Understanding Risks of Structured Products 
07/04/2009 
 

This education document is intended as a general guide to highlight some basic facts and characteristics of certain types of securities.  HKEx and/or its subsidiaries endeavor to ensure the accuracy and reliability of the information provided, but does not guarantee its accuracy and accepts no liability (whether in tort or contract or otherwise) for any loss or damage arising from any inaccuracies or omissions.  If investors require further information for investing in securities, they should refer to the listing documents issued by the issuers on the HKExnews website (http://www.hkexnews.hk) and consult their brokers or other professional advisors prior to making any decision.

Some Risks Associated with Structured Products
 
1.

Issuer default risk
 
In the event that a structured product issuer becomes insolvent and defaults on their listed securities, investors will be considered as unsecured creditors and will have no preferential claims to any assets held by the issuer.  Investors should therefore pay close attention to the financial strength and credit worthiness of structured product issuers. 

Note:   “Issuers Credit Rating” showing the credit ratings of individual issuers is now available under the Issuer and Liquidity Provider Information sub-section under Dervative Warrants and under CBBCs section on the HKEx corporate website.
 

2.

Uncollateralised product risk
 
Uncollateralised structured products are not asset backed.  In the event of issuer bankruptcy, investors can lose their entire investment.  Investors should read the listing documents to determine if a product is uncollateralised.
 

3.

Gearing risk
 
Structured products such as derivative warrants and callable bull/bear contracts (CBBCs) are leveraged and can change in value rapidly according to the gearing ratio relative to the underlying assets.  Investors should be aware that the value of a structured product may fall to zero resulting in a total loss of the initial investment.
 

4.

Expiry considerations
 
Structured products have an expiry date after which the issue may become worthless.  Investors should be aware of the expiry time horizon and choose a product with an appropriate lifespan for their trading strategy.
 

5.

Extraordinary price movements 
 
The price of a structured product may not match its theoretical price due to outside influences such as market supply and demand factors.  As a result, actual traded prices can be higher or lower than the theoretical price.
 

6.

Foreign exchange risk
 
Investors trading structured products with underlying assets not denominated in Hong Kong dollars are also exposed to exchange rate risk.  Currency rate fluctuations can adversely affect the underlying asset value, also affecting the structured product price.
 

7.

Liquidity risk

The Exchange requires all structured product issuers to appoint a liquidity provider for each individual issue.  The role of liquidity providers is to provide two way quotes to facilitate trading of their products.  In the event that a liquidity provider defaults or ceases to fulfill its role, investors may not be able to buy or sell the product until a new liquidity provider has been assigned.

   
Some Additional Risks Involved in Trading Derivative Warrants
  
1.

Time decay risk
 
All things being equal, the value of a derivative warrant will decay over time as it approaches its expiry date.  Derivative warrants should therefore not be viewed as long term investments. 
 

2.

Volatility risk
 
Prices of derivative warrants can increase or decrease in line with the implied volatility of underlying asset price.  Investors should be aware of the underlying asset volatility.

 
Some Additional Risks Involved in Trading CBBCs
 
1.

Mandatory call risk
 
Investors trading CBBCs should be aware of their intraday “knockout” or mandatory call feature.  A CBBC will cease trading when the underlying asset value equals the mandatory call price/level as stated in the listing documents.  Investors will only be entitled to the residual value of the terminated CBBC as calculated by the product issuer in accordance with the listing documents.  Investors should also note that the residual value can be zero.
 

2.

Funding costs
 
The issue price of a CBBC includes funding costs.  Funding costs are gradually reduced over time as the CBBC moves towards expiry.  The longer the duration of the CBBC, the higher the total funding costs.  In the event that a CBBC is called, investors will lose the funding costs for the entire lifespan of the CBBC.  The formula for calculating the funding costs are stated in the listing documents. 
  

For more information on derivative warrants and CBBCs, please visit the HKEx corporate website:

Derivative Warrants, Products & Services Section (http://www.hkex.com.hk/eng/prod/secprod/dwrc/dw.htm)

Callable Bull/Bear Contracts, Products & Services Section (http://www.hkex.com.hk/eng/prod/secprod/cbbc/Intro.htm)