GENERAL DESCRIPTION OF FINANCIAL INSTRUMENTS, INVESTMENT PRODUCTS AND ASSOCIATED RISKS

Transcription

1 GENERAL DESCRIPTION OF FINANCIAL INSTRUMENTS, INVESTMENT PRODUCTS AND ASSOCIATED RISKS Risk categorization of investment products In compliance with Commission Directive 2006/73/ЕО implementing Directive 2004/39/ЕО of the European Parliament and of the EU Council on markets in financial instruments (MiFID), as well as the local Markets in Financial Instruments Act, First Investment Bank AD (the Bank) categorizes the risk profile of the investment products it offers according to the nomenclature below. Table.1 (Five-rank risk categorization) R1 Description No fluctuations of the investment value, except usual risk Low fluctuations of the investment value (up to 10% on a yearly basis, with possible higher fluctuations) Balanced level of fluctuations of the investment value (above 10% on a yearly basis, with a possible loss of the whole investment in particular cases) Speculative investment that may lead to losing the whole investment made, due to the Principal s aim of higher profit potential Extremely risky investment that may lead to additional financial liabilities for the Principal, apart from losing the whole investment made Provided by the above criteria stated in Table.1, the investment product, described below are categorized in the following risk groups: * Table.2 (Complex investment products - derivatives) Product FOREX forward FOREX swap FOREX option buy FOREX option sell Cross currency swap Interest-option buy Interest option-sell Interest rate swap buy Interest rate swap sell FRA buy FRA sell Equity option buy Equity option sell Futures Commodities KIKO- Knock-In/ Knock-Out options * Transactions direction (buy / sell) is from the point of view of the Principal 1

2 Table.3 (Standard investment products) Product Bonds Bulgarian government securities Foreign securities rated А-ААА Local and foreign corporate bonds rated higher than ВВВ-(S&P) Unrated Bulgarian corporate bonds Foreign bonds rated lower than ВВВ- (S&P) Shares Shares of enterprises rated higher than ВВВ- (S&P) Foreign shares rated between B and ВВВ- (S&P) Local shares traded on Official market Foreign shares rated lower than В (S&P) Shares not traded on Official market Bulgarian collective investment schemes Investment funds on money market, managed by Management companies with a majority shareholder, companies licensed under the Law on Credit Institutions Investment funds on bonds, managed by Management companies with a majority shareholder, companies licensed under the Law on Credit Institutions Investment funds on bonds, managed by Management companies with a majority shareholder, companies not licensed under the Law on Credit Institutions Equity and high-risk funds Foreign investment funds Funds on money market Investment funds in foreign currency rated up to ВВВ (S&P) Other investment funds Mixed investment funds Mutual funds High-profit investment funds Hedge funds Venture-capital investment funds Special purpose vehicles Shares of local special purpose investment trusts Shares of foreign special purpose investment trusts Others Structured products with a 100% guarantee of invested capital Structured products with no guarantee of invested capital Warrants Unit linked life insurance Fund based life insurance General description of the financial instruments under Art. 10 of Ordinance No 38 The Bank accepts, executes and/or transfers orders for transactions in financial instruments, as follows: Shares, traded on the Bulgarian Stock Exchange - Sofia ( BSE-Sofia ); Rights on capital increase of companies issuers of such shares; Corporate and municipal bonds issued by Bulgarian companies traded on the BSE-Sofia and on international regulated markets; Bulgarian treasury bills and government bonds; Units/shares of collective investment schemes; Compensation instruments; ОTC derivative instruments on interest rates or currency; Instruments on the money market, including ОТС instruments on the money market. 2

