The passing on of this electronic edition is not permitted.

RISKS IN SECURITIES TRADING

3rd Edition

EN
IM
EC

Information Brochure
SP

on Types of Financial Instruments

and Associated Risks
The passing on of this electronic edition is not permitted.

EN
IM
EC
SP
The passing on of this electronic edition is not permitted.

Contents

EN
Contents ......................................................................................................................................................................3
Introduction .................................................................................................................................................................5
I. Purpose and content ......................................................................................................................................................... 5
II. The client's rights to information from the bank .............................................................................................................. 6

Section One:

II.
III.

Section Two:
IM
General risks associated with investments in financial instruments ...................................................................7
I. General risks associated with financial instruments......................................................................................................... 7
Other general risks ........................................................................................................................................................... 8
Risk of total loss and unlimited risks ............................................................................................................................... 9

Overview of the characteristics and product-specific risks of financial instruments.......................................10

I. Bonds ............................................................................................................................................................................. 10
EC
II. Money market instruments............................................................................................................................................. 11
III. Shares ............................................................................................................................................................................. 11
IV. Investment funds ............................................................................................................................................................ 12
V. Derivatives / Forwards and futures ................................................................................................................................ 15
1. Options ...................................................................................................................................................................... 15
2. Forwards and futures ................................................................................................................................................. 20
3. Forward exchange contracts ...................................................................................................................................... 22
4. Swaps ........................................................................................................................................................................ 23
VI. Structured products ........................................................................................................................................................ 24
1. Capital protection products ....................................................................................................................................... 25
2. Yield enhancement products ..................................................................................................................................... 26
3. Participation products ................................................................................................................................................ 26
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4. Leverage products ..................................................................................................................................................... 27

VII. Products used for financing or risk transfer ................................................................................................................... 27
VIII. Alternative (non-traditional) investments ...................................................................................................................... 28
1. Hedge funds .............................................................................................................................................................. 29
2. Private equity ............................................................................................................................................................ 31
3. Real estate ................................................................................................................................................................. 32
4. Precious metals and other commodities .................................................................................................................... 32

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EN
Section Three:
Additional information .............................................................................................................................................34
I. Investments in emerging markets................................................................................................................................... 34
II. Guarantees ..................................................................................................................................................................... 35
III.
IV.
V.

Appendix 1:
IM
Securities lending ........................................................................................................................................................... 35
Performance of financial instruments under different market conditions ...................................................................... 36
Barriers to minimising misinvestments .......................................................................................................................... 37

Overview of the characteristics and risks of selected financial instruments ....................................................38

Appendix 2:
Financial instruments ...............................................................................................................................................43
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SP

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Introduction RISKS IN SECURITIES TRADING

Introduction

EN
I. Purpose and content cannot always be foreseen at the outset, so that the
remarks contained in this section should not be
Trading in financial instruments holds opportunities, considered exhaustive. Due to the dynamic develop-
but also financial risks. To understand the various ment in the securities trading business, this brochure
financial instruments and to recognise and limit the can likewise not make the claim to comprehensively
risks associated with them, knowledge of their
essential characteristics and risks is necessary. For this
reason, the law of the European Economic Area (EEA)
and the Liechtenstein Banking Act and Banking
Ordinance demand of the Liechtenstein banks that:

x they conduct themselves in a fair, honest, and

professional manner in the best interests of their
IM describe all possible or conceivable financial instru-
ments and product groups. Accordingly, this brochure
has deliberately not been designed as a comprehensive
reference.

SECTION THREE contains special information on

investments in emerging markets, guarantees, and
securities lending.
clients when performing investment services, and
EC
x they provide appropriate information in an under-
Supplementing the information presented in Sections
One and Two, APPENDIX 1 contains a brief tabular
standable form to their existing and potential clients overview of selected financial instruments, their
on the financial instruments offered. special features, and their characteristic risks.

Against the background of this legally prescribed The terminology and technical terms used in this
information requirement, this brochure aims to provide brochure are based on the applicable laws. The term
you with information on the basic terminology, the "financial instrument" used in this brochure is an
most important types of financial instruments, and the umbrella term for all securities, book-entry securities,
risks associated with these financial instruments. and derivatives, including those not standardised or
traded on an exchange or regulated market. An
SECTION ONE briefly describes potential general exhaustive list of the financial products covered is
SP

risks in connection with investments in financial contained in the Liechtenstein Banking Act and
instruments. reproduced in APPENDIX 2. The term "securities",
also used in this brochure, includes all fungible
SECTION TWO discusses the special characteristics securities that are negotiable on the capital market.
and risks of specific groups of financial instruments in
more detail. "Risk" in this context means the non- Please read this brochure carefully, and ask your bank
achievement of an expected return on invested capital if you have any questions.
and / or the loss of up to the total value of the invested
capital. Depending on the structure of the product,
these risks may be due to several causes – located in
the product, the markets, or the issuer. These risks

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Introduction RISKS IN SECURITIES TRADING

II. The client's rights to information personal tax situation, nor does it discuss other legal
from the bank consequences pertaining to securities transactions (e.g.

EN
duties of disclosure). We advise you to look into these
What are the client's rights to information matters yourself or to obtain professional advice.
from the bank?
According to the Liechtenstein Banking Ordinance,
banks are required to provide their clients with a
general description of the type and risks of the
financial instruments before carrying out services. This
description must contain the characteristics of the type
of financial instrument concerned as well as the
associated risks in sufficient detail. Accordingly, this
information brochure discusses customary product
characteristics and explains the various financial
instruments and their associated risks in a general way.
The brochure does not provide information on the risks
associated with specific individual financial instru-
ments. The risk arising from the creditworthiness of
the issuer of a product always depends on the specific
case, and the investor must therefore pay particular
attention to such credit risks. The risks of a particular
product are thus ultimately always determined by its
IM
specific composition. The description below cannot
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replace the product descriptions by the issuers or a
detailed examination of the specific product by the
investor.

Product descriptions by the issuers of

financial instruments
Financial instruments offered to the public are subject
to the prospectus requirement. Prospectuses may be
requested directly from the issuer. Some are also
available on the internet. As a rule, the issuer also
offers "term sheets" summarising the essential infor-
mation on the financial instruments in question, in
SP

particular on the specific risks and any guarantors.

Your bank is happy to provide you with such
documents where available.

Taxation and other legal consequences

Investments in financial instruments may have tax
consequences that diminish returns. The purchase,
holding, or sale of financial instruments may also be
subject to tax rules (e.g. withholding tax) outside the
investor's country of domicile. This information
brochure does not discuss taxes or their effect on your

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Section One RISKS IN SECURITIES TRADING

Section One:

EN
General risks associated with investments
in financial instruments

I. General risks associated with Inflation risk / monetary value risk

financial instruments Inflation may diminish the value of an investment. The
purchasing power of the invested capital decreases
Issuer risk (credit risk) when the inflation rate is higher than the return gene-
Credit risk is determined by the borrower's credit rated by the securities.
capacity and creditworthiness and is therefore a
measure of the borrower's solvency. The issuer risk is
the danger of the insolvency of the borrower, i.e. the
borrower's potential inability to fulfil obligations in a
timely or complete manner, such a dividend payments,
interest rate payments, repayment, etc. This risk can be
estimated with the help of ratings, a scale for
evaluating the solvency of the borrower. The rating is
IM Market risk / price fluctuation risk
The market risk or price fluctuation risk is the potential
fluctuation in the value of a financial instrument. If the
market value of the financial instrument drops, the
assets shrink.

Country risk / transfer risk

published by the recognised rating agencies, ranging Investments abroad are subject to country risk.
EC
from "AAA" (best credit rating) to "D" (worst credit Insecure political, economic, and social circumstances
rating). The higher the credit risk, the lower the in another country may have negative effects on all
corresponding rating and, as a rule, the higher the borrowers situated in that country. Country risk mani-
interest rate (risk premium) paid on a financial fests itself financially mainly in the form of exchange
instrument. A deterioration of solvency or the rate risks and transfer risk, which may impede or
complete insolvency of the borrower entails at least a entirely prevent the international movement of pay-
partial loss of the invested capital. ments or capital. The latter may occur in the form of
foreign exchange controls, capital movement restric-
Settlement risk tions, debt restructuring, and – in extreme cases – the
A settlement risk occurs when you have to pay the "freezing" of accounts of foreign business partners.
purchase price of a financial instrument in advance but
receive the security with a time delay. In this event, the There is also a risk that political or foreign exchange
SP

risk is that you will pay the purchase price and receive measures may prevent or aggravate the realisation
the securities late or even not at all. Conversely, when of investments or the payment of interest and
you are obliged to deliver financial securities that you dividends. Problems may also occur when settling
have sold, you may not receive the purchase price from orders. In the case of foreign currency transactions,
the buyer at the same time. Settlement risks mainly such measures may also entail that the foreign
occur in emerging markets (see page 34). currency is no longer freely convertible.

Guarantor risk Liquidity risk

Where a third party acts as the guarantor of an issuer, The possibility of purchasing or selling a financial
the insolvency of the guarantor may make timely instrument at any time at prices in line with the market
settlement impossible (see also issuer risk). is called "liquidity". In the case of liquid financial

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Section One RISKS IN SECURITIES TRADING

instruments, sufficient supply and demand generally Risks in order placement

exist for the transaction to be concluded immediately. Order placement is the request by a client for his bank

EN
In the case of illiquid securities, supply or demand to buy or sell financial instruments. Buy or sell orders
may be insufficient or non-existent, so that the must at least indicate the number / par value of which
purchase or sale may not be possible at the desired financial instruments are to be bought or sold at what
time and / or the desired price. Especially in the case of price.

x Market order
shares of unlisted companies or small companies
(secondary stocks), structured products, issue of own
securities, alternative investments, or investments with By marking "market order" (without limit price) on
sales restrictions, it should be expected that the market the order, you accept any possible price; the buy
may experience (phases of) illiquidity. price or sell price is uncertain. Market orders are
customarily processed immediately or in accordance
Currency risk with the practice of the trading centre.
If an investment in a financial instrument is carried out
in a foreign currency, the return or performance of this
transaction depends heavily on the development of the
exchange rate of the foreign currency in relation to the
base currency of the investor (e.g. Swiss franc).
Sinking exchange rates lead to a diminishment in the
value of the foreign currency investment. Investors
only investing in their own country's currency can
exclude this risk. However, internationally operating
IM Orders may include provisions to limit risk, which may
however also increase the risk of non-execution.

x Limit price
With a "buy limit", you can limit the buy price of an
order and thus your capital invested (upper limit
price); i.e., no purchases will be carried out above
the limit price. With a "sell limit", you can specify
companies are more or less heavily exposed to the lowest acceptable sell price (lower limit price);
EC
exchange rate fluctuations. These fluctuations may i.e. no sales will be carried out below the limit price.

x Time limit
therefore indirectly also affect the market value of
financial instruments.
You can limit the validity of an order with a time
Interest rate risk limit. The validity of orders without time limits is
Fluctuations in the interest rate level of money and generally based on the practices of the trading centre
capital markets directly affect the values of fixed- used.
interest securities. As a rule, rising interest rates have a
negative impact on the market values of equity papers Your relationship manager will be happy to provide
and bonds. Sinking rates, conversely, have a positive you with information on other order restrictions.
effect on market values.
Risks associated with custody of financial
SP

instruments
II. Other general risks Financial instruments are generally held where they
are most often traded (in your country or abroad). They
Purchase of financial instruments on are governed by the regulations that apply there. If
credit ("leveraging") your bank becomes insolvent, Liechtenstein law
The purchase of financial instruments on credit stipulates that the financial instruments deposited with
represents an increased risk. The borrowed funds must that bank will not form part of its bankruptcy assets,
be repaid irrespective of the investment's success. The but will be kept separate for your benefit. However,
costs for taking out the loan also diminish the return. insolvency proceedings can delay the transfer of the
financial instruments to you or another bank. If a third-
party custodian becomes insolvent, the law in many

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Section One RISKS IN SECURITIES TRADING

countries provides that the financial instruments require all shareholders and creditors to assume full
deposited with that custodian by your bank are also liability.

EN
normally protected. In less advanced markets (see page
34), however, financial instruments deposited with a
third-party custodian in the country concerned may be
included in the custodian's bankruptcy assets.

III. Risk of total loss and

unlimited risks

There are basically two types of financial instruments:

those with limited risk and those with unlimited risk.
With the purchase of financial instruments without
margin calls, you assume a limited risk and, at worst,
may lose the entire amount of your invested capital
(total loss).

