RISK WARNING BROCHURE

Transcription

1 RISK WARNING BROCHURE AUGUST 2016 General Information on associated with Financial Instruments BANQUE CARNEGIE LUXEMBOURG S.A. Supervised by the Commission de Surveillance du Secteur Financier (CSSF) 283, route d Arlon, L-1150 Luxembourg

2 GENERAL INFORMATION ON RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS Introduction The information contained in this document is provided to you in compliance with MiFID rules under which, as a Retail Client, you are afforded the highest level of investor protection. This document cannot disclose all the risks and other significant aspects of financial instruments, i.e. transferable securities, money market instruments, investment funds, warrants and derivative products such as futures, options, contracts for differences, and structured products. You should not deal in these financial instruments unless you understand their nature and the extent of your exposure to risk. You should also be satisfied that the financial instrument is suitable for you in the light of your circumstances and financial position. Although complex financial instruments, such as warrants and/or derivative instruments can be utilised for the management of investment risk, some of these products are unsuitable for many investors. Different instruments involve different levels of exposure to risk due to elements such as leveraging and in deciding whether to trade in such instruments you should be aware of the risks involved. The present document does not in any case constitute investment advice. Generally speaking, the word risk may be used to express both the risk of loss and the chance of profit. In the description below, however, the word risk is used solely to designate the risk of loss, that is to say the risk that the total return on the investment be negative. I. General risks associated to any financial instrument The following risks are the main risks inherent to any financial instrument of any kind whatsoever. 1. Economic situation The general economic condition and the changes in economic forecasts and expectations impact the value of all financial assets. The economic cycle may vary in different countries, impacting the rate of returns in financial portfolios accordingly. 2. Inflation risk Rising inflation represents a significant threat to the rate of return of most financial assets. Furthermore, most instruments react to the changes in inflation expectations, meaning that investors may suffer substantial losses from inflation risk, even if there has been no observed rise in the inflation level. 3. Country risk Country risk refers to the negative impact following political instability and associated consequences. Via currency controls, devaluation or regulatory changes or other risks such as mass riots, civil war or other events, a country may not be able to honour its financial commitments, leading to substantial losses in investment instruments issued by such countries or by economic agents residing or operating in such countries. 4. Currency fluctuation The purchase (or selling) of financial assets or instruments denominated outside the investors base currency is subject to currency translation risk. Investors should be especially alert to any mismatch between the denomination of his assets and liabilities, as adverse currency movements may inflate the value of the debt, while negatively impacting the value of the assets financed by such debt. 5. Liquidity risk In case of insufficient market liquidity, investors may not be able to liquidate their financial instruments. The insufficiency of liquidity may result from the laws of supply and demand as well as from characteristics intrinsic to the financial instrument in question or from the market habits. The insufficiency of liquidity due to the laws of supply and demand happens when supply abnormally exceeds demand, or vice versa. In this case, liquidation of investments may be impossible or possible under very unfavourable conditions. The insufficiency of liquidity due to the characteristics intrinsic to a financial instrument or to the market habits may arise as a consequence of long execution delays or of a short-term need of liquidity for instance. 6. Legal risk New or change in legislation can significantly alter the pricing and liquidity of all financial instruments 1

3 7. Insolvency The insolvency or default of an issuer of financial securities may lead to the liquidation of positions at an unexpected moment or to the absence of reimbursement of investments. 8. Psychological risk Factors such as opinions or rumours may affect the pricing of financial instruments even if such opinions or rumours are without merit. It may happen that the company does not distribute any dividend. The main risk associated to shares is the price risk. Indeed, the price of a share depends on various factors, and in particular the following ones: - Current and/or expected financial situation of the company (its current or expected profits, developments, losses or debts, internal organisation, management, disruptions to production ); - General interest rate level; II. Specific risks associated to certain financial instruments 1. Transferable securities This instrument category covers those classes of securities that are negotiable on the capital markets, such as: a) shares in companies and other securities equivalent to shares in companies, partnerships or