivery of an asset of the secured party s reference obligor) in exchange for payment of the nominal amount (physical delivery), or makes a settlement payment to cover the loss in value that has occurred (cash settlement), whereby the security provider remains in the risk position, in this case. The security provider s premium payments are discontinued from this point in time. Risks With the CDS, the security provider bears the credit risk of the secured party s reference obligor, without actually needing to acquire it. Only the credit risk is secured, however, no value changes are triggered by movements of the underlying interest rate market. The security provider therefore assumes the risk of the reference obligor s creditworthiness deterioration, right up to "default. Default is regarded as full or partial omission of service performance agreed between the secured party and the reference obligor or non-punctual payment for this service. 12. Credit Linked Notes (CLN) A credit linked note (CLN) is a securitised form of a credit default swap (CDS), i.e. a combination of a CDS and a bond. The issuer (a bank or a special purpose company) of a CLN issues the bond, which is redeemed at its nominal value on maturity, if none of the agreed credit events occur during the term. If a credit event should occur, the reference value is either physically delivered or repaid, up to the amount of the residual value in an extreme case, not at all. The buyer of the bond (obligor, security provider) receives a regular monetary/interest payment over the entire term for the enormous risk assumption, which is regarded as the premium for the assumed credit risk. The interest is provided at market conditions plus a significant risk premium. The precise structure of a credit linked note is outlined in the relevant issuing conditions. Risks Specifically special purpose companies are usually established to issue the CLN, also called special purpose vehicles (SPV), which are not endowed with their own capital. The risk, if a credit event should occur, lies in the Credit Linked Note only being partially redeemed or not at all. If a portfolio of receivables should be an underlying asset, the bond can already default if a reference value becomes distressed (defaults). The buyer of such a form of bond assumes the default risk of the reference value, as well as the issuer s creditworthiness risk, i.e. the risk exists that he will not receive his invested capital, either due to default of the reference obligor or the issuer. The buyer of a Credit Linked Note is therefore exposed to the credit risk of the issuer and or one or more reference obligors or reference values. There is no guarantee that the creditor will fully receive the nominal amount of such debentures back or receive interest on it and, in the most extreme case, the issuer s payment obligation could be reduced to zero. Accordingly, the return on credit linked notes can be negative and buyers of such debentures can entirely or partially lose the value of their investment. 13. Total Return Swaps (TRS) With a Total Return Swap, the entire income from an asset is transferred between the partners. During the term, the buyer (security provider) of the TRS is paid out the ongoing coupon of the security provider s reference asset (e.g. bond) and must simultaneously deliver an agreed (variable) coupon (e.g. LIBOR + x BP) to the secured party. At maturity, the difference between the initial and final value of the reference asset (e.g. price difference) is settled. If the asset performs positively, the Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 11 of 12

12 secured party must pass on the income to the security provider. If the asset should develop negatively, the security provider must bear the loss. Risks The total return swap is a financial instrument with which the market price risk and the counterparty risk are transferred to the security provider in relation to a specific reference asset (issued debt instrument of the reference address) generally an interest-bearing security. The security provider also bears the entire price risk of the reference asset. 14. Collateralised Debt Obligations (CDO) Collateralised debt obligations, or CDOs, are a special type of asset backed securities (ABS). Like the ABS, they are securitised debt instruments that are secured by assets, mainly in the form of loans, derivatives or bonds. With regard to the asset, a distinction can basically be made between three types of CDOs: a) Collateralised Loan Obligations (CLOs) -> Loans as assets b) Collateralised Bond Obligations (CBOs) -> Bonds as assets c) Collateralised Synthetic Obligations (CSOs) -> Derivatives as assets The idea behind a collateralised debt obligation is to form a pool of bonds and loans. Combining these collateralised assets makes it possible to form and sell diverse capital structures. Regarding the functionality and risks of the CDOs, reference is made to the comments regarding the ABS. Furthermore, depending on the structure of the pool, the risks need to be coordinated differently with the assets contained in the pool. For the buyer, there is particularly the advantage, on the one hand, that higher income is possible on the basis of the possible higher risk participation and, on the other hand, that the risk distribution can be influenced by selecting a CDO with different underlying assets. Risk Information for Expanded Investment Transactions and Forward Exchange Transactions Page 12 of 12