On the other hand, there are certain financial

instruments that can require an additional outlay of
capital over and above the original investment. The
margin call may amount to many times the purchase
IM
price of the investment and, in theory, be unlimited.
EC
In the event of the insolvency of an issuer (e.g. the
issuer becomes overindebted or is unable to meet its
payment obligations), the value of financial instru-
ments issued by that issuer will decline significantly
(potentially resulting in a total loss of the capital
invested). As a general rule, insolvency administrators
or government agencies will be appointed, and they
will determine whether the undertaking can be
continued or must be wound up under recovery and
resolution procedures. The issuer’s shareholders and
creditors will either receive just a proportion of their
SP

claims, calculated on the basis of the liquidation assets,

or will have the opportunity to hold an interest in the
undertaking if it continues to operate. This ordinarily
involves significant downgrading of shareholder or
creditor claims and a substantial reduction in the
nominal value of shares or a deterioration in the value
of creditor claims. Shareholders or creditors are at risk
of being bailed in under a bail-in regime, even if, in
practice, losses must first be absorbed by other
shareholders or creditors. Ultimately, this would

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Section Two RISKS IN SECURITIES TRADING

Section Two:

EN
Overview of the characteristics and product-specific risks
of financial instruments

I. Bonds currencies are US dollar, yen, Swiss franc, pound

sterling and euro.
What are bonds?
Bonds are securities for which the issuer (= borrower) x Notes
is obliged to pay interest on the capital received from Notes are privately placed, securitised, medium-term
the bearer (= creditor, buyer) and to repay the capital
in accordance with the agreed conditions (interest rate,
issue price, maturity, denomination, repayment
conditions, paying agent, guarantees, etc.).

What are the most common types?

x Medium-term bank notes
IM debt instruments of foreign borrowers.

PLEASE NOTE: Private placement means that the

securities are not traded on an exchange or a
regulated market, but rather are only made available
to a restricted circle of investors, which increases the
liquidity risk.

x Convertible bonds / exchangeable bonds

Medium-term bank notes are medium-term, fixed-
interest debt instruments issued on an ongoing basis
EC
according to the needs of the issuing bank. These are bonds that can be converted / exchanged

x Straight bonds
into equity papers (e.g. shares) of the same company
(convertible bonds) or of another company (ex-
Straight bonds are issued by governments or private changeable bonds), under certain prerequisites and
companies in return for cash. They are long-term conditions. If no conversion occurs, the bonds are
partial debt instruments issued in round amounts. paid back upon maturity at the par value or in

x Eurobonds
accordance with the terms of the issue.

Eurobonds are bonds with medium and long x Warrant issues

durations (between 5 and 15 years) on the Euro- Warrant issues are bonds giving the owner the right
market, which unlike foreign bonds do not to buy a security (e.g. shares) traded on a regulated
correspond to the currency of the placement country. market within a certain time at a fixed price, in
SP

Eurobonds are generally issued by international bank exchange for the warrant. This security (underlying)
consortia. The borrowers are private companies, can be bought in addition to the bond. These
governments and other public bodies as well as warrants can also be traded independently of the
supranational institutions. bond.

PLEASE NOTE: "Eurobond" does not refer to the x Mortgage bonds

currency, but only means that the bond borrower is Mortgage bonds are straight bonds issued by
domiciled outside the country in which the bond is specially authorised mortgage bond institutes, with
issued. A Eurobond may therefore be issued in special repayment and interest payment guarantees.
dollars or francs, for instance. The predominant bond The mortgage bond is secured directly by a lien on

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Section Two RISKS IN SECURITIES TRADING

outstanding accounts and indirectly by a lien on What are the most common types?
property. The most common money market instruments include:

EN
How are bonds traded? x Certificates of deposit
Bonds are traded on an exchange or regulated market Money market papers with maturities of generally 30
or over-the-counter. Upon request, your bank can to 360 days, issued by banks.

x Commercial papers
provide you with the buy and sell prices of specific
bonds.
Short-term borrower's notes with maturities of
What are the earnings and return generally 5 to 270 days, issued by large corporations.
expectations?
The earnings consist of the interest paid on the x Treasury bills
invested capital and any difference between the buy Short-term pecuniary claim against a state (espe-
price and the price obtained when the bond is sold (e.g. cially USA, Canada, UK).
issue price is less than redemption price) or upon
maturity.

PLEASE NOTE: Any return can only be stated in

advance if the bond is held until the regular repayment
date. If the bond is sold before the regular repayment
date, the achievable sell price is uncertain and
depends on supply and demand, i.e. the effective
IM How are money market instruments
traded?
Typically, there is no regulated secondary market for
money market instruments, i.e. they are not traded on
an exchange or regulated market.

What are the earnings and return

return may differ from the originally calculated return. expectations?
EC
The calculation of the net return should also take The earnings and return expectations are largely
account of fees. equivalent to those of bonds (see page 11).

What are the particular risks? What are the particular risks?
x
x
Issuer risk / credit risk Like the earnings and return expectations, the risk

x
Inflation risk / monetary value risk components of money market instruments largely

x
Market risk / price fluctuation risk correspond to those of bonds. Money market

x
Liquidity risk instruments have special liquidity risks, however.

x
Currency risk (in the case of foreign currency bonds) Since there is no secondary market, availability cannot
Interest rate risk be ensured at all times. The liquidity risk recedes if a
sufficiently solvent issuer guarantees repayment of the
invested capital at any time. Due to the short maturity,
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II. Money market instruments the interest rate sensitivity of these instruments is
lower than that of bonds.
What are money market instruments?
"Money market instruments" designate financial
instruments which, on the basis of their maturity and III. Shares
circle of issuers and investors, can be attributed to the
money market. Financial instruments are attributed to What are shares?
the money market if their maturity does not exceed 12 Shares are securities that securitise participation in a
months. (joint stock) company.

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Section Two RISKS IN SECURITIES TRADING

What are the most common types?

x Classification according to transferability
exceptional cases, a dividend may also be distributed
even though the company has not generated a profit.

EN
Bearer shares are easily tradable, since the transfer of The amount of the dividend is either indicated as an
rights occurs with the transfer of the security. The absolute amount per share or as a percentage of the par
shareholder remains unknown to the company. For value. Shares thus allow shareholders to participate
this reason, bearer shares must always be fully paid- directly in the economic success or failure of a
up. company.

In the case of registered shares, shareholders are As a rule, the more substantial part of the earnings
entered in a share register. Only persons entered in from shares consists in the performance (price
the register are recognised as shareholders. Register- development) of the share.
ed shares with restricted transferability are shares
whose transferability is limited by the articles of What are the specific rights and duties?
incorporation. Capital and membership rights can be distinguished.

x Classification according to rights

Preference shares or preferred shares enjoy certain
privileges relating to dividends, subscription rights,
and liquidation proceeds compared with ordinary
shares. Often, however, these privileges are in ex-
change for a renunciation of voting rights. Ordinary
shares are also called common stock.
IM x Membership rights in the general meeting of the
company:
These include the right of participation, voting
rights, the right to elect and stand for election, rights
of control, and the right to contest resolutions.

x Capital rights:
Capital rights primarily include the right to a
EC
Voting shares are a particular type of preference dividend, the right to subscribe for new shares during
shares. These are shares with a lower par value than capital increases (subscription rights), and the right
other shares of the same company, but with the same to part of the liquidation proceeds.
voting rights. Voting shares also exist with the same
What are the particular risks?
x
par value but greater voting rights.

x
Issuer risk / credit risk

x
Companies may also issue stock-like securities. Country risk / transfer risk

x
These participation certificates and dividend-right Liquidity risk

x
certificates grant owners certain property or other Market risk / price fluctuation risk
rights defined in the articles. Currency risk

How are shares traded?

SP

Shares can be traded on an exchange or regulated IV. Investment funds

market as well as over-the-counter.
What are investment funds?
What are the earnings and return An investment fund is a pool of assets, established as a
expectations? separate legal entity, in which investors hold shares
Share earnings can be composed of dividend pay- under an agreement with identical content concluded
ments, proceeds from subscription rights, and price between a number of investors, thereby establishing a
gains / losses, so that they cannot be predicted. management company and a depository for the
purposes of investing, managing and holding the
A dividend is a proportion of the company profit collective assets in safekeeping on behalf of investors.
distributed by resolution of the general meeting. In Unless otherwise specified, the fund assets are

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Section Two RISKS IN SECURITIES TRADING

managed by a management company for collective related Liechtenstein Investment Undertakings

investment on behalf of investors in accordance with Ordinance (IUO; Investmentunternehmensverord-

EN
the investment strategy and the principle of risk- nung – IUV).
spreading. Capital invested by multiple investors is
therefore pooled in the investment fund and reinvested. What types of investment fund are there?
Securities funds and non-securities funds are subcate- The law distinguishes between the following fund
gories of investment funds. types, based on the type of investment:

First of all, it is necessary to draw a distinction between x Undertakings for collective investment in transferable
investment funds in terms of their governing law: securities (UCITS)

x Foreign investment funds governed by foreign

Since 2011, undertakings for collective investment in
transferable securities (UCITS or UCITS funds) have
statutory provisions, which may vary significantly been governed by the UCITS Act. The Act sets out
from the laws and regulations applying in the rules and procedures for the licensing,
Liechtenstein

x Liechtenstein investment funds governed by

Liechtenstein law, which are described in more detail
below

Investment funds under Liechtenstein law

Liechtenstein investment funds are governed by a
IM supervision and investment activities of investment
funds and related management companies. The Act
applies to all UCITS that are established in
Liechtenstein or available to the general public either
in or from Liechtenstein. Because the Principality of
Liechtenstein is a member of the EEA, Liechtenstein
management companies and related UCITS funds
benefit from EU passporting rights, providing direct
number of different laws. The EU UCITS IV Directive access to the European market. The sole object of
EC
was transposed into national law by means of the UCITS is the collective investment of capital raised
Liechtenstein Act on Certain Undertakings for from the public in transferable securities or in other
Collective Investment in Transferable Securities liquid financial assets referred to in the UCITS Act
(UCITS Act; Gesetz über bestimmte Organismen für by operating on the principle of risk-spreading with
gemeinsame Anlagen in Wertpapieren – UCITSG) and units which are, at the request of holders,
the related Liechtenstein Ordinance on Certain Under- repurchased or redeemed, directly or indirectly, out
takings for Collective Investment in Transferable of such undertakings’ assets. Action taken by a
Securities (UCITS Ordinance; Verordnung über UCITS to ensure that the stock exchange value of its
bestimmte Organismen für gemeinsame Anlagen in units does not significantly vary from their net asset
Wertpapieren – UCITSV). In comparison, the follo- value are regarded as equivalent to such repurchase
wing two pieces of legislation apply to non-securities or redemption. The management company may be
funds: constituted in accordance with contract law (as an
SP

x Liechtenstein Alternative Investment Fund Managers

investment fund managed by a management
company), trust law (as unit trusts or collective
Act (AIFM Act; Gesetz über die Verwalter alter- trusts) or under articles of association (as an
nativer Investmentfonds – AIFMG) and the related investment company). Investment companies must
Liechtenstein Ordinance on Alternative Investment be set up as a public limited company with variable
Fund Managers (AIFM Ordinance; Verordnung über or fixed capital.
die Verwalter alternativer Investmentfonds –
AIFMV) x Alternative investment funds (AIFs)

x Liechtenstein Investment Undertakings Act (IUA;

The AIFM Act applies to all AIF managers of all
types of fund that either qualify as a UCITS, within
Investmentunternehmensgesetz – IUG) and the the meaning of the UCITS Act, or as an investment

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Section Two RISKS IN SECURITIES TRADING

undertaking, within the meaning of the IUA, an institution or structure which in total has
irrespective of whether they are constituted under more than one investor.

EN
contract law or have any other legal form. Unlike the
approach in the UCITS Act, which focuses on the (2) IUs for families
fund product, the AIFM Act is centred around the IUs set up for the sole purpose of investing the
fund manager (AIFM). The AIFM is responsible for assets of members of a family, irrespective of the
ensuring compliance with regulatory requirements. type of legal structure involved, where the only
There are four types of AIF as follows: investors are members of the family.

(1) AIF for liquid assets (3) IUs for interest groups
AIFs for liquid assets have at least 70 % of their IUs set up for the sole purpose of investing the
net asset value (NAV) invested in liquid assets. assets of certain, qualified investors within the
interest group, irrespective of the type of legal
(2) AIFs for illiquid assets structure involved, where the only investors are
AIFs for illiquid assets have at least 70 % of
their NAV invested in illiquid assets.

