RISKS TO CONSIDER
All investments are associated with risk. The concept of risk has different meanings for different individuals. There are different types of risk related to investments. To simplify the discussion, below is reference to market risk, ie the risk that determines the value of an investment.
Risk and return are two sides of the same coin. High returns requires exposure of your capital to a high degree of risk, alternatively, a low capital exposure to risk results in lower returns.
As an investor you must always weigh the potential return against the risk of loss. The understanding of the relationship between risk and return is therefore an important part in making investment decisions. Below we have summarized the main categories of risks of structured Products.
Remember to always read the information regarding the risks in the issuers base prospectus and final terms and conditions before investing.
One of the main risks regarding structured products, the credit risk, something that became clear in that the US investment bank Lehman Brothers went bankrupt. When buying structured products, you take a credit risk to the issuer, ie the repayment of the principal amount and any interest requires that the issuer is able to meet these commitments on the maturity date. If the issuer becomes insolvent, then you risk losing part or all of the position, no matter how the underlying market has developed.
One way to assess whether the issuer is creditworthy is to look at the ratings issued by rating companies such as Standard & Poor’s and Moody’s. Issuers’ creditworthiness is also reflected in something called credit default swaps (CDS), which shows the cost of insuring against credit events from the Publisher.
Market risk and risk related to the premature sales
Throughout the duration of the product the value can be affected by various factors including market development, remaining maturity, expected future changes (volatility) in the underlying market, market interest and any declared dividend. The principal protection of capital-protected products is only applicable on the maturity date. If you decide to sell the position before the repayment date and the market value is lower than what you paid for at start, you risk making a loss.
Under normal market conditions the organizer typically offers a bid price for those who want to sell prematurely. The bid price is based on the factors mentioned above, and how the structured product is designed. Under certain market conditions it may be difficult or impossible to sell a structured product during the term.
A structured product’s value is generally determined by the market development, placement design and often the so-called participation rate. Participation rate determines how much of the return you are entitled to. This means that if the participation rate is less than 100 percent, you get less than the actual return. Participation rate is determined by the publisher and is determined among other things by the tenor, movement (volatility) of the underlying market, interest rates and expected dividend (if the position is related to the share market).
Premium on capital-protected products
Capital protected products are often offered with different levels of risk. Sometimes a investor is offered an alternative to the nominal investment, a option where you pay a more than the nominal amount, called a premium. Since the capital protection only applies to the principal amount you risk losing the premium if you select a higher level of risk. This is to increase your chance of higher returns.
If the market is unfavorable, you get back the principal on the maturity date should you have a capital-protected product. For other structured products, you may get back less or nothing at all. This means that you may also miss out on the interest that you would have received if you had instead chosen a fixed income investment.
Usually structured products are issued and repaid in Swedish kronor. Meaning that the principal amount is not affected by any possible change in exchange rates. However, there are structured products that are affected by changes in exchange rates between the Swedish krona and other currencies. Then a currency appreciation or depreciation in relation to the Swedish krona can affect the return.
Construction Risk and Complexity
This risk is primarily concerned with the complexities of the derivatives and the yield calculations. Structured products from various actors, at first glance resemble each other and may be linked to the same market, but be designed in different ways. Therefore, comparability between different structured products can be limited. Before buying a structured product you should familiarize yourself with how it works. To get an overall picture of the product, you should read the base prospectus and final terms.
Please note that structured products are not covered by the state deposit guarantees.