3 General description of the transactions in financial instruments the Bank executes orders for and the associated risks Shares traded on the Bulgarian Stock Exchange Sofia Shares are stocks, issued by joint stock companies, to certify the participation of the holder in the joint stock company capital. Shares grant the right of dividend, the right to vote at the general assembly of shareholders and a liquidation quota. Any investment in shares is associated mainly with market risk, liquidity risk, currency risk, issuer s risk and settlement risk for the investor. The market risk for investments in shares is associated with the probability of the price of securities going down because of market factors, or the so called systemic risk. The liquidity risk of the investments in shares is associated with the risk that the investor cannot sell the quantity of shares he/she wants to sell. Liquidity risk of the shares traded domestically is associated with the freely tradable volume of securities (free float), and determined for each traded issue. Currency risk for shares domestically is associated and dependent on currency exchange rates fluctuations. The risk is usually lower for investments which basic currency is the Euro (because of the Currency Board in Bulgaria) and the risk is zero for those whose base currency is the Bulgarian Lev (since the shares, traded in the country are issued only in Bulgarian Levs). Issuer s risk for the investments in shares is probable if the issuer becomes financially unstable, or the so called nonsystemic (or specific ) risk. Settlement risk can occur in cases of default or delay in the process from the moment when the transaction is made to the moment when it is finalized and any potential unfavourable conditions that may occur within this period. The risk is usually higher for transactions outside a regulated market or transactions where the delivery versus payment (DVP) method is not applied. Rights on the capital increase of companies issuers of such shares The rights are securities giving the option for subscription of a particular number of shares, in relation to a decision taken for a capital increase of a public company. The rights are term derivative financial instruments, whose profitability depends on the expected profitability of the class of shares they refer to. The rights are traded on the BSE-Sofia, being dematerialized securities, like the shares they refer to. They are regulated in the Law on Public Offering of Securities. The additional risk in investing in rights should be taken in consideration, namely the losing of the whole investment made in relation to the short term of the existing of the rights if the exercising of the rights turns out to be inexpedient due to a negative trend in the shares price, falling below the subscription price underlined in the rights. Corporate and municipal bonds issued by Bulgarian companies, traded on the BSE-Sofia and on international regulated markets Bonds are types of debt securities which bring to their holders cash revenue in the form of fixed or floating interest rate (coupons), according to the issuer's prospectus. The bond issuer is obliged to pay a principle under the bond on a specified date, referred to as the maturity date. As per the issuer, the bonds can be: municipal bonds (issued by local authorities), corporate bonds (issued by companies), mortgage bonds (issued by banks based on their mortgage credit portfolios). Investing in corporate and municipal bonds traded within the country and on international regulated markets is mainly associated with market, liquidity and currency risk, as well as issuer s risk and settlement risk. The market risk for the bonds is associated with a negative change in the market interest rates, compared to the issued debt securities with a fixed or floating interest rate. Short-term bonds carry a lower risk, while long-term bonds are carry a higher level of risk. Liquidity risk for the bonds is associated with the risk of delay or impossibility for the investor to trade his/her debt financial instruments. Liquidity risk for this type of financial instruments is associated with the limited volumes of contractual loans traded in the country. Liquidity risk for this type of financial instruments is reduced given the larger volumes of contractual loans traded on the international markets compared to such in Bulgaria. Currency risk for corporate/municipal bonds is lower for investments which base currency is BGN and the Euro (because of the Currency Board in Bulgaria). For investments with another base currency the currency risk depends on exchange rate fluctuations. The issuer s risk is associated with the possibility of the issuer (company or municipality) becoming financially unstable and incapable of paying up the principal and interests accrued under a contractual loan. Settlement risk for the bonds is associated with potential unfavourable market changes during the default or a delay in the process between the moment when the transaction was made and the moment when it is finalized. The risk is usually higher for transactions outside markets or transactions where the method "delivery versus payment" is not applied. Bulgarian treasury bills and government bonds Government securities are debt instruments issued by the Ministry of Finance (MF) being a representative of the state, to finance short-term and long-term government expenditures. Government securities entitle its holders to receive cash revenue by discounting the price below the face value or by receiving a fixed annual interest rate. The Ministry of Finance, jointly with the Bulgarian National Bank, regulate the procedure and the conditions applied to the issue of dematerialized government securities on the internal market. Transactions in government securities are mediated by primary dealers (banks and investment intermediaries) permitted to acquire 3