(3) Flex funds

A flex fund is an AIF that can invest in a mixture
of liquid and illiquid assets under its investment
policy. Details of the investment policy must be
set out in the constitutive documents.
IM members of the interest group.

(4) IUs for affiliated groups

IUs set up for the sole purpose of investing the
assets of the relevant group undertakings,
irrespective of the type of legal structure that
may be put in place by them, where the only
investors are group undertakings.
EC
(4) Leveraged AIFs PLEASE NOTE: The categories set out above only
Leveraged AIFs are AIFs in which the AIFM is apply to Liechtenstein investment funds. Foreign
permitted to employ leverage exceeding three investment funds may be assigned to different
times the NAV in accordance with the applicable categories.
provisions of the AIFM Ordinance.
PLEASE NOTE: Hedge funds are high-risk invest-
x Investment undertakings (IUs) ment vehicles. Please read the information set out in
An IU means any undertaking for collective the "Alternative (non-traditional) investments" section
investment, including segments thereof, that does not on page 28.
qualify as a UCITS under the UCITS Act or as an
AIF under the AIFM Act, is intended solely for How are investment fund units traded?
qualified investors and does not raise capital (or Investment fund units may be acquired and redeemed
SP

distribute units). The IUA defines four categories of directly from the management company or AIFM
IU, i.e. IUs for single investors, IUs for families, IUs concerned and / or traded on a stock exchange or
for interest groups and IUs for affiliated groups: regulated market.

(1) IUs for single investors The units of investment funds with variable capital
IUs that are intended solely for individual (open-ended funds) can, in principle, be redeemed at
qualified investors, as specified in the net asset value (market value) at any time. Unit
prospectus, do not invest assets which they have certificates are issued on a regular basis. Redemptions
raised from more than one legal entity or may be restricted in exceptional circumstances, as
individual with a view to investing them for the defined in the prospectus.
benefit of those persons, and does not consist of

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Section Two RISKS IN SECURITIES TRADING

PLEASE NOTE: Capital deposited in investment investment funds are investment products that typi-
funds with fixed capital (closed-ended funds) is cally only make economic sense if capital is invested

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invested in specific investments. The number of unit over a longer time horizon (with the exception of
certificates is defined in advance. It is important to note money market funds).
that, in certain circumstances, it may not be possible to
redeem the units of such investment funds (e.g. What are the risks involved?
SICAFs) at any time. Risks will vary depending on the investment strategy
deployed by the investment fund. The main risks are as
What are the potential earnings or
x Issuer risk / credit risk
follows:
returns?
x Inflation risk / monetary value risk
x Liquidity risk
The earnings generated from investment funds consist

x Market risk / price risk

in annual distributions (unless the fund is a capital

x Currency risk
appreciation fund that reinvests earnings rather than
distributing them) and any gain in the calculated net
asset value for the investment fund. Earnings cannot be
determined in advance.

Performance will depend on the investment policy set

out in the prospectus and how the markets perform for
the individual assets comprising the investment fund.

PLEASE NOTE: Depending on the composition of

IM V. Derivatives / Forwards and futures

What are derivatives?

Derivatives are futures contracts, the value of which
depends on the development of one or more under-
lying variables. The basic forms of derivative products

x options (see page 15)

the investment fund, any special risk indications should include:
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x forwards (see page 20)
be duly noted.

Where can key information on specific x futures (see page 20)

investment funds be found? x swaps (see page 23)
A full prospectus must be prepared for each

x structured products (see page 24)

investment fund, allowing investors to evaluate the Other possible derivative products include:

x products for financing or risk transfer purposes

proposed investments in detail and assess the level of
risk involved.
(see page 27)
Key investor information must also be prepared for
each investment fund, summarising the information
contained in the full prospectus. This should set out the 1. Options
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most important information in a clear and readily

understandable manner that allows investors, for What are options?
example, to assess the investment policy, and contain Options in principle give the buyer the right, but not
an explanation of the fund’s risk profile. the obligation, to make use of an offer. In the financial
sector, options are derivative financial products, i.e.
What is special about investment their value is derived from an underlying assets (often
fund units? simply referred to as the "underlying"). The price of an
The term to maturity of an investment fund is defined option is closely linked to that of the underlying asset.
in the prospectus, and funds are generally established Any change in the market value of the underlying asset
for an unlimited period of time. Although it is will result in a greater change in the price of the option
normally possible to redeem units at any time, (leverage effect). This allows disproportionate parti-

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Section Two RISKS IN SECURITIES TRADING

cipation in any rise or fall of the market value of the This does not, however, normally affect their
underlying asset. tradability on the secondary market (e.g. on a stock

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exchange or regulated market).
How are the different types of options
traded? What underlying assets can options
x Warrants are options in securitised form that are be based on?

x assets such as Shares, bonds, commodities (e.g.

traded on an exchange or over the counter. The commonest underlying assets for options are:

x Exchange-traded options are standardised contracts

x benchmark rates such as currencies, interest rates,
precious metals);
that are non-securitised, but are traded on an

x derivatives; and
exchange or a regulated market. and indices;

x OTC (over-the-counter) options are neither x any combination of the above.

securitised nor traded on an exchange or a regulated
market. They are agreed directly off-exchange
between the writer and the buyer. Cancelling
(closing out) an option before the expiration date
requires a corresponding offsetting trade between
the same parties. OTC options with precious metals
and currencies as their underlying are offered
publicly as standardised products. Tailor-made OTC
options, by contrast, are specially created for
IM What is "physical settlement"?
Where a call option provides for "physical settlement",
you can require the counterparty (the writer of the
option) to deliver the underlying asset when you
exercise the option. With a put option, the writer is
obliged to buy the underlying asset from you.

What is "cash settlement"?

individual investors. If an option provides for "cash settlement", you are
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only entitled to a sum of money corresponding to the
What are your rights and duties? difference between the strike price and the applicable
As the buyer of an option, you have the right to buy a market value of the underlying asset on the expiration
specified amount of an underlying asset from the seller date of the option.
(call option) or sell it to him / her (put option) at a
predefined price (strike price) up until a set time What do "in the money", "out of the
(expiration date). The price you pay for this right is money" and "at the money" mean?
called the premium. A call option is "in the money" if the current market
value of the underlying asset is above the strike price.
As the seller (writer, covered writer) of an option, you A put option is in the money if the current market
must sell the underlying to the buyer at the strike price value of the underlying asset is below the strike price.
(call option) or buy the underlying from him / her at the An option that is "in the money" is said to have an
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strike price (put option) up until the expiration date, "intrinsic value".
irrespective of the market value of the underlying asset
at the time, if he / she chooses to exercise the option. As A call option is "out of the money" if the current
the seller of an option, you receive the premium. market value of the underlying asset is below the strike
price. A put option is "out of the money" if the current
What are "American-style" and market value of the underlying asset is above the strike
"European-style" options? price. In this case, the option has no intrinsic value.
"American-style" options can normally be exercised on
any trading day up to the expiration date. "European- If the current market value of the underlying asset is
style" options can only be exercised on the expiration the same as the strike price, the option is "at the
date, in other words the date set out in the contract. money". In this case, it has no "intrinsic value".

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What determines the price of an option? PLEASE NOTE: You must therefore be prepared for
The price of an option depends on its intrinsic value a potential loss in the value of your option, or for it to

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and on the time value. expire entirely without value. In such a scenario, you
risk losing the whole of the premium you paid.
The intrinsic value is the positive difference between
the current market value of the underlying asset and What risks do you face as the writer
the lower strike price for call options / the higher strike (seller) of a covered call option?
price for put options. If, as writer of a call option, you already have a
corresponding quantity of the underlying at your
The time value depends on a variety of factors, disposal, the call option is described as covered. If the
including the remaining life of the option and the current market value of the underlying exceeds the
volatility of the underlying. The time value reflects the strike price, your opportunity to make a profit is lost
difference between the intrinsic value of the option and since you must deliver the underlying to the buyer at
the current price of the option and corresponds to the the strike price, rather than selling the underlying at
amount that a buyer is willing to pay, in light of the
chances of an option. It is therefore higher for options
with a long duration and a very volatile underlying and
for options that are at the money.

What is margin cover?

As the writer (seller) of an option, you have to deposit
either an amount of the underlying asset or another
IM the (higher) market value. You must have the under-
lying assets freely available as long as it is possible to
exercise the option, i.e. they may not, for example, be
blocked by being pledged for other purposes (such as
for a Lombard loan). Otherwise, you are essentially
subject to the same risks as when writing an uncovered
call option (see below).

form of collateral for the entire duration of the What risks do you face as the writer
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contract. The level of this collateral (margin) is (seller) of an uncovered call option?
determined by the bank. The bank or regulated market If, as the writer of a call option, you do not have a
stipulates a minimum margin for traded options. corresponding quantity of the underlying at your
disposal, the call option is described as uncovered. In
PLEASE NOTE: If the margin cover proves insuffi- the case of options with physical settlement, your
cient, the bank can require you provide additional col- potential loss amounts to the price difference between
lateral (via a "margin call", see page 9). the strike price paid by the buyer and the price you
must pay to acquire the underlying assets concerned.
What risks do you face as the buyer Options with cash settlement can incur a loss amoun-
of an option? ting to the difference between the strike price and the
Generally speaking, if the market value of the under- market value of the underlying.
lying asset falls, so does the value of your call option.
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The value of your put option tends to fall if the PLEASE NOTE: Since the market value of the
underlying asset rises in value. Normally, the less your underlying can move well above the strike price, your
option is in the money, the larger the fall in the potential loss cannot be determined and is theoretically
option's value. In such cases, value reduction normally unlimited.
accelerates close to the expiration date.
As far as American-style options in particular are
The value of your call option can drop even when the concerned, you must also be prepared for the fact that
value of the underlying remains unchanged or rises. the option may be exercised at a highly unfavourable
This can happen as the time value of your option falls time when the markets are against you. If you are then
or if supply and demand factors are unfavourable. Put obliged to make physical settlement, it may be very
options behave in precisely the opposite manner.

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Section Two RISKS IN SECURITIES TRADING

expensive or even impossible to acquire the corres- Given the special composition of exotic options, their
ponding underlying assets. price movements can vary markedly from those of

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their "plain vanilla" cousins.
You must be aware that your potential losses can be
far greater than the value of the underlying assets you PLEASE NOTE: You must also be aware that larger
lodged as collateral (margin cover) either when transactions can trigger price movements even shortly
entering into the contract or thereafter. before expiration and that these can render an option
worthless. There is no limit to the possible structures
What risks do you face as the writer for exotic options. We cannot describe in full here the
(seller) of a put option? risks involved in any particular case. Before buying any
As the writer of a put option, you must be prepared for exotic options, be sure to seek comprehensive advice
potentially substantial losses if the market value of the about the particular risks involved.
underlying falls below the strike price you have to pay
to the seller. Your potential loss corresponds to the The examples of exotic options listed below can be
difference between these two values (minus the
premium received).

As the writer (seller) of an American-style put option

with physical settlement, you are obliged to accept the
underlying assets at the strike price, even though it
may be difficult or impossible to sell the assets and
may well entail substantial losses.
IM broadly divided into two categories: path-dependent
options and options on more than one underlying.

What are path-dependent options?

Unlike "plain vanilla" options, for path-dependent
options, it is not just when the option expires or is
exercised that the market value of the underlying is
important. You also need to take into account
fluctuations in the market value of the underlying
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PLEASE NOTE: Your potential losses can be far during the life of the option when contemplating such
greater than the value of any underlying assets you an investment. The following are examples of path-
may have lodged as collateral (margin cover). You dependent options:

x Barrier options
could in a worst case lose your entire capital invested.

