The zero bond is a particular type of investment. Unlike traditional bonds, this debt instrument does not pay out current interest. Instead, the bond, also called a zero coupon bond, is quoted below par at the time of issue and is repaid in full at the end of the term. The initial discount depends on the yield level. Here the principle is that the higher the interest rate, the lower the issuing price of the zero bond. As is well known, investors on bond markets have been living off scraps over the last few years, with the steady interest rate more or less disappearing in the wake of ultra-loose monetary policy. Zero bonds were correspondingly unattractive. Now, though, a sea-change is occurring: having for years hovered along the zero line or even fallen below it, the yield on the ten-year Swiss government bond is now 0.87%. Not only is this trend bringing the zero coupon bond back onto the menu for investors, it is also opening up new possibilities for investors in structured products.
Zero bonds are a central pillar of capital protection certificates. The issuers use the initial interest charge to finance the option component of this class of derivatives. This made it difficult to enable a form of participation alongside the capital protection during the phase of low or even negative yields. The rise in medium to long-term interest rates has changed the picture, however, as a recent new issue from Leonteq demonstrates. On the one hand, the issuer is guaranteeing full repayment of the nominal at the end of the five-year term. On the other, there is also the opportunity for a coupon. Whether there will eventually be any payout depends on the performance of the underlyings. Leonteq has put together five Swiss large caps for this purpose: Nestlé, Novartis, Roche, Swiss Re and Zurich Insurance. The quintet jointly account for more than 60% of the SMI’s capitalisation.
Coupon Trigger Level 1: 110% - Coupon Amount 1: CHF 100 - Total Coupon Recieved: CHF 100
Coupon Trigger Level 2: 120% - Coupon Amount 2: CHF 100 - Total Coupon Recieved: CHF 200
Coupon Trigger Level 3: 140% - Coupon Amount 3: CHF 200 - Total Coupon Recieved: CHF 400
In simple terms, the underlyings must climb a ladder if a payout is to be achieved. The first “rung” is located at 110% of the initial fixing. If all five stocks finish above coupon level 1 at the end of the term, the investor receives a repayment of 110% of the investment, which is denominated in CHF 1,000. The second rung is at 120%. If it is passed by every underlying on maturity, Leonteq will pay a premium of CHF 200 on the nominal amount. The coupon is even twice as high if the quintet finishes more than 40% up on the starting level in five years. Coupon level 3, then, triggers a payout of 40%, which would simultaneously be the maximum yield of this issue.
Having recently appreciated in value, all five underlyings are travelling in the right direction. The rise in yields already mentioned is playing into the hands of the financial stocks, Swiss Re and Zurich. Meanwhile, Roche and Novartis are model examples of the momentum in the pharmaceuticals sector. The “pillmakers” are tempting investors with growth prospects that are relatively insensitive to economic conditions alongside attractive dividends. Next week Roche (25 April) and Novartis (26 April) will be presenting their figures for the first quarter of 2022. Nestlé published its sales figures for the January to March period on 21 April (after we went to press). These were set to reveal the extent to which the food group has been able to pass on the rising cost of raw materials to consumers across the world through price adjustments. Holders of the new capital protection certificate should be able to take a pretty relaxed view not only of the current reporting season: this product puts them on the safe side – regardless of what the next five years on the stock market will bring. Should quotations head up, an attractive payout is even possible.
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