Risks assessment in the world of leverage Structured Products

Investing in securities always comes with risks, and certain investment products carry particular risks that investors need to be aware of.

Let’s take a closer look at some of the special risks associated with the following investment products (note that this list is not exhaustive):

1. Variable pricing factors: The value of most investment products is influenced by a variety of factors, such as changes in implied volatility, interest rates, dividends, and remaining term to maturity. This means that the value of an investment product can develop differently than what the investor originally expected during the product’s term. Ultimately, the repayment profile of structured products is only achieved at the end of their term.
2. Safety threshold: Many investment products come with a safety threshold. If the underlying instrument breaches this level, the repayment profile of the product can change significantly. As the underlying instrument approaches the threshold, the probability of it being violated increases, which can cause the value of the investment product to deteriorate even before an actual breach occurs.
3. Leverage: Certain product types can react disproportionately to movements in the underlying instrument due to their leverage. This means that investors could experience heavy losses or sizeable gains within a short period of time. In some cases, investors could even incur a total loss on an investment product that does not carry a capital guarantee.
4. No additional income: Most investment products do not provide investors with any rights to receive interest or dividend payments during the product’s term to maturity.
5. Limited term: Investment products have a limited lifespan, and the rights acquired through their purchase can lose value during the term or even lapse entirely upon maturity. The shorter the remaining term to expiration, the greater the risk of a loss in value.
6. Underlying instruments denominated in foreign currency: If the underlying instrument is traded on its home exchange in a currency other than the Swiss franc, investors bear an additional foreign exchange risk. This is because the value of the investment product is derived directly from the price of the underlying instrument. Investors bear no currency risk in the case of a currency-protected certificate.
7. Issuer default risk: Structured products are considered unsecured debentures of the issuer. If the issuer has difficulty meeting its payments or becomes insolvent, the invested capital is not protected. Therefore, investors also bear a creditworthiness risk (except for secured products).

Investing in securities always comes with a degree of risk, but leverage products present investors with an additional set of potential pitfalls to consider. Leverage products, such as warrants and knock-out products, offer the potential for high returns, but they also come with a set of unique risks that investors should be aware of before diving in.

Perhaps the most significant risk associated with leverage products is the potential for heavy losses. Leverage products offer investors the ability to amplify their gains by using borrowed money, but they also amplify potential losses. If a warrant or knock-out product experiences a significant drop in value, it could result in a total loss of the invested capital.

Another risk associated with knock-out products is the knock-out level. If a knock-out event occurs, the product will become valueless even before its original expiration date. As a result, investors could experience a significant loss of capital in a very short period of time.

Like other investment products, warrants and knock-out products have a limited lifespan. As the expiration date approaches, the value of the product can decrease or even lapse entirely, leading to a loss in value for investors.

Other price-influencing factors can also impact the value of warrants and knock-out products. Changes in implied volatility, interest rates, and expectations for dividends on the underlying instrument, as well as attrition of the remaining term to expiration, can all have an impact on the value of these products.

Investors should also consider the potential for foreign exchange risk when investing in leverage products. If the underlying instrument is traded in a currency other than the Swiss franc, investors face additional foreign exchange risk because the intrinsic value of the product is calculated in that foreign currency.

Finally, from a legal standpoint, almost all structured products are considered to be unsecured debentures of the given issuer. If the issuer experiences financial difficulties or becomes insolvent, the invested capital is not protected, and the investor is left exposed to creditworthiness risk.

In conclusion, while leverage products offer the potential for high returns, they also come with a unique set of risks that investors must carefully consider. By understanding the potential risks and rewards associated with leverage products, investors can make informed decisions about whether these investment products are appropriate for their investment goals and risk tolerance.