What are option strategies? Your exercise rights for knock-in barrier options
If you acquire two or more options, based on the same only arise if the market value of the underlying
underlying, which differ in either the option type (call reaches a fixed threshold (barrier) within a specified
or put), the quantity, the strike price, the expiration period. Exercise rights for knock-out barrier options
date or the type of position (long or short), this is expire if the market value of the underlying reaches
referred to as an option strategy or combination. the specified barrier during the given time period.
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PLEASE NOTE: Given the large number of possible If this barrier is between the market value of the
combinations, we cannot go into detail here about the underlying at the time the option was entered into
risks involved in any particular case. Before entering and its strike price, it is referred to as a kick-in /
into any such transaction, be sure to consult your bank kick-out barrier option.
about the particular risks involved.
Double-barrier options have both an upper and a
What are exotic options? lower barrier and may take the form of knock-in and
Unlike the "plain vanilla" put and call options de- knock-out barrier options.
scribed above, exotic options are linked to additional
conditions and agreements. Exotic options come in the PLEASE NOTE: When buying a barrier option, you
form of tailor-made OTC options or as warrants. must be aware that your exercise rights only arise

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Section Two RISKS IN SECURITIES TRADING

when the market value of the underlying reaches the PLEASE NOTE: For an average-strike option, the
barrier ("knock-in" / "kick-in" option) or that they average strike price of a call option can be consider-

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expire irrevocably when that barrier is reached ably higher than the price originally set. For an equi-
("knock-out" / "kick-out" option). valent put option, the strike price can similarly be

x Payout options
lower than the price originally set.

Payout options accord you the right to payment of a x Lookback options

fixed amount agreed in advance. With a lookback option, the market value of the
underlying is recorded periodically over a specified
In the case of a digital (otherwise known as "binary") time period.
option, you receive payment if the market value of
the underlying reaches a fixed value once during a For a strike-lookback option the lowest value (call
specified time period (one-touch digital option) or option) or the highest value (put option) of the
precisely on the day of expiration (all-or-nothing underlying becomes the strike price.
option). For the one-touch digital option, payment
occurs either immediately once the barrier is reached
or on the date of expiration (lock-in option).

With lock-out options, you only receive the fixed

payment if the market value of the underlying does
not reach the agreed barrier during a specified time
period.
IM The strike price remains unchanged for a price-look-
back option, with the highest value (call option) /
lowest value (put option) being used in calculating
the option value of the underlying.

PLEASE NOTE: For lookback options, both the

calculated strike price and the calculated value of the
underlying can vary considerably from the market
EC
PLEASE NOTE: As the writer (seller) of a payout prices prevailing on the expiration date. As the writer
option you owe the full fixed amount if the barrier is (seller) of an option of this type, you must be aware
reached, regardless of whether or not the option is in that it will always be exercised at the most unfavour-
the money when exercised or on the expiration date, able value for you.

x Contingent options
or to what extent. This means that the amount you
owe can be considerably larger than the option's
intrinsic value. When you buy a contingent option you must pay the

x Asian options
premium only if the market value of the underlying
reaches or exceeds the strike price during the life of
For Asian options, an average value is derived from the option ("American-style" option) or on the
the market value of the underlying over a specified expiration date ("European-style" option).
time period. This average is used to determine the
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underlying's value for an average-rate option and to PLEASE NOTE: You will have to pay the entire
calculate the strike price for an average-strike option. premium even if the option is only just at the money
or just in the money.
PLEASE NOTE: The calculation of an average
value for the underlying in the case of the average- x Cliquet and ladder options
rate option can result in the value of the option on For cliquet options (also known as ratchet options),
the expiration date being considerably lower for the the strike price is modified for the following period,
buyer and considerably higher for the writer than the normally at regular intervals, in line with the market
difference between the strike price and the current value of the underlying. Any intrinsic value of the
market value on expiry. option is locked in. All "lock-ins" arising over the
entire life of the option are accumulated.

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For ladder options, these modifications take place party (risk buyer), who receives a premium in return.
when the underlying reaches specified market prices, If the defined credit event occurs, the risk buyer is

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rather than at regular intervals. Normally, only the obliged to effect a cash settlement or take on the
highest intrinsic value is locked in. In rare cases, all non-performing loan (or another delivery obligation)
the intrinsic values recorded are added together. by way of physical settlement at a previously deter-
mined price. Credit default options are a form of
PLEASE NOTE: As the writer (seller) of a cliquet credit derivatives.
option, you are required on the expiration date to pay
the buyer all the accumulated lock-ins in addition to PLEASE NOTE: The risk of chain reactions on the
any intrinsic value of the option. If you sell a ladder credit market is high and can easily be under-
option you must pay the buyer the highest lock-in estimated. There is also the risk that lack of liquidity
amount, which can be considerably higher than the will lead to price distortions when volumes are low.
option's intrinsic value on the expiration date. This may mean that the investment can only be sold
at a low price, longer term or even not at all.
What are options on more than one
underlying?
Examples of options on more than one underlying are:

x Spread and outperformance options

Both spread and outperformance options are based
on two underlyings. With a spread option, the abso-
lute difference in movement between the two under-
IM 2. Forwards and futures

What are forwards and futures?

Forwards are transactions in foreign currency, money
market, and precious metal trading, for which delivery
and payment take place on a specified date in the
lyings forms the basis for calculating the option's future. All conditions (scope of the contract, price,
EC
value. By contrast, the value of an outperformance duration, beginning of the contract) are already
option is based on the relative difference, i.e. the negotiated at the time the contract is concluded.
percentage outperformance of one underlying com- Forwards are not traded on an exchange or regulated
pared to the other. market; hence they are referred to as OTC (over-the-
counter) forwards. Their specifications may also be
PLEASE NOTE: Even if the underlying performs standardised; otherwise they may be individually
positively, the difference between the underlyings agreed between the buyer and the seller.
may be equal or lower in absolute as well as relative
terms, thus having a negative impact on the value of Futures are traded on an exchange. They grant the
the option. right / duty to buy / deliver specified financial instru-

x Compound options
ments at a specified due date and at a specified price.
They take the form of contracts in which the quantity
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The Compound options have an option as their of the underlying and the expiration date are
underlying, i.e. they are options on options. standardised.

PLEASE NOTE: Compound options have an What are your rights and duties?
especially large leverage effect. As a writer (seller) of With forwards and futures you undertake to deliver or
an option of this type, you can be faced with very take delivery of a defined quantity of an underlying on
substantial obligations. a specified expiration date at a price agreed on the

x Credit default options

contract date.

With a credit default option, a credit risk of the PLEASE NOTE: Forwards and futures involve spe-
original risk-taker (risk seller) is transferred to a third cial risks. You should therefore only make investments

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Section Two RISKS IN SECURITIES TRADING

of this type if you are familiar with this type of instru- position or agree an offsetting trade with identical
ment, have sufficient liquid assets and are able to terms. Concluding such an offsetting trade means that

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absorb any losses that may arise. the obligations to deliver and receive cancel one
another out.
What underlying assets can forwards
and futures be based on? PLEASE NOTE: For standardised OTC forwards, the

x assets such as shares, bonds, commodities (e.g.

Underlyings for forwards and futures are: market is transparent and liquid. As a rule, such
contracts can therefore be closed out at any time. For

x benchmark rates such as currencies, interest rates,

precious metals), etc. OTC forwards with individual conditions of the
contract, no actual market exists. Such contracts can
and indices therefore only be closed out with the agreement of the
counterparty.
What are the most common types
of futures? How is the transaction settled?
Futures can be distinguished according to the follo-

x interest rate futures

wing types of underlyings:

x currency futures
x commodity futures

What is a margin?
When you buy or sell (short) an underlying asset on
IM If you do not close out the contract prior to the
expiration date, you and the counterparty must settle it.

If the underlying in your contract is a physical asset,

settlement is achieved by physical delivery or a cash
payment. Generally, the asset is physically delivered.
Only in exceptional cases do the contract provisions or
stock exchange practice call for cash settlement. All
the futures market, you must supply a specified "initial other fulfilment specifications, especially the defini-
EC
margin" when entering into the contract. This is tion of the place of fulfilment, can be found in the
usually a percentage of the total value of the contracted relevant contract provisions.
instruments. In addition, a "variation margin" is calcu-
lated periodically during the life of the contract. This The difference between physical delivery and cash
corresponds to the book profit or loss arising from any settlement is that with physical delivery, underlyings
change in value in the contract or underlying instru- amounting to the entire contractual value must be
ment. The way in which the variation margin is delivered, whereas with cash settlement, only the
calculated will depend on the rules of the exchange difference between the agreed price and the market
concerned and / or the conditions of the contract. value on settlement needs to be paid. This means that
you need more funds available for physical delivery
As the investor, you are obliged to deposit the required than for cash settlement.
initial and variation margin cover with the securities
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dealer for the entire life of the contract. If the underlying in your contract is a reference rate or
benchmark, fulfilment by physical delivery is not
PLEASE NOTE: In the event of a book loss, the permitted (except for currencies). Instead, settlement is
variation margin can be several times as large as the always in cash.
initial margin.
What special risks do you need
How is a transaction closed out? to bear in mind?
As the investor, you are entitled to close out the For forward sales, you must deliver the underlying at
contract also at any time prior to the expiration date. the price originally agreed even if its market value has
How this is done depends on the type of contract or since risen above the agreed price. In such a case, you
stock exchange practice. You either close out your risk losing the difference between these two amounts.

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PLEASE NOTE: Theoretically, there is no limit to ment between two parties to exchange two agreed
how far the market value of the underlying can rise. currency amounts at a specified future date.

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Hence, your potential losses are similarly unlimited
and can substantially exceed the margin requirements. How are forward exchange
contracts settled?
PLEASE NOTE: For forward purchases, you must Forward exchange contracts are regularly settled
take delivery of the underlying at the price originally effectively. On the due date the contracting parties
agreed even if its market value has since fallen below exchange the respective currency amounts as agreed.
the agreed price. Your potential loss corresponds to Delivery and receipt of the counter currency thus take
the difference between these two values. Your place with the same value date.
maximum loss therefore corresponds to the originally
agreed price. Potential losses can substantially exceed Can forward exchange contracts
the margin requirements. be terminated / closed out early?
There are two ways to terminate / close out forward
In order to limit price fluctuations, an exchange or
regulated market may set price limits for certain
contracts. Find out what price limits are in place before
effecting forward or futures transactions. This is
important since closing out a contract can be much
more difficult or even impossible if a price limit of this
type is reached.
IM exchange contracts early:

x by settling the contract early as a spot exchange

transaction, where any arising interest costs are
billed between the contracting parties, and

x by entering into a position counter to the original

transaction.
PLEASE NOTE: If you sell forward an underlying
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which you do not hold at the outset of the contract, this What is the use of forward
is referred to as a short sale. In this case, you risk exchange contracts?
having to acquire the underlying at an unfavourable Forward exchange contracts serve as forward cover.
market value in order to fulfil your obligation to effect Using forward exchange contracts for hedging purpo-
delivery on the contract's expiration date. In the worst ses means fixing an exchange rate so that the expenses
case, it may be impossible to obtain the underlyings or earnings of the hedged transaction are neither in-
due to the illiquidity of the market, so that you will be creased nor diminished by intervening exchange rate
unable to fulfil your obligation to effect delivery. fluctuations. Forward exchange contracts also serve to
protect foreign currency balances and foreign currency
What special factors apply to securities with short and medium maturities. Forward
combinations? exchange contracts are also often used for speculation
Since combinations comprise a number of elements, purposes.
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closing out individual elements can considerably alter

the risks inherent in the overall position. Before What special risks do you need
entering into any such transaction, be sure to consult to bear in mind?
your bank about the particular risks involved. As a seller in a foreign exchange contract, you
undertake to deliver foreign currency at an agreed
exchange rate. If the exchange rates rise, you will still
3. Forward exchange contracts have to delivery at the previously agreed price, which
may be very substantially lower than the current
What are forward exchange contracts? exchange rate.
A forward exchange contract is a contractual agree-

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Section Two RISKS IN SECURITIES TRADING

PLEASE NOTE: Your potential loss as a seller may interest payments are exchanged, with no capital
be far greater than the collateral provided, if you do not flow.

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own the foreign currency as a seller but rather want to
acquire the currency only at the due date. In this case, The buyer of the IRS makes a profit if the market
you may incur substantial losses, since – depending interest rate level rises; the seller, if it drops. Neither
on the market situation – you may have to buy the can be determined in advance.
currency at a very high price or pay compensation if
you are unable to acquire the currency. PLEASE NOTE: IRSs are not standardised. The
settlement details must be contractually agreed in
As a buyer, you undertake to purchase foreign advance. They are customised products. It is
currency at the agreed price, even if the exchange rate therefore especially important to obtain information
drops in such a way that the price is substantially on the precise conditions.

x Currency swaps
higher than the current exchange rate.

PLEASE NOTE: Your potential loss as a buyer

cannot be determined in advance and may be far
greater than any collateral you may provide.

Transfer risk is of particular importance for forward

exchange contracts. Through governmental measures,
the transfer of currency or the conversion thereof into
another currency may be prohibited.
IM A currency swap is the exchange of two currencies
over a specified time period. The interest rate
difference of the two involved currencies is taken
into account by premiums and discounts in the re-
exchange rate. Delivery and receipt of the counter
currency take place with the same value date.