other entities, and depositary receipts in respect of shares; b) bonds or other forms of securitised debt, including depositary receipts in respect of such securities; a) Shares Shares, which are also referred to as equities or stocks, are securities representing a part of the capital of a company or limited partnership. There are different types of shares, and in particular the following ones: - Bearer shares which are not registered on the books of the issuing company, negotiable without endorsement and transferred by delivery; - Registered shares which are issued in a shareholder s name and can only be transferred with endorsement; - Preferred shares grant to their holder more benefit than those enjoyed by ordinary shareholders. This is often the right to receive a fixed dividend before the common shareholders. Return Income may be derived in the form of dividends, which are payable at the discretion of the company s management, and capital appreciation resulting from a rising share price. In other words, the value of your investment resides in the company s ability to be successful and profitable, and the market s ability to recognize that success, which is a trickier issue than the hard fact of whether or not a company is actually likely to be successful and profitable. - Quantity of a particular share that is bought or sold (the turnover); - National or international conditions for the industry; - Changes in tax and customs charges, - Disasters, terrorist acts - Economic, political, social changes, - Inflation, public debt, economic growth or depression, - Irrational factors, such rumours, opinions and trends, - Etc. These factors may affect the price of a share in a way that does not always seem rational. In the worst case, if a company is declared bankrupt, the share capital will be used first in order to pay the company's debts, which means that the shares in the company will become worthless. It is therefore important that you assess the equity risk linked to this type of instrument before taking the decision to carry out such an investment, and be prepared to sustain a capital loss in the event of a depreciation caused by stock market dynamics. b) Bonds A bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. In other words, a bond is simply a loan, but in the form of a security. The issuer is equivalent to the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds, i.e. they are generally issued for a fixed term (the maturity) longer than ten years. There are many types of bonds, and in particular: - Zero-coupon bonds: bonds with no interest payments and generally issued at a very low price but offers a large redemption premium; - Fixed-rate bonds: bonds with an annual interest fixed rate; 2

4 - Floating-rate bonds: bonds with an interest rate varying over its term; - Subordinated bonds: bonds that are repaid after the other bonds and liabilities of the issuing company but before its shares in case of liquidation or bankruptcy; - Step-up/ step-down bonds: bonds with interest rate increasing (step-up) or decreasing (step-down); - Convertible bonds: bonds that can be converted into shares under certain conditions defined on issuance; - Reverse convertible bonds: bonds of which coupon is higher than those of a common bond and repayment depends on the rate of a benchmark action. - Etc. Return The yield from a bond generally consists in coupon interests, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains). However, some bonds do not pay interest. Although many bonds are considered to be quite safe, investing in the bond market as a whole is not without its risks. All bond instruments carry risk, but the degree of risk varies with the type of debt and the issuer. There are several different types of risk, of which interest rate risk, the risk of default and the call risk are the most important, and you should be aware of how these affect your bond investments. Interest rate risk Bond prices are inversely related to interest rates: if interest rates decreases, the price of the bond will increase, and vice versa. 2. Money market instruments Money market is a market on which financial institutes (central banks, private banks, insurers, funds managers and other big companies) invests their holdings under short-term (less than a year). Money market instruments include those classes of instruments which are normally dealt in on the money market, such as treasury bills, certificates of deposit and commercial papers. These investments are suitable for investors who prefer an investment time period of one year or less. Treasury bills, notes or bonds are fixed-income security instruments issued by a government, which makes them a rather safe investment vehicle, depending however on the issuing country s creditworthiness. They make up the largest, most important, and most liquid fixed-income marketplace in the world. Certificates of deposit represent a loan from an investor to a bank, usually ranging from a fixed time period of ninety days to as long as ten years. Negotiable certificates may be issued for substantial amounts by the largest and safest banks. A commercial paper represents an unsecured short-term loan from an investor to a corporation. It is sold to investors at a discount to its face value and is redeemed at face value upon maturity. Most commercial papers have a very short maturity term of between 30 and 90 days. Both certificates of deposit