4 government securities directly at the auctions organized by the Bulgarian National Bank. Government securities are: treasury bonds, government securities, Bad Credit Settlement bonds, and Eurobonds. Any investment in government securities mean to the investor mostly market risk, liquidity risk and issuer s risk. The market risk of government securities is associated with the probability that market interest rate levels go up (change) compared to fixed interest rate of issued debt securities. Depending on the maturity of government securities, shorter-term government securities are associated with a lower market (interest) risk and vice-versa,, longer-term government securities are associated with a higher market (interest) risk. The liquidity risk of government securities is lower compared to other debt financial instruments, since the market of government securities is deemed to be a highly liquid market. The issuer s risk of government securities is lower compared to other debt financial instruments since the issuer is the state, and the risk of it to becoming financially unstable and incapable of paying the principal and the interests on debt stocks is lower. Units/shares of collective investment schemes The units/shares of a collective investment scheme are financial instruments giving the right for redemption of the units/shares of the investment scheme, if it is an open-end type of investment scheme, as well as for periodic earnings. The collective investment scheme is a collective entity for investing in securities and other liquid financial instruments of funds raised by the public offering of units/shares based on the principle of risk allocation. Investing in collective investment schemes is principally related to market risk and concentration risk. The market risk for the collective investment schemes is associated with a decrease in the market prices of the investment scheme s investments and the value of its units/shares following changes in the economic and market environment. The concentration risk for the collective investment schemes is associated mainly with having the financial instruments invested predominantly in one market (state, geographic region) or invested in financial instruments in a single industry. Compensation instruments Compensation instruments are dematerialized, nominal tenders used to compensate owners whose property, buildings or agricultural land have been nationalized or expropriated. They are tradable on regulated stock markets only. Compensation instruments can be compensation notes and housing compensation notes under the Compensation of Owners of Nationalised Property Act, as well as registered compensation vouchers under the Ownership and Use of Farm Land Act and under the Restitution of Forests and Lands within the Forestry Fund Act. Compensation instruments can be used to pay interests under Bad Credit Settlement bonds, to tender for agricultural land belonging to the state land fund or making payment in privatization transactions through the Bulgarian Stock Exchange. Investing in compensation instruments is associated mainly with market, liquidity and target risk. The market risk for the investments in compensation instruments is associated with the probability that the price of the financial instrument goes down. Liquidity risk for the compensation instruments is associated with the risk of delay or the impossibility of selling the compensatory financial instruments of the investor. The target risk for the compensation instruments is associated with the restriction related to the target use and investing this type of financial instruments only in particular projects and transactions as a tender accepted by the state (paying interests under Bad Credit Settlement bonds, tendering for agricultural land belonging to the state land fund or making payments in privatization transactions through the Bulgarian Stock Exchange in Sofia). ОTC derivative instruments on interest rates or currency The ОTC derivative instruments include different types of financial instruments with different specifications and risk characteristics, such as interest rate and currency swaps and other more complex financial instruments, traded as their base. The Bank shall offer conclusion of particular derivative contracts to its clients. The disclosure of information regarding the particular market and contractual risks shall be performed in compliance to the provisions of Ordinance No 38 of the Financial Supervision Commission. Instruments on the money market, including ОТС instruments on money market OTC transaction instruments on the money market are over-the-counter transactions in financial instruments traded on the local money market. Financial instruments of such a type are: short-term government securities (treasury bills), certificate of deposit and commercial stocks (except payment instruments). OTC transaction instruments on the local money market are associated with the principal risks related to debt securities. Leverage, its consequences and the risk of losing the whole investment made Leverage in the field of investment services means employing various methods for raising borrowed capital (margin trade) in order to earn a greater rate of return. Leverage is an investment method where a position is opened to trade funds repeatedly exceeding the own funds (deposited funds) of the investor. Investment leverage instruments can be options, futures, margin trade and other derivatives. 4

5 The use of leverage is associated with an extra risk, since this type of investment leads to an increase of potential loss, rather than on profit only. The current General description of the financial instruments, investment products and the associated risks is inseparably bound to the General conditions applicable to clients of First investment bank AD for investment services and activities with financial instruments. 5