The earnings (profit / loss) for the user of currency

swaps arise from the positive / negative development
EC
of the interest rate difference and may be generated
4. Swaps during the term of the currency swap in the case of a
counter transaction.
What are swaps?
A swap is an agreement to exchange payment streams. x Cross currency swaps (CCS)
Swaps are mainly used to hedge certain assets against A cross currency swap governs both the exchange of
fluctuations due to changes in the interest rate level, differently defined interests payable and of different
currency ratios, or other risks. They may also be used currencies on a fixed nominal amount between two
to optimise earnings. Swaps are not traded on an contracting parties. As a rule, a cross currency swap
exchange or en masse. is an exchange of fixed interest payments in two
different currencies. Both interest payments may of
What are the most common course also take place within variable interest
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types of swaps? obligations. The payment streams take place in

The most common and familiar swaps include interest different currencies on the basis of the same capital
rate swaps (IRS), currency swaps, and cross currency amount, which is fixed on the contract date at the
swaps (CCS). applicable spot exchange rate.

x Interest rate swaps (IRS) In addition to the exchange of interests payable and
An interest rate swap governs the exchange of interests receivable, a capital exchange takes place
differently defined interest rate obligations on a fixed both at the beginning (initial exchange) and at the
nominal amount between two contracting parties. As end (final exchange) of the term. Depending on the
a rule, the swap concerns the exchange of fixed needs of the contracting parties, the initial exchange
against variable interest payments. Thus, only may be omitted.

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If the exchange rate and the interest rate difference make a price. Even if they are, liquidity risks can still
develop positively, earnings may be generated when arise. If the market is not liquid, you run the risk of

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the CCS is cancelled early. Should the CCS be having to either hold the financial instrument until the
concluded to improve the interest rate difference, the end of its term or sell it during the term at an
lower interest rates in another currency may generate unfavourable price.
earnings. These earnings may, however, be offset by
any currency losses. Should the currency ratio It can also be difficult or impossible to determine a fair
develop positively, the earnings may even be price or even compare prices at all, as there is often
improved. Any earnings cannot be determined in only one market maker.
advance, however.
What special risks do you need
PLEASE NOTE: CCSs are not standardised. to bear in mind?
These are also tailor-made products. Again, it is Every structured product has its own risk profile, and
therefore especially important to obtain information the risks of its individual components may be reduced,
on the precise conditions.

VI. Structured products

What are structured products?

Structured products are derivative financial instru-
ments that may consist of several components.
IM eliminated or increased. In particular, it may profit to
different degrees from rising, constant or falling
market values of the underlying, depending on the
product involved.

PLEASE NOTE: It is extremely important to find out

exactly what the risks are before acquiring a product of
this kind. This information can be found in, for
example, the issue documents or the product descri-
EC
Structured products are issued either publicly or ption concerned.
privately. Their redemption value depends on the
performance of one or more underlyings. They may Are structured products covered by the
have a fixed or unlimited term and consist of one or regulation on investment funds?
more components. Structured products are not categorised as investment
funds according to the investment fund regulation.
What are the most common types Unlike with collective investments, the issuer is liable
of structured products? with his or her own assets (as is any guarantor, to the
Here is a list of the most common product categories, extent of a guarantee they have provided), and there is
based on the categorisation model used by the Swiss no backing from specially protected assets. You

x capital protection products (see page 25)

Structured Products Association (SSPA): therefore need to bear in mind that in addition to a

x yield enhancement products (see page 26)

potential loss resulting from a decline in the market
SP

x participation products (see page 26)

value of the underlyings (market risk), you may in the

x leverage products (see page 27)

worst case lose your entire investment because the
issuer or guarantor becomes insolvent (issuer or
guarantor risk).
How are structured products traded?
Structured products may be listed for trading on Do you have an entitlement to voting
an exchange or regulated market, but do not have rights and dividends?
to be. You do not normally have any entitlement to voting
rights or dividends if you buy a structured product.
The tradability of a structured product depends on
whether the issuer or a market maker is prepared to

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Section Two RISKS IN SECURITIES TRADING

however, the issue / purchase price is less than the

1. Capital protection products nominal value, the protection of your capital outlay

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rises accordingly.
What types of capital protection are there?
Some structured products offer capital protection. The Is the invested capital fully protected?
level of this protection is fixed by the issuer when the The capital protection component can be well under
product is issued and indicates the percentage of the 100 % of the capital invested, depending on the
nominal value that will be repaid to the investor on product. Capital protection does not therefore mean
expiration. However, capital protection generally only 100 % repayment of nominal value or the purchase
applies at the end of the term and may, depending on price for all products. Structured products with capital
the product conditions, be (far) lower than 100 % of protection generally offer lower returns than direct
the invested capital. investments in the underlying, as the capital protection
costs money.
PLEASE NOTE: Some structured products offer only
conditional capital protection, which can be lost if the
value touches, falls below or rises above a predefined
threshold (barrier, "knock-out level"). Repayment is
then dependent on the performance of one or more
underlyings.

What are structured products with

capital protection?
IM Does the capital protection still apply if
you sell the product during its term?

PLEASE NOTE: If you wish to sell a structured

product with capital protection before it expires, you
may receive less than the capital protection compo-
nent as the capital protection only applies until the end
of the term.
Structured products with capital protection consist of
EC
two elements, such as a fixed-income investment What is the purpose of the
(especially a bond or a money market investment) and participation component?
an option. This combination enables the holder to The participation component determines how you
participate in the performance of one or more under- benefit from price movements in the underlying(s)
lyings (via the option or participation component) when you buy a structured product. In other words, it
while at the same time limiting potential losses (via the fixes the level of your potential return over and above
fixed-income investment or capital protection compo- the capital protection component. Some structured
nent). The capital protection component may only products with capital protection offer only a limited
cover a portion of the capital invested. potential participation (those with a cap); some (those
without a cap) offer unlimited potential participation.
What is the purpose of the capital Others require the market value of the underlying to
protection component? touch, rise above or fall below a specific barrier before
SP

The capital protection component determines the you can make a profit.
minimum repayment you receive on expiration,
regardless of how the participation component How high is the risk on the
performs. participation component?
The risk on the participation component is the same as
What does the capital protection relate to? that on the corresponding option or combination of
The capital protection is linked to the nominal value options. Depending on the movements in the market
rather than the issue price or purchase price. Hence, if value of the underlyings, the participation component
the issue / purchase price you pay exceeds the nominal may therefore be zero.
value, only the nominal value is capital-protected. The
protection of your capital outlay drops accordingly. If,

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Section Two RISKS IN SECURITIES TRADING

What is the maximum possible loss? falls below a predefined barrier during the term of the
financial instrument. If the performance of the

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PLEASE NOTE: Your maximum loss on a structured underlying is negative, the financial instrument can
product with capital protection is limited to the trade some way below the issue price during its term
difference between the purchase price and the even if the barrier is not touched, exceeded or
specified conditional or absolute capital protection, undershot.
provided you continue to hold the product until
expiration. You may also miss out on a profit due to The level of interest rate is directly related to the level
the fact that full or partial repayment of the capital is of the barrier. The nearer the barrier is to the market
guaranteed but no income (interest) is paid. price of the underlying on the day of issue, the higher
the interest you receive will generally be, but the
higher the risk that the barrier will be reached, and vice
2. Yield enhancement products versa.

What are structured products

with yield enhancement?
Structured products with yield enhancement consist of
two elements, such as a fixed-income investment and
an option (mainly on shares or currencies), and
possibly a currency swap. This combination enables
you to participate in the performance of one or more
underlyings (via the option component). However,
IM What is the maximum possible loss?

PLEASE NOTE: When you invest in a structured

product with yield enhancement, you could in the worst
case scenario lose the entire capital that you have
invested.

these financial instruments offer no or only conditional 3. Participation products

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capital protection. The interest that is paid means you
receive a higher return than with a direct investment if What are structured products
the price of the underlying remains essentially with participation?
unchanged. On the other hand, you will not benefit Structured products with participation enable you to
from the full potential return of the underlying. participate in the performance of one or more under-
lyings. However, they offer no or only conditional
If the market value of the underlying rises, you will capital protection.
receive the stipulated interest and the nominal value on
expiration (equally, the product may provide for a If the participation product offers conditional capital
discount on the issue price). If the market value of the protection, the risk is smaller than with a direct
underlying rises sharply, you could possibly have investment provided the market value of the
earned a higher return on a direct investment. How- underlying does not reach a specific barrier (termed the
SP

ever, if the market value of the underlying falls "knock-out").

sharply, you will receive both the interest payment and
the underlying on expiration (unless the product PLEASE NOTE: If the market value of the underlying
offered a discount on the issue price). touches, rises above or falls below the barrier, you will
lose the capital protection.
What special risks do you need
to bear in mind? What special risks do you need
Many products with yield enhancement provide that to bear in mind?
you as the investor receive the security with the worst The risk of a structured product with participation is
performance on expiration (either physically or in the generally the same as that of the underlying. Unlike
form of cash) if the underlying touches, rises above or with a direct investment, however, you do not receive

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Section Two RISKS IN SECURITIES TRADING

voting rights and you are not entitled to a dividend. What is the maximum possible loss?
You do, though, bear the credit risk of the product's

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issuer. PLEASE NOTE: When you invest in a structured
product with leverage, you could in the worst case lose
Many products with participation refer to several the entire capital that you have invested.
underlyings. You as investor receive the security with
the worst performance on expiration (either physically
or in the form of cash) if the market value of the VII. Products used for financing or risk
underlying touches, rises above or falls below a transfer
predefined barrier during the term of the financial
instrument. The financial instrument can trade some What exactly are these products?
way below the issue price during its term even if the The financial instruments discussed under this heading
barrier is not touched, exceeded or undershot. combine traditional financial instruments for the
Moreover, the level of participation is directly related purpose of financing or risk transfer. The risks
to the level of the barrier. If you have a higher risk
tolerance when selecting the barrier, you will enjoy a
higher participation.

What is the maximum possible loss?

PLEASE NOTE: When you invest in a structured

product with participation, you could in the worst case
IM associated with these derivative products are not
necessarily the same as those of the financial
instruments they contain. It is therefore extremely
important to find out exactly what the risks are before
acquiring a product of this kind. This information can
be found in, for example, the product description
concerned.

lose the entire capital that you have invested. Such financial instruments may be listed for trading on
EC
an exchange, but do not have to be.

4. Leverage products What are credit and catastrophe

derivatives?
What are structured products There are some products that are mainly used to
with leverage? transfer risks. These include credit and catastrophe
Structured products with leverage enable you to derivatives. They are financial instruments where the
participate disproportionately in the performance of the "underlying" is an event such as a credit event (default
underlying. The leverage occurs because the same of a loan or bond) or a natural disaster. Derivatives of
performance can be achieved as with the underlying, this type can be used by the bearer of a risk to transfer
but with a lower investment of capital. This means you it to others. Credit derivatives come in the form of
can benefit from short-term trends. swaps, options or hybrid financial instruments.
SP

Structured products with leverage are suitable for PLEASE NOTE: Credit and catastrophe derivatives
short-term speculation but also for strategically involve a liquidity risk. Often such instruments cannot
hedging a portfolio. be sold before the end of their term, because there is
no market for them.
What special risks do you need
to bear in mind? Credit bonds securitise the risks and transfer them to
Because of the leverage effect, you need to carefully third parties as credit-linked notes, collateralised
and regularly monitor the underlying, since structured debt obligations and asset-backed securities. As a
products with leverage can experience a larger rise in result, the buyer takes on the risk associated with a
profits but also a bigger loss than the underlying. loan portfolio.

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Section Two RISKS IN SECURITIES TRADING

x Asset-backed securities (ABS) partially redeemed, or not redeemed at all.

In ABSs, risks (such as a range of receivables) are

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grouped together and transferred to a special purpose The value of a CDO is based primarily on the
vehicle (SPV). The SPV finances this transaction by probability of a credit event affecting the individual
issuing securities backed by a pool of assets or a companies in the portfolio. This probability of
portfolio. If the collateral is a mortgage, this kind of default is determined using statistical methods and
instrument is called a mortgage-backed security on the basis of historical data, and can cease to be
(MBS). The individual components of the portfolio meaningful in extreme market conditions.
would be unattractive or even unobtainable in this
form for individual investors. Before you invest in a CDO, you should also look at
the track record of the manager in charge of it: he or
However, the composition of the portfolio makes she will receive a performance-related bonus and
it possible to combine together and sell a range of will often have a holding in the CDO him / herself. If
assets and risks. By grouping together different the portfolio is not run by a manager (which is
types of credit risk, different risk profiles can be
created.

x Credit-linked notes (CLN)

CLNs are bonds whose redemption and interest pay-
ments depend on the performance of a specific
underlying or benchmark portfolio (e.g. loan, bond).
IM termed a "static" portfolio), its composition remains
unchanged throughout its term. In this case you
should pay special attention to the composition of the
portfolio.