and commercial papers are generally regarded as rather safe investments, depending however on the risk of default of the issuing counterparty. They are mostly sold to large institutional investors such as money market funds. Risk of default If issuing companies default on their obligations, go to liquidation or bankruptcy, the bonds can become worthless. Call risk Some bonds must be redeemed by the bondholder at the issuing company s request. This usually happens to enable the issuing company to issue new bonds at a lower interest rate. In this case, the bondholder is forced to reinvest the principal sooner than expected, usually at a lower interest rate. Additional risk related to off-exchange securities transactions Transactions in off-exchange securities may involve greater risk than dealing in exchange traded securities because there is no exchange market through which to liquidate your position, or to assess the value of the securities or the exposure to risk. Bid and offer prices need not be quoted, and even where they are, they will be established by dealers in these instruments and consequently it may be difficult to establish what is a fair price. Money market is reserved to significant investments done by professionals. Most of private investors only accedes money market through Monetary Undertakings for Collective Investment. Credit risk related to monetary instruments first consist in the default of payment of the interests and in the partial non-payment of the capital investment. However, a generalised risk over the money markets of the OCDE countries can only happen in case of a very acute banking crisis. Reinvestment risk Considering the short lifespan of the instruments of money market, the investor bears the risk that the investment be remunerated at a lower interest rate. 3

5 3. Undertakings for Collective Investment An Undertaking for Collective Investment (UCI) is a company or organisation collecting funds from a number of investors for the purpose of placing the sums in different assets based on the principle of risk diversification and enabling its shareholders or members to benefit from the results of the management of their assets. Investment funds, like stocks and bonds, are very common investment instruments among large and small investors. When buying shares or units of a fund, you become part owner, along with other investors in the fund, of a sizeable investment portfolio made up of a large number of individual securities issuers. A professional investment advisor manages the fund s investments according to its stated objectives. This is one of the main reasons that mutual funds have become so popular. Most investors, especially private individuals, would be extremely hard-pressed to successfully direct or even afford such a large number of different singular investments. Furthermore, the diversification inherent in so many separate issuers within a single fund works to mitigate the risk of serious loss due to the underperformance of any one company or industry. Investment funds by their nature tend to invest in a range of individual securities. However, if the securities are all in a similar type of asset class or market sector then there is a systematic risk that all the shares could be affected by adverse market changes. There are three types of UCI: - classic UCI; - UCITS which invests in Transferable Securities - SIF (Specialised Investment Funds), mutual funds which reserves their shares to one or several institutional investor(s). There are two legal forms of UCI: a) Contractual-type fund (FCP Fonds Commun de Placement ) The FCP is an unincorporated collective investment fund constituted by investors whose liability is limited to their participation. As such, the FCP has no legal personality and has to be run by a management company, under management rules, in the sole interest of the unit holders. Management rules concern in particular the investment policy, the distribution policy and methods of issuing and redeeming the FCP units. When subscribing to FCP units, the investor agrees to the management rules and to any of its potential later amendments. Indeed, investors in FCP do not have voting rights. b) Open or closed investment company (SICAV or SICAF) These types of UCI have a legal personality. Investors have voting rights and can participate at the general shareholders meeting. We can distinguish: - The SICAV (open-end fund), where the number of shares and participants is not fixed. At each valuation date (generally daily, weekly or monthly) this type of fund issues new shares to investors and buys back shares from investors wishing to leave the fund; - The SICAF (closed-end fund), where the number of shares issued is limited to a specific number. Unlike open-end funds, however, closed-end funds issue shares to the public only once. They do not continually sell new shares, or redeem already outstanding ones, until the fund is liquidated. Typically, an investor may acquire shares in a closed-end fund by buying shares on a secondary market from a broker, market maker, or other investor. In this case, the price of a share is determined partially by the value of the investments in the fund, and partially by the premium (or discount) placed on it by the market; - Exchange-traded fund (ETF): this type of fund is often referred to as an open-end investment fund. However, ETFs combine characteristics of both open-end and