Opportunity and risk are considered the "Siamese twins" of investment. One parameter cannot do without the other. In plain language, the more opportunities an investor wants to exploit, the greater the risk he must take. Structured products make it possible to deviate from this norm. This also and especially applies to the capital protection certificate. Simply put, this product allows the risk of loss to be largely or even completely eliminated. And yet there is the possibility of participating in rising prices - at least to a certain extent.
At the moment, the capital protection certificate is experiencing a small renaissance. The background is the interest rate turnaround. As is well known, important central banks have vehemently raised their key rates in the fight against inflation. The interest rate level is one of the main factors influencing the conditions of capital protection certificates. In general, the higher the bond yields in the respective product currency, the more interesting risk-reward profiles are possible - more on this later.
Not only structurally, but also in terms of investment tactics, the capital protection certificate fits well into the current environment. In times of high inflation, many investors focus on preserving value or trying to compensate for inflation. The capital guarantee helps here; the product holder can count on a fixed minimum repayment at maturity. The income opportunity comes on top and holds the potential for an attractive return.
There are different variants of capital protection certificates. A common form is the capital protection certificate with participation. Here, the issuer provides a repayment guarantee for a certain percentage of the nominal value. As a rule, this amount, known as the "floor" in technical jargon, ranges between 90% and 100%. The underlying is usually one or more individual shares. Alternatively, indices, exchange rates or commodities can be used as underlyings. The product participates in a positive performance of the underlying asset. However, due to the costs associated with this structure, full or unrestricted participation is not normally possible. The issuers have various options for taking the "obolus" into account. One option is a disproportionately low participation rate. Here is an example:
Term: 3 years
Denomination: CHF 1'000
Issue price: 100%.
Underlying: Example Ltd. (initial fixing CHF 100)
Strike price: CHF 100
Settlement type: cash
Capital protection: 100%
Participation rate: 60%
The price of Example Ltd. at the final fixing is CHF 140. Due to the participation rate of 60%, the redemption of the capital protection certificate amounts to CHF 1'240. The investment would thus yield a return of 24%.
Calculation: Denomination x (Capital Protection + Participation Rate x Positive Underlying Price Development)
= CHF 1'000 x (100% + 60% x 40%) = CHF 1'240
The price of Example Ltd. is at CHF 80 at the final fixing. In this case, the participation component does not apply. Instead, the capital protection takes effect, whereby the certificate is redeemed at CHF 1'000.
A stronger or full participation in rising prices is also possible. For this, however, the opportunity must usually be capped. This is how the capital protection certificate with participation and cap is created.
Maturity: 3 years
Maximum amount (cap): 120
Participation rate: 100%
The share price of Example Ltd. at the final fixing is CHF 115. Due to the participation rate of 100%, the redemption of the capital protection certificate amounts to CHF 1'150. The investment would thus yield a return of 15%.
Calculation: Denomination x (Capital Protection + Participation Rate x Positive Underlying Performance)
= CHF 1'000 x (100% + 100% x 15%) = CHF 1'150
The price of Example Ltd. at the final fixing is CHF 130. In this case, the participation component and the cap come into effect. The repayment corresponds to the maximum amount and amounts to CHF 1'200.
The price of Example Ltd. is at CHF 80 at the final fixing. In this case, the participation component and cap do not apply. Instead, the capital protection takes effect, whereby the certificate is redeemed at CHF 1'000.
Capital protection certificates are structured by combining bonds with option transactions. The capital guarantee comes from a zero bond. Since this debt instrument pays no coupon, it is also known as a "zero coupon bond". Instead of a regular distribution, the bond is issued at prices below 100%. For the difference, the issuer acquires one or more call options for participation in the underlying. At this point, the buzzword "interest rate turnaround" comes into play again: Thanks to the increased yields, more capital is available in principle for the option component or the chance to participate as extensively as possible in rising quotations.
There are other forms of this product category. In the case of the capital protection certificate with coupon, the investor receives the participation via a distribution. Meanwhile, the participation in the capital protection certificate with barrier is linked to the fact that the underlying does not reach a certain price threshold. A kind of balancing act is made possible by the twin-win certificate. Here, the investor participates to a certain extent in both rising and falling prices.
One of the special forms of capital protection products is the money market certificate. Here, too, the issuer provides a guarantee at the expiration date. At the same time, the product yields an ongoing return. The coupon is usually based on current money market conditions and goes up a little with each distribution day. Conditional capital protection is provided by the reference debtor certificate. In principle, the issuer also provides a guarantee here. However, the redemption is at the same time linked to the creditworthiness of a reference debtor. As soon as a credit event occurs, the capital protection expires. The structured product is then settled for the liquidation amount. This can be significantly lower than the denomination. As a kind of compensation for this risk, a more pronounced participation or higher coupons are possible.
Capital protection and participation only take effect at maturity. During the term, various factors influence the value of the capital protection certificate. In addition to the underlying and its volatility, these include in particular the interest rate level and the creditworthiness of the issuer or a reference debtor. The capital protection certificate may therefore be quoted below the guarantee level (floor) during its term.
As is usual with structured products, the capital protection certificate is also subject to issuer risk. If the issuer defaults, the investor may lose his entire investment.
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