CDOs typically have a term of several years. As

there is generally no secondary market, you should
assume that you will not be able to sell the CDO
Look closely at the creditworthiness of the borrower before the end of its term.
EC
to which the CLN is linked, as the CLN can end up
being valueless if a credit event occurs. There is an Even if a pool or portfolio is created, lack of diversi-
issuer risk, i.e. a credit risk of the issuing bank, just fication can lead to a concentration of risk.
as with structured products. The secondary market
for CLN is highly illiquid, and you should therefore PLEASE NOTE: Credit bonds are often issued by
assume that you will not be able to sell one before particular types of offshore companies, so-called
the end of its term. Special Purpose Verhicles (SPV). In this event you

x Collateralised debt obligations (CDO)

should pay special attention to the issuer risk and the
quality of government supervision of such SPVs.
CDOs are bonds backed by a diversified debt
portfolio (mostly loans, bonds or credit default
swaps). They give you access to investments that are VIII. Alternative (non-traditional)
SP

unattractive or even unattainable for individual investments

investors. Since CDOs are often divided up into a
number of tranches with differing credit risks, you What are alternative or non-traditional
can decide what credit risk you wish to take on. If a investments?
borrower in the debt portfolio experiences a credit Alternative or non-traditional investments are invest-
event, the share-like tranches are affected first: they ments that do not fall within the traditional asset
may be only partially redeemed, or not redeemed at classes, such as shares, bonds or money market
all. If a number of borrowers default, this affects the products. They include a wide range of instruments
remaining tranches in order of creditworthiness, until and strategies. This section focuses on the classes that
finally the tranche with the highest credit rating are most important in terms of risk information:
(comparable to that of first-class bonds) may only be

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Section Two RISKS IN SECURITIES TRADING

x
x
hedge funds (see page 29) with the risks of structured products, forward contracts

x
private equity (see page 31) and futures, as these were discussed in the preceding

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x
real estate (see page 32) sections.
precious metals and other commodities (see page 32)

This list is not exhaustive and this brochure cannot 1. Hedge funds
point out all the risks and aspects that need to be taken
into account in connection with alternative or non- What are hedge funds?
traditional investments. Hedge funds are the best-known form of alternative or
non-traditional investments. Despite what their name
PLEASE NOTE: In addition to the general risks (see suggests, hedge funds do not necessarily have anything
pages 7 et seqq.), alternative investments are subject to to do with hedging. Indeed, they take on sometimes
high product-specific risks. Be sure to obtain compre- very high levels of risk in order to obtain an above-
hensive advice before investing in alternative or non- average return.
traditional investments, and examine the offering
carefully.

You can invest in alternative and non-traditional

investments either directly or indirectly.

What do you need to bear in mind when

making direct investments in alternative
IM Hedge funds include all forms of investment funds,
investment companies and partnerships that use
derivatives not just for hedging but also for
investment, that are able to engage in short selling or
take on significant leverage by borrowing. Other
features typical of hedge funds include their freedom
to choose their asset classes, markets (including
or non-traditional investments? emerging markets) and trading methods. Hedge funds
EC
Instruments allowing for direct investment can make normally require high minimum investments. They
sense in terms of diversifying a portfolio (risk distri- frequently offer only limited opportunities for
bution) because their returns are less dependent on subscription and redemption, with long notice periods.
factors such as the performance of the markets and The portfolio managers of hedge funds receive
levels of interest rates than those of conventional performance-related bonuses and often hold a personal
investments. However, the minimum outlay required stake in the funds.
for direct investments is generally very high, and they
are often not accessible to all investors. What should you particularly bear
in mind about hedge funds?
What about indirect investments in
alternative or non-traditional investments? PLEASE NOTE: Pay special attention to the following:
To overcome these obstacles and avoid the risks of the
x A hedge fund may be less transparent than a tradi-
SP

large direct investments required, the financial sector

has developed instruments for indirect investment. tional investment fund, for example, as investors
They include certificates, notes, investment funds, are not always informed about planned strategies
funds of funds, commodity futures and forward con- and changes to them, or changes of portfolio
tracts. All these structures are based on one or more of manager. Hedge funds are also not subject to any
the asset classes mentioned below. If you are interested disclosure requirements.
in indirect investments, you need to bear in mind not
just the risks of alternative investments as an asset x Unlike traditional collective investments, hedge
class, but also the risks of the instrument concerned – funds have limited liquidity (units may generally
the risks associated with structured products, for only be redeemed once a month, quarterly or
example. Please note that this section does not deal annually). Normally, investors can only invest in a

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Section Two RISKS IN SECURITIES TRADING

hedge fund at specific times. There are generally merger arbitrage, distressed securities and special
long notice periods for redemptions and "long lock- situations.

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x Global macro
up periods" (periods during which investors are
obliged to leave their capital in the fund).
Hedge funds that pursue global macro strategies
x Delays may occur, and unfavourable prices may attempt to identify macro-economic developments
result, when settling buy and sell orders for hedge such as changes in interest or exchange rates at an
fund units. There is no guarantee that investors will early stage and exploit them for profit. This category
be able to enforce their rights. includes growth funds and emerging market funds.

What are funds of hedge funds x Managed futures

or multi-manager hedge funds? This type of hedge fund deals in futures (standar-
Investors invest in funds of hedge funds (FoHF) or dised, exchange-listed contracts) on financial instru-
multi-manager hedge funds in order to reduce risk. ments, currencies and commodities.
These funds invest their capital in a number of hedge
funds and spread it across a range of hedge fund
managers that cover different investment styles,
markets and instruments. There are also structured pro-
ducts that you can use to invest in hedge funds or
hedge fund indices.

What strategies do hedge funds pursue?

IM What risks do you take on when you
invest in a hedge fund?
Generally speaking, hedge fund managers do not need
to be licensed by an authority and are largely
unregulated. In particular, hedge funds are not subject
to the numerous investor protection regulations that
apply to authorised collective investments. These
The main hedge fund strategies seen on the market are include rules on liquidity, redemption of fund units at
EC
as follows: any time, avoiding conflicts of interest, fair prices for

x Equity hedge ("long", "short")

fund units, disclosure and limitations on borrowing.

Equity hedge funds identify undervalued (buy or Since these rules do not apply to hedge funds, they can
long position) and overvalued (short selling or short use much more leverage than traditional authorised
position) Equities in specific regions or market funds, and engage in complex investment transactions
segments. The hedge fund manager attempts to make that are not permitted for traditional collective invest-
profits in the belief that sooner or later these posi- ments. A hedge fund is allowed to adopt aggressive
tions can be closed out at a profit. strategies including the widespread use of short

x Arbitrage strategies
selling, leverage, swaps, arbitrage, derivatives and
programme trading. Their investment strategies are
Arbitrage strategies identify price differences often highly complex and very intransparent. You will
SP

between identical or similar investments in different often receive little or no information about changes of
markets and try to exploit them. Such strategies in- strategy that may lead to a significant increase in risk,
clude equity-market neutral, fixed-income arbitrage, or receive such information only at a late stage.
convertible-bond arbitrage and mortgage-backed-
securities arbitrage. As part of their investment strategy, hedge funds can

x Event-driven
also use derivatives such as futures, options,
speculation on difference, and equity swaps that may
Managers that pursue this kind of strategy try to make be listed for trading on an exchange but do not have to
a profit from events such as upcoming changes in a be. These instruments may be subject to significant
company (mergers, takeovers, restructurings, price volatility, resulting in a high risk of loss for the
turnarounds, etc.). Examples of such strategies are fund. The low margins typically required to build up a

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Section Two RISKS IN SECURITIES TRADING

position in such instruments mean that high levels of the quality of the private equity manager. The exit can
borrowing can be used. Depending on the instrument, be effected by going public ("initial public offering" or

EN
a relatively small change in the price of the contract IPO), a sale to another company ("trade sale") or to
can therefore lead to a large profit or loss in another private equity fund (secondary sale), or a
comparison with the capital lodged as collateral and management buyout. The choice of solution will
hence to further, unforeseeable losses that can exceed depend largely on the market conditions prevailing at
any margin cover. the time. How easy or difficult the exit phase is, and
whether the proceeds meet expectations, will depend
PLEASE NOTE: Investment vehicles that are not on factors such as the performance of the equity
listed on an exchange or regulated market also involve markets.
further risks as there is neither an exchange or
regulated market nor a secondary market where units What are the risks of private equity
can be sold or open positions closed out. It may be investments?
impossible to unwind an existing position or determine Private equity investments are not regulated compared
the value or risk of a position. If a hedge fund sells
uncovered options on securities, it may be exposing
itself to an unlimited risk of loss.

2. Private equity

What is private equity?

IM to equities listed for trading on an exchange. This
means that investors may be exposed to more risks, for
example due to lack of transparency (e.g. limited
access to financial statements, lack of publication).

Private equity investments involve considerable risks

and can lead to substantial losses. They are based on a
long-term approach and are much less liquid than
Private equity is a form of risk capital financing for exchange-listed equities. Normally, private equity
EC
companies that either are listed on an exchange or investments cannot be sold until some years after the
regulated market or – occasionally – wish to delist. original investment. You should be aware that your
Investments are usually made at an early stage in a capital will be tied up, either completely or with access
company's development, when its chances of success subject to restrictions, for a long time. No distributions
are uncertain and the risks are therefore high. are made prior to exit from investments. You do not
normally have any entitlement to exit early. Compa-
Where private equity flows into young companies nies that are potential candidates for private equity
("start-ups") or small companies with growth potential investments may have high levels of borrowing and
that are at an early stage in their development, the term therefore be more sensitive than established companies
venture capital is also used. Private equity now also to negative market developments such as rising interest
extends to risk capital made available to a company rates. There is also a greater danger of the company
immediately before it goes public ("late-stage" becoming insolvent and going bankrupt than with
SP

financing, "mezzanine" financing). Normally the fi- listed companies.

nancing is constructed in such a way that the proceeds
of the initial public offering are used to wholly or PLEASE NOTE: It is not unusual for further calls for
partially redeem the holdings of the shareholder capital to be made at short notice after the initial
entrepreneurs. If a change of ownership is financed, for investment. If you fail to comply with such a demand,
example a delisting, the term "buyout" is customarily you may lose all the capital you have invested up to
used. that time.

The success of a private equity investment depends on PLEASE NOTE: A change of management in a
the correct timing of the "exit" or sale and – especially young company where the personality of the
with indirect investments via a fund, for example – on individuals occupying key functions is a particularly

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Section Two RISKS IN SECURITIES TRADING

important factor can have a highly detrimental effect on What risks do you need to be aware
a private equity investment. of when investing in real estate?

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Real estate investments are based on physical assets –
What do you need to bear in mind when land and buildings – in which trading is not regulated.
making indirect investments?
With indirect investments, there is no guarantee that Where real estate is concerned, it is therefore often
the manager of a private equity fund will be able to difficult, or even impossible, to spread risks adequately
make investments and generate profits that fulfil the or diversify investments sufficiently. With direct real
expectations for this form of investment. The abilities estate investments especially, broad spreading of risks
of the private equity manager are therefore crucial to by region, real estate type, and use of the property is
the success of an indirect investment. only possible with substantial investment volume.

Property markets are also frequently intransparent, and

3. Real estate require precise knowledge of local circumstances. It is

How can you invest in real estate?