closedend funds. An ETF usually tracks a stock index and shares are issued or redeemed by institutional investors in large blocks. Investors typically purchase shares in small quantities through brokers at a small premium or discount to the net asset value. UCI may also be classified by type of investments or investment strategy: - Money Market funds investing in money market instruments. This kind of fund is deemed to entail the least risk, as well as lower rates of return; - Real estate funds investing in real estate; - Bond funds investing in bonds under one or several currency; - Equity funds investing mostly in equities; - Mixed funds investing in both bonds and shares; - Funds of funds (FoFs) investing in other underlying mutual funds; - Capital guaranteed funds which guarantee investors initial capital investment from any losses or which guarantee investors a minimum return linked to the performance of an underlying asset. Such protection is usually conditioned to the subscription of a particular type of insurance; - Hedge funds which are allowed to use aggressive investment strategies such as short selling, entering into futures, swaps and other derivative contracts and leverage. A hedge fund will often seek to generate returns 4

6 that are not closely correlated to those of the broader financial markets by hedging its investments against adverse movements in those markets. value of derivative securities, such as options, forwards and swaps is determined by (respectively, derives from) the prices of the underlying securities. As a hedge fund is largely unregulated, its investment manager is able to deploy a wider range of investment strategies and tactics than it could for a regulated fund, and investing in a hedge fund is therefore considered to carry a higher risk. For the purposes of consumer protection, in most countries hedge funds are prohibited from marketing to investors who are not professional investors or individuals with sufficient private wealth, unlike traditional funds. Price risk UCI are subject to all risks related to the assets in their portfolio. Indeed, UCI units or shares are exposed to the risk of a drop in their value in accordance with the decrease in value of their portfolio s assets. This is why it is considered that the risks are lower when the assets of a fund are diversified and higher when the fund is specialised. Management risk The return on investment in UCI depends, among other factors, on the investment decisions made by the fund managers. Therefore, UCI are exposed to the risk of loss resulting from wrong management decisions. 4. Structured products Structured products are synthetic investment instruments specially created to meet specific needs that cannot be met from the standardized financial instruments available in the markets. Structured products can be used: - as an alternative to a direct investment; or - as part of the asset allocation process to reduce risk exposure of a portfolio; or - to utilize the current market trend. Even though structured products may have certain benefits, such as principal protection, enhanced returns and reduced volatility or risk within an investment, they are unlisted illiquid investments linked to the performance of one or more market prices, rates, indices, securities and other financial instruments that introduce significant risk that will affect the performance of the structured product. 5. Securitised derivatives Derivatives are financial instruments whose value varies according to the value of the underlying asset (underlying); the underlying may be a market index, an interest rate, a currency, a commodity price or even another derivative. These instruments often involve a high degree of gearing or leverage, so that a relatively small movement in the price of the underlying investment results in a much large movement, unfavourable or favourable, in the price of the instrument. The price of these instruments can therefore be volatile. These instruments have a limited life, and may (unless there is some form of guaranteed return to the amount you are investing in the product) expire worthless if the underlying instrument does not perform as expected. Concerning derivatives, a distinction must be made between: - Options, which give the holder the right, but not the obligation, to enter into a transaction; - Forward transactions, where the parties enter into a transaction that must be performed at a specified date in the future; - Contracts for difference, where the buyer and the seller agrees that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. a) Options and warrants A structured product is generally a pre-packaged investment strategy which is based on derivatives (i.e. options and to a lesser extent, swaps) but which features protection of principal if held to maturity. Combinations of derivatives and financial instruments create structures that have significant risk/return and/or cost savings profiles that may not be otherwise achievable in the marketplace. Structured products are designed to provide investors with highly targeted investments tied to their specific risk profiles, return requirements and market expectations. Options belong to the category derivative securities. Buying an option gives the right to purchase (call) or sell (put) a certain quantity of an underlying asset at a set price (strike price) on or before a given date (the expiration date). The seller of an option undertakes to sell or to buy the fixed quantity of the underlying if the buyer exercises its option. The buyer of a call will make a profit if at the expiration date the price of the underlying asset (stock price) is higher than the strike price. A put option has positive monetary value when the underlying has a stock price below the strike price. These products are created through the process of financial engineering, i.e. by combining underlying instruments like shares, bonds, indices or commodities with derivatives. The A call is said in the money when the rate of the underlying exceeds the strike price. A put is said in the money when the rate of the underlying is below of the strike price. A call is out 5