Investments in real estate can be made directly or
indirectly. Real estate comprises office buildings, retail
and industrial premises, residential property and
special real estate (such as hotels or hospitals). The
variables that determine the value of a property are its
location, construction, equipment fittings and the
IM therefore vital to involve local experts, which hampers
access to the market. Real estate often reacts to interest
rate changes in a similar way to bonds: when interest
rates are low, for instance, mortgages are cheap and it
is easy to generate above-average profits. Conversely,
high interest rates cause profits to contract. Fiscal
incentives offered by the state to promote home
ownership and attractive lending conditions can also
variety of ways in which it can be used. lead to excessively high prices.
EC
What do you need to bear in mind when
making direct investments? 4. Precious metals and other
A direct investment involves actually buying property. commodities
This will usually require a high capital outlay, a long
term investment horizon, in-depth knowledge of the What are commodities?
sector, familiarity with the location and often personal Commodities are physical goods that are produced via
involvement, as property needs to be professionally agriculture and mining, for example, and standardised
managed. for use as the underlying of a transaction. Derivatives
on commodities such as energy sources, precious and
What about indirect investments? other metals, and agricultural products are traded on
Indirect investments in real estate generally require a futures markets.
SP

lower capital outlay than direct investments. Indirect

investments are divided into those that are exchange- Contractual agreements allow investors to buy or sell
listed and those that are not. Examples of unlisted futures linked to the performance of a particular com-
indirect investments include real estate funds, shares of modity. This means that they can buy a standardised
real estate companies that are not listed for trading on amount of a commodity at a specific time in the future
an exchange, and certificates on real estate funds. Real for a specific price.
estate funds can reduce risk by diversifying across
geographical areas and real estate categories. The main The commonest way in which private individuals
category of exchange-listed indirect investments is invest indirectly in commodities is via structured pro-
"real estate investment trusts" (REITs). ducts. There are other alternatives, such as commodity
swaps and options that are not listed for trading on an

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Section Two RISKS IN SECURITIES TRADING

exchange. These are traded directly between the parties

concerned and are tailor-made products. More infor-

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mation on how forwards and futures work can be
found above in this brochure (see page 20).

PLEASE NOTE: With commodity futures, you may

receive physical delivery of the commodity concerned
on expiration, while structured products normally pro-
vide for cash payment. If you prefer cash settlement,
you will have to close out the futures on time. Such
products are therefore more risky than, for instance,
shares or investment fund units.

What are the risks of commodity

investments?
The price of commodities is influenced by a number of

x the relationship between supply and demand

factors. These include:

x climate and natural disasters

x state programmes and regulations, national and inter-

x state intervention, embargoes and tariffs

national events
IM
x movements in interest and exchange rates
x trading in commodities and the corresponding con-
EC
x provisions relating to monetary policy, trading, fiscal
tracts

and currency controls.

These variables can lead to additional investment risks.

Commodities investments are more volatile than
conventional investments, and yields on commodities
can collapse at short notice. The volatility of commo-
dity prices also affects the value, and hence the price,
of a futures contract based on those commodities.
SP

Conventional futures on oil, base and precious metals

are normally easy to trade, regardless of their term.

PLEASE NOTE: When market activity is limited, a

contract can become illiquid. Depending on how the
yield curve moves, such illiquidity can lead to
significant price changes. This is a typical feature of
commodities.

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Section Three RISKS IN SECURITIES TRADING

Section Three:

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Additional information

I. Investments in emerging markets PLEASE NOTE: Investing in products linked to

emerging markets is therefore often speculative.
What are emerging markets? Before investing in emerging markets, you should form
There is no standard definition of the term "emerging an impression of them that allows you to assess the
markets". In the broadest sense, the term includes all risks involved.
countries with markets that are not yet established, but
with one or more of the following characteristics: lack
of political stability, uncertain financial markets and
economic development, financial market under deve-
lopment, or an economy that is still weak. Common
criteria for defining what is an emerging market are
per capita income, the level of development of the
financial sector, and the proportion of the total eco-
IM What are the individual risks involved?
When investing in emerging markets, the following
risks should be taken into account, some of which have
already been mentioned in general; special attention
must be paid to the specific circumstances of the coun-
try concerned. The list is not exhaustive. Depending on
the type of investment product, there may of course be
nomy that is made up by the service sector. additional risks involved as described elsewhere in this
EC
brochure.

x Settlement risk
The creditworthiness (credit rating) of countries that
fall within this definition can vary widely: from very
high to very low, with – in the latter case – very high Certain emerging markets have very different clearing
default risk. and settlement systems, if at all. These are often
outmoded and prone to processing errors as well as
Although they can be at very different stages in their considerable delays in settlement and delivery. Some
economic development, most emerging markets have a countries do not have any such systems at all.

x Issuer risk (credit risk)

political system that is very new (for instance they
have only recently become democracies) or is curren-
tly changing. This means that the political system and Investments in debt securities (e.g. bonds, notes)
its institutions may be less stable than in an advanced issued by emerging market governments or com-
SP

nation. panies tend to entail higher levels of risk than estab-

lished market debt. This can be due to inferior credit-
What factors should you be especially worthiness, a high level of government debt, debt
aware of when making investments in restructuring, a lack of market transparency or a lack
emerging markets? of information. It is also much more difficult to
There are risks linked to investments in emerging assess credit risk due to inconsistent valuation stan-
markets that are not encountered in their advanced dards and the absence of ratings.
counterparts. This is also the case when the issuer or
provider of a product has its headquarters or primary x Liquidity risk
focus of activity in an emerging nation. Liquidity is dependent on supply and demand. The
impact on the emerging markets of social, economic

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Section Three RISKS IN SECURITIES TRADING

and political changes or natural disasters can involve their financial markets often lack an adequate
a much more rapid and lasting change to this supply structure and sufficient supervision.

EN
and demand equation than would be the case in the
established markets. In an extreme case, illiquidity x Current risk and inflation risk / monetary value risk
can be the result. This can make it impossible for an The currencies of emerging market countries are
investor to sell his / her investments. subject to greater unpredictable fluctuations in value

x Market risk / price fluctuation risk

than those of established markets. It is also ex-
tremely important to note that some countries limit
Because there is little or no supervision of financial the export of their currency or can impose short-term
markets in emerging market nations, regulation, restrictions. Hedging can help limit losses resulting
market transparency, liquidity and efficiency are from currency swings, but they can never be entirely
often inadequate. Moreover, high volatility and large eliminated. Large fluctuations in the value of the
price differences are characteristic of these markets. currency and an insufficiently developed financial
Finally, the inadequacy or absence of regulatory market can make it difficult for an emerging market
measures gives rise to an increased danger of market
manipulation or insider trading.

x Country risk / transfer risk

A government's political inexperience or the
IM
instability of the political system increases the risk of
short-term, fundamental shifts in a nation's economy
and politics. The consequences for you as an investor
nation's central bank to stick to its inflation targets.
As a result, inflation may fluctuate more than in
advanced countries.

II. Guarantees

What is a guarantee?
can include the confiscation of your assets with no The term "guarantee" may have different meanings.
EC
compensation, the restriction of your rights of dis- On the one hand, it may mean the assurance of a third
posal over your assets, or government-imposed party different from the issuer, with which the third
controls. State intervention in specific sectors of party ensures the settlement of the issuer's liabilities.
industry can result in a dramatic fall in the value of Such a guarantee can limit the credit risk. The guaran-
investments in those sectors. tor only is liable to the extent of the guarantee, how-
ever.
Legislation to protect the rights of shareholders and
creditors (e.g. duties of disclosure, insider trading On the other hand, a guarantee may also be the assu-
ban, management responsibilities, minority share- rance of the issuer to provide a certain performance
holder protection) may often be inadequate or non- irrespective of the development of specific indicators
existent. The absence or inadequacy of financial that would in principle determine the amount of the
market supervision can lead to your legal rights issuer's obligation. Such a guarantee can limit the
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being difficult or impossible to enforce. Moreover, liquidity risk.

legal uncertainty may exist due to the inexperience
of the emerging nation's judiciary.
III. Securities lending
Emerging market economies are more sensitive to
changes in interest and inflation rates, which are in What is securities lending?
any case subject to greater swings than in the The term "securities lending" means the lending of
developed nations. The focus of such economies is securities in exchange for payment of a fee. It is a legal
often relatively narrow, allowing single events to transaction similar to a loan, in which the lender
have a magnified impact. In addition, emerging temporarily undertakes to transfer ownership in certain
nations generally have a lower capital base. Finally, securities to the borrower, while the borrower under-

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Section Three RISKS IN SECURITIES TRADING

takes to reimburse securities of the same type, amount, exchange) or outside an organised market, the value of
and quality and to transfer any earnings to the lender the financial instrument will increase. If demand

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for the duration of the securities lending contract. decreases, the price of the financial instrument concer-
ned, whether on an organised market or outside an
What are the advantages of organised market, will usually decrease as well.
securities lending?
The advantage of securities lending is that the lender Increases or reductions in demand may be caused by
can generate an additional return on the securities different market conditions. Positive company reports,
thanks to the lending fee, without having to enter into good financial results or a company’s good reputation
greater risks. As a rule, the borrower (generally a in general may boost demand for its shares or other
custodian bank) receives collateral in the form of financial instruments because investors want to invest
securities or cash. in the shares of companies that have performed well or
in financial instruments offering the prospect of good
What are the disadvantages of returns. Less positive information released about
securities lending?
The disadvantages of securities lending are that the
lender no longer has membership rights (participation
in the general meeting, voting rights) for effectively
lent securities (shares) and, in the case of registered
shares, re-entry in the share register is not guaranteed.

What are the risks involved in

IM companies may have precisely the opposite effect,
potentially causing demand for the financial instru-
ments to decrease and their value to decline.

However, the performance of a financial instrument is

not just affected by the information on the issuer but
also by other market factors, such as the political cli-
mate, the macroeconomic situation on various markets
securities lending? and general trends and market sentiment. If the interest
EC
The main risks are counterparty and price fluctuation paid on bonds increases, for example, demand for
risk. If the borrower is unable to return the borrowed equities may decrease, and vice versa. The same im-
securities at all or on time, the lender may be forced to pact can be perceived for certain regions or sectors, for
sell collateral and buy the originally lent securities on example if interest rates only increase in certain coun-
the market. The lender may then suffer a loss. tries. This may reduce demand for bonds or equities in
other countries, so that capital gains will be realised in
Please note also that securities lending may have the country where rates are rising, triggering losses on
specific tax implications in the country in which the bonds and equities in the other country or region. Even
lender is resident, given that such transactions do not if rates are generally increasing within a given country
constitute investments but involve the borrowing and or region, this may cause losses on existing bonds if
lending of securities. the yields on such bonds are comparatively low.
SP

A generally critical sentiment towards specific indu-

IV. Performance of financial stries, technologies or regions may cause demand to
instruments under different market contract, even though reports on particular companies
conditions may be viewed favourably. There are therefore a wide
range of factors which, taken together, create the
What determines the performance of market conditions affecting the price of a financial
financial instruments? instrument. For further information on factors that may
As a general rule, the performance of financial instru- impact the markets for various financial instruments,
ments is determined by the principle of supply and we recommend reading the relevant prospectus and
demand. If demand for a particular financial instru- product information.
ment increases on an organised market (e.g. a stock

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Section Three RISKS IN SECURITIES TRADING

V. Barriers to minimising In many cases, it is only possible to make accurate

misinvestments assessments in retrospect once detailed information on

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the relevant market trends becomes available. We
How can misinvestments be minimised, therefore recommend reading the relevant product
and what are the barriers preventing this? documents and, in particular, the sales prospectus and
In general, investors look for opportunities to minimise product information.
misinvestments, which usually means selling invest-
ments that have been purchased previously. However,
they often encounter barriers to minimising misinvest-
ments, for example in situations where a particular
financial instrument is illiquid. Further information on
liquidity risk is set out on page 7 of this brochure.

Fixed maturities for financial instruments may pose a

further obstacle. If the financial instruments cannot be
redeemed or income distributed until the end of the
specified term, there may be no liquid market in which
to sell. If there is no market in which to sell such
financial instruments, investors must wait until the
maturity date before receiving redemption payments or
distributions of income. During the term to maturity,
investors may not be able to sell or generate income on
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the financial instrument, or may only be able to do so
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by incurring a loss.

If necessary, investors must take steps to exit their

investment through a private sale, which will preclude
them from redeeming the financial instrument from the
issuer or realising any proceeds by selling it on a liquid
market. Financial instruments may also become
illiquid unexpectedly if demand for the instrument
suddenly collapses.

In this type of scenario, or similar scenarios, there is a

risk that investors will not recover the initial
SP

transaction costs for the financial instrument concerned

through capital gains, payouts or distributions. Trans-
action costs are generally incurred on purchasing
financial instruments. If transaction costs of 2 % were
charged, for example, and the financial instrument
yielded an annual net return of 2 %, it would take
investors a year to recover the initial transaction costs
paid. Given initial transaction costs of 4 % and assu-
ming the same net return, a two-year time frame would
be required before the initial transaction costs were
recovered and the financial instrument could be sold.

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Appendix 1 RISKS IN SECURITIES TRADING

Appendix 1:

EN
Overview of the characteristics and risks of selected
financial instruments

Financial instrument Characteristics Characteristic risks

Asset-backed security In its basic form, provides for the sale of Like "straight bond"
(ABS) the receivables of a company or a credit
institute to a vehicle specially formed for Of special importance, however, are
this purpose ("Special Purpose Vehicle"). issuer risk / credit risk and liquidity

Bond ex warrant

Bond with warrant

attached
IM
The sole task of the special purpose
vehicle is to buy the receivables and to
refinance them by issuing securities
backed by the receivables.

Like "straight bond"

Represents a pecuniary claim against the

issuer (borrower). Depending on the
risk.

Like "straight bond"

Like "convertible bond"

market situation, it may offer a higher

EC
return than other fixed-interest investment
instruments. The warrant entitles the
holder to participate directly in the
success of the company by subscribing for
shares.

Call option Standardised buy option, traded on For the buyer: Like "warrant"
exchange (EUREX or other derivatives For the seller: Like "warrant"
exchange). Additionally: Risk of having to sell
For the buyer: Like "warrant" the underlying instrument below its
For the seller: Possibility of gaining current market price.
additional earnings or improving the
SP

return on an existing position.

Certificate of deposit x
x
Represents a short-term pecuniary claim Issuer risk / credit risk
(CD)
x
against a bank. Monetary value risk / inflation risk

x
Country risk / transfer risk

x
Liquidity risk

x
Market risk / price fluctuation risk

x
Currency risk
Interest rate risk

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Appendix 1 RISKS IN SECURITIES TRADING

Financial instrument Characteristics Characteristic risks

EN
Collateralised debt Bond secured by diversified debt portfolio Like "straight bond"
obligation (CDO) (usually loans, bonds, or credit default
swaps). Of special importance, however, are
issuer risk / credit risk and liquidity
risk.

Commercial paper Represents a short-term pecuniary claim Like "Certificate of deposit (CD)"
in the form of a promissory note issued by
an industrial or financial company.

Commodities x
x
Represent homogeneous mass goods; Market risk / price fluctuation risk

x
classic commodities are metals (gold, Liquidity risk

x
silver, copper, etc.), agricultural products Country risk

Convertible bond IM
(wheat, soy, etc.), and energy sources
(crude oil, natural gas, etc.).

Represents a pecuniary claim against the

issuer (borrower). Depending on the
market situation, it may offer a higher
return than other fixed-interest investment
x
x
x
x
x
Currency risk

Issuer risk / credit risk

Monetary value risk / inflation risk
Country risk
Liquidity risk

x
instruments. The right to convert the bond Market risk / price fluctuation risk

x
into shares enables the holder to Currency risk
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participate directly in the success of the Interest rate risk
company.

Credit-linked note Bond cancelled at expiration, if none of Like "straight bond"

(CLN) the agreed credit events occurred during
the term. Of special importance, however, are
issuer risk / credit risk and liquidity
risk.

Cross currency swap x

x
Exchange of differently defined interests Issuer risk / credit risk
(CCS)
x
payable and of different currencies on a Country risk / transfer risk

x
fixed nominal amount. Market risk / price fluctuation risk

x
Currency risk
SP

Interest rate risk

Currency swap x
x
Combination of a spot exchange Issuer risk / credit risk

x
transaction with a forward exchange Country risk / transfer risk

x
transaction. Market risk / price fluctuation risk
Currency risk

Debt register claim Represents a pecuniary claim against Like "medium-term bank note"
public or private institutions arising from
a loan or credit entered in an official
register.

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Appendix 1 RISKS IN SECURITIES TRADING

Financial instrument Characteristics Characteristic risks

EN
Dividend-right Like "share" (but with no membership Like "share"
certificate (non-voting, rights)
no par value)

Eurobond Like "straight bond" Like "straight bond"

Exchange-traded fund Listed investment fund units traded like Like "unit of investment fund"
(ETF) shares.

Forward x Issuer risk / credit risk

x High market risk / price fluctuation
Off-exchange foreign currency, money
market, and precious metals trades, where

x Liquidity risk
delivery and payment are at a future date. risk due to leverage effect

x Country risk / transfer risk

All conditions (scope of contract, price,

Forward exchange
contract
is concluded.
IM
maturity, beginning of contract) are
already negotiated at the time the contract

Purchase or sale of a traded foreign

currency at a specific future date. The
amount and price are agreed in advance.
x Currency risk
x Other risks depend on underlying

x
x
x
x
asset

Issuer risk / credit risk

Country risk / transfer risk
Market risk / price fluctuation risk
Currency risk

x High market risk / price fluctuation

EC
Future Standardised futures contract traded on-

x Country risk / transfer risk

exchange (EUREX or other derivatives risk due to leverage effect

x Currency risk
exchange), with high potential for price

x Other risks depend on underlying

gains on the underlying instrument on
account of the low initial margin
(leverage effect). Possibility of hedging asset
existing positions.

Hedge fund x Country risk / transfer risk

x Liquidity risk
Funds that are often domiciled offshore

x High market risk / price fluctuation

and, unlike traditional funds, primarily
use alternative investment strategies and

x Currency risk
instruments free from legal restrictions. risk due to leverage effect
SP

x Interest rate risk

These include, for instance, borrowing,
the use of derivatives to increase the level
of investment (leverage), and the sale of
assets not in the possession of the fund at
the time of sale ("short sale").

Interest rate swap (IRS) x Issuer risk / credit risk

x Market risk / price fluctuation risk
Exchange of differently defined interests

x Interest rate risk

payable on a fixed nominal amount.

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Appendix 1 RISKS IN SECURITIES TRADING

Financial instrument Characteristics Characteristic risks

EN
Medium-term bank
x
Represents a medium-term pecuniary Issuer risk / credit risk
note
x
claim, e.g. against a Liechtenstein bank. Inflation risk / monetary value risk

x
Market risk / price fluctuation risk

x
Liquidity risk
Interest rate risk

Money market Financial instruments which, due to their Like "straight bond"
instrument maturity and their circle of issuers and
investors, can be attributed to the money Of particular importance, however, is
market. These include treasury notes, liquidity risk.
certificates of deposit and commercial
papers, with the exception of payment

Mortgage bond

Notes

Participation certificate
instruments.

IM
Represents a pecuniary claim, e.g. against
the Swiss central mortgage bond
institutes.

Represents a medium-term pecuniary

claim against the issuer (borrower)

Like "share" (but with no membership

Like "medium-term bank note"

Like "straight bond"

Like "share"
(non-voting share) rights)
EC
Private Equity x Country risk
x Liquidity risk
Risk capital financing for companies that

x High market risk / price fluctuation

are normally not listed on an exchange or
regulated market or want to withdraw

x Currency risk
from an exchange or regulated market, risk due to leverage

x Interest rate risk

typically in the form of venture capital,
capital for the non-exchange buyout of
existing companies or parts of companies,
or investments in companies in financial
or operational difficulties ("special
situations").
SP

Put option Standardised sell option, traded on For the buyer: Like "warrant"
exchange (EUREX or other derivatives For the seller: Like "warrant"
exchange). Additionally: Risk of having to buy
For the buyer: Like "warrant" the underlying instrument above its
Possibility of hedging existing positions. current market value.
For the seller: Like "call option"

Real estate x
x
Investments in real estate or in companies Issuer risk / credit risk

x
and investment instruments that operate in Country risk / transfer risk

x
real estate or are invested in real estate. Liquidity risk
Market risk / price fluctuation risk

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Appendix 1 RISKS IN SECURITIES TRADING

Financial instrument Characteristics Characteristic risks

EN
Share
x
As an equity paper, it represents a share in Issuer risk / credit risk

x
(domestic and foreign; the company and therefore enables the Country risk / transfer risk

x
bearer; registered, holder to participate directly in the Liquidity risk

x
preference, ordinary, success of the company, e.g. through Market risk / price fluctuation risk
priority, voting) share price gains (capital and membership Currency risk
rights).

Straight bond x
x
Represents a pecuniary claim against the Issuer risk / credit risk

x
issuer (borrower). Inflation risk / monetary value risk

x
Liquidity risk

x
Market risk / price fluctuation risk
Currency risk (for foreign currency

Treasury bill

Unit of an investment
fund
UK).
IM
Represents a short-term pecuniary claim
against a state (especially USA, Canada,

Represents a participating share in an

investment fund or an investment
x Interest rate risk
bonds)

Like "Certificate of deposit (CD)"

Differs depending on the investment

strategy (see fund prospectus); the

x Issuer risk / credit risk

company and therefore enables the holder most important are:
EC
x Inflation risk / monetary value risk
to participate directly in the success of the

x Liquidity risk
investment fund or the investment

x Market risk / price fluctuation risk

company.

x Currency risk

Warrant x Issuer risk / credit risk

x High market risk / price fluctuation
It gives the holder a specific buying or
selling right to other instruments within a

x Country risk
stipulated period. On account of the risk due to leverage

x Liquidity risk
leverage effect, price fluctuations are

x Currency risk
significantly higher than with a direct

x Interest rate risk

commitment.
SP

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Appendix 2 RISKS IN SECURITIES TRADING

Appendix 2:

EN
Financial instruments

According to Annex 2, Section C of the Banking Act,

financial instruments are: 5. options, futures, swaps, off-market forward rate
agreements and any other derivative contracts
1. transferable securities of all classes traded on the relating to commodities that must be settled in
capital market, such as cash or may be settled in cash at the option of one

a) shares and other securities equivalent to

shares or interests in companies, partnerships
or other legal entities, including certificates
(collateral notes) for such securities;

b) bonds or other securitised debt securities, in-

cluding certificates (collateral notes) for such
IM 6.
of the parties (otherwise than by reason of a
default or other termination event);

options, futures, swaps, and any other derivative

contract relating to commodities that can be
physically settled, provided that they are traded on
a regulated market and/or a multilateral trading
facility (MTF);
securities;
EC
7. options, futures, swaps, forwards and any other
c) all other securities entitling to buy or sell derivative contracts relating to commodities that
securities or leading to a cash payment deter- can be physically settled not otherwise mentioned
mined on the basis of transferable securities, in point 6 and not being for commercial purposes,
currencies, interest rates or interest earnings which have the characteristics of other derivative
or other indices and benchmarks; financial instruments, having regard to whether,
inter alia, they are cleared and settled through
2. money market instruments normally traded on the recognized clearing houses or are subject to
money market, such as treasury notes, certificates regular margin calls;
of deposit and commercial papers, with the ex-
ception of payment instruments; 8. derivative instruments for the transfer of credit
risk;
SP

3. units in collective investment undertakings: units

in undertakings for collective investment in 9. financial contracts for differences; or
transferable securities, in investment undertakings
and alternative investment funds; 10. options, futures, swaps, off-market forward rate
agreements and any other derivative contracts re-
4. options, futures, swaps, off-market forward rate lating to climatic variables, freight rates, emission
agreements and any other derivative contracts allowances, or inflation rates or other official
relating to securities, currencies, interest rates or economic statistics that must be settled in cash or
yields, or other derivatives instruments, financial may be settled in cash at the option of one of the
indices, or financial measures which may be parties (otherwise than by reason of a default or
settled physically or in cash; other termination event), as well as any other

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Appendix 2 RISKS IN SECURITIES TRADING

derivative contracts relating to assets, rights,

obligations, indices, and measures not otherwise

EN
mentioned in this Section C, which have the
characteristics of other derivative financial instru-
ments, having regard to whether, inter alia, they
are traded on a regulated market or an MTF, are
cleared and settled through recognized clearing
houses, or are subject to regular margin calls.

IM
EC
SP

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IM
EC
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The passing on of this electronic edition is not permitted.

EN
IM
EC
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The passing on of this electronic edition is not permitted.

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EC
The brochure "RISKS IN SECURITIES TRADING" is
a publication of the Liechtenstein Bankers Association.

October 2017 edition: third, fully revised version

(First published in 2002, second edition in August 2008)

If you have any suggestions or comments about this

brochure, please send them to:

Liechtenstein Bankers Association

P.O. Box 254, 9490 Vaduz
Principality of Liechtenstein
SP

P: +423 230 13 23
F: +423 230 13 24
info@bankenverband.li
www.bankenverband.li

In the case of contradictions or discrepancies between

this language version and the original German version
the German language version shall prevail.

© Liechtenstein Bankers Association

The passing on of this electronic edition is not permitted.

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EC
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