7 of the money when the rate of the underlying is inferior to the strike price. A put is out of the money when the rate of the underlying is higher than the strike price. When the rate of the underlying equals the strike price, the option is at the money. There are many different types of options with different characteristics, and in particular the following ones: - American options which can be exercised anytime until the expiration date; - European options which can be exercised only at a fixed date, usually the expiration date; - Exotic options which are subject to additional conditions concerning the underlying asset or the calculation of how or when the investor receives a certain payoff. These options are more complex than options that trade on an exchange, and generally trade over the counter and under the form of warrants. The variants of exotic options are unlimited. This is why it is imperative for investors to seek for relevant information regarding the risks involved on a case-by-case basis; - Knock-in option which is a latent option contract that begins to function as a normal option only once a certain price level is reached before expiration; - Knock-out option which functions as a normal option until the underlying reaches a certain price level; - Warrants which are a type of option traded on the stock market, under transferable securities and generally issued by financial institutions. A warrant is a time-limited right to subscribe for shares, debentures, loan stock or government securities and is exercisable against the original issuer of the underlying securities. A relatively small movement in the price of the underlying security results in a disproportionately large movement, unfavourable or favourable, in the price of the warrant. The prices of warrants can therefore be volatile. Warrants are financial instruments with leverage effects, which means that they are subject to price variations generally higher than changes in the underlying asset price. It is essential for anyone who is considering purchasing warrants to understand that the right to subscribe that a warrant confers is invariably limited in time with the consequence that if the investor fails to exercise this right within the predetermined time-scale then the investment becomes worthless. You should not buy a warrant unless you are prepared to sustain a total loss of the money you have invested plus any commission or other transaction charges. Option value (premium) The option value (premium) is the amount per underlying that an option buyer pays to the seller. Price risk Option prices follow the law of supply and demand but are also affected by various factors such as interest rates, market liquidity, the underlying asset price, time to maturity and the volatility of the underlying instrument. Considering the various factors in question, the value of an option may decline although the price of the underlying asset remains unchanged or even appreciates. Leverage risk Options and warrants are sensitive to the leverage effect, which means that a small movement in the underlying may have a significant impact on their valuation. This leverage effect can be both beneficial and disadvantageous to the investor. Time value The difference between an options strike price and the value of the underlying asset is called the options intrinsic value. The difference between this intrinsic value and the price of the option is time value. As the option moves towards its expiration date, this time value will decrease to zero. At maturity, the gain (or loss) from investing in the option is solely decided by its intrinsic value. Option sale specific risk If you write (sell) an option, the risks involved are considerably greater than buying options. You will be required maintain collateral to support your position and a loss may be sustained well in excess of the premium received. By writing an option, you accept a legal obligation to purchase or sell the underlying asset if the option is exercised against you. If you already own the underlying asset which you have contracted to sell (when the options will be known as covered call options ) the risk is reduced. If you do not own the underlying asset ( uncovered call options ) the risk can be unlimited. Only experienced investors should contemplate writing uncovered options, and then only after securing full details of the applicable conditions and potential risk exposure. b) Futures Futures designate contracts by which two parties firmly agree to buy or to sell a certain quantity of an underlying asset at a set price and at a fixed date (the expiration date). Futures are contracts traded on a stock exchange. They are standardised regarding the quantity of the underlying asset and expiry date of the transaction. If, at the expiration date, the price of the underlying asset is higher than the price fixed when the contract is concluded (the initial margin), the buyer of the contract earns a profit. On the contrary, it bears a loss. 6

8 As in any derivative instrument, futures are concerned by the leverage effect. Leverage effect The gearing or leverage often obtainable in futures trading means that a small deposit or down payment can lead to large losses as well as gains. It also means that a relatively small movement can lead to a proportionately much larger movement in the value of your investment, and this can work against you as well as for you. Changes in value of a contract or underlying asset The seller will have to deliver the underlying asset at the price initially agreed, which may be much lower than the market price at delivery. On the contrary, the purchaser will still be obliged to accept the asset at the price initially agreed, which can potentially be much higher than the price at delivery, even if the value of the contract or underlying asset decreases. For the buyer as well as for the seller, the risk is equal to the difference between the agreed contract price and the market value at delivery. In any case, the potential loss may considerably exceed initially required margins, and you will be required to continuously provide adequate collateral to keep the position open. c) Other forward contracts - Over-the-counter (OTC) contracts are contracts that are not traded on a stock exchange. They may be standardised or individually negotiated between purchaser and seller. While some off-exchange markets are highly liquid, transactions in off-exchange or non-transferable derivatives may involve greater risk than investing in on-exchange derivatives because there is no exchange market on which to close out an open position. It may be impossible to liquidate an existing position, to assess the value of the position arising from an off-exchange transaction or to assess the exposure to risk. Bid prices and offer prices need not be quoted, and, even where they are, they will be established by dealers in these instruments and consequently it may be difficult to establish what is considered a fair price. - Forward foreign exchange contracts are OTC agreements between two parties to exchange a specified amount of one currency for another currency at a specified foreign exchange rate on a future date. The foreign exchange market is virtually free of any external controls, making it almost impossible for anyone to manipulate it. It is also the largest liquid financial market and, because of its liquidity, positions in the market can be opened and closed extremely quickly. utilise marginal trading to try to obtain large short-term gains. The combination of small but generally constant daily fluctuations in currency prices creates an attractive environment for a wide range of investors with differing investment strategies. However, the potential for profit or loss from forward foreign exchange transactions will be affected by these fluctuations. d) Contracts for differences A contract for difference (or CFD) is a contract between two parties, buyer and seller, stipulating that the seller will pay to the buyer the difference between the current value of an asset and its value at contract time. If the difference is negative, then the buyer pays instead to the seller. When applied to equities, such a contract is an equity derivative that allows investors to speculate on share price movements, without the need for ownership of the underlying shares. CFDs allow investors to take long or short positions, and unlike futures contracts have no fixed expiry date or contract size. Trades are conducted on a leveraged basis with margins typically ranging from 1% to 30% of the notional value for CFDs on leading equities. Investing in a CFD carries the same risks as investing Directly in the underlying instrument. However, unlike other derivative contracts, CFD contracts can only be settled in cash. e) Special risks associated with securitised derivatives: contingent liability investment transactions Contingent liability investment transactions, which are margined, require you to make a series of payments against the purchase price, instead of paying the whole purchase price immediately. If you trade in futures or contracts for differences, or if you sell options, you may sustain a total loss of the margin you deposit with your firm to establish or maintain a position. If the market moves against you, you may be called upon to pay substantial additional margin at short notice to maintain the position. If you fail to do so within the time required, your position may be liquidated at a loss and you will be responsible for the resulting deficit. Even if a transaction is not margined, it may still carry an obligation to make further payments in certain circumstances over and above any amount paid when you entered the contract. Margined or contingent liability transactions are primarily carried out on or under the rules of a recognised or designated investment exchange. Contingent liability investment transactions which are not so traded may expose you to substantially greater risks. Some investors may want to participate in the foreign exchange market for long-term hedge positions, while others 7