Factor Certificate
A factor certificate is - similar to a mini future - or knock-out certificate - a financial market leverage product . With a factor certificate, an investor can participate disproportionately in the performance of a base or reference value (e.g. share or share index ).
Basics
Factor certificates belong to the category of bearer bonds . The issuer gives the owner a vested right to provide a defined service. Factor Certificates are basically designed in two forms: as a long position in order to participate in rising prices and as a short position in order to participate in falling prices (see long and short position ). Depending on the factor, the performance is many times that of the base value. Factor Certificates have an unlimited term and are usually traded on the regular capital market ( stock exchange ). They can therefore be bought or sold every trading day.
functionality
In contrast to the mini future or knock-out certificate , a factor certificate has no knock-out threshold (strike level). So it cannot expire worthless. The calculation or performance is based on a specially calculated index that reflects the change in value of the underlying at the previous day's closing price, multiplied by a specified factor. The leverage is therefore constant, which is a major difference to the knock-out certificate and many other leverage products. Since the value development is not only dependent on the development of the reference value, but in particular on the change in value compared to the previous day, one speaks of a path dependency. This can be a major disadvantage, since with this type of construction a sideways price development of the underlying already leads to losses. It is therefore only suitable for a short term for significantly rising or falling price developments. Furthermore, the investor bears the financing costs for the leverage as well as an annual management fee. Like other certificates, factor certificates are issued with a subscription ratio to the base value (usually 0.01 or less).
In principle, the issuer does not enter into an opposing position to the investor, but rather hedges. In the simplest case, this is done by buying an amount of the underlying asset, i.e. a share or a future, to be multiplied by the leverage factor. The financing costs for the leverage are usually based on a surcharge on a market-wide reference interest rate, such as B. the respective daily interbank overnight rate EONIA, taken directly into the pricing of the certificate.
Factor certificates are usually available with a factor of 2 to 10.
example
An investor would like to benefit from rising prices on the DAX share index with a factor certificate of factor 2 and subscription ratio 0.01 (long position).
The DAX index and the associated certificate now show the following price development over the course of 5 days (fees not taken into account):
| Initial course | day 1 | day 2 | Day 3 | Day 4 | Day 5 | |
|---|---|---|---|---|---|---|
| DAX | 10,000 pts. | 10,300 | 9,270 | 8,991.9 | 9,531.4 | 10,008 |
| + 3% | −10% | −3% | + 6% | + 5% | ||
| Factor certificate 2x | 100 EUR | 106 | 84.80 | 79.71 | 89.28 | 98.20 |
| + 6% | −20% | −6% | + 12% | + 10% |
The certificate always makes double the profit or double the loss of the reference value. Although the underlying shows hardly any change in the end, the certificate has made a loss.
Compared to the knock-out certificate
The advantage compared to the knock-out certificate only becomes apparent when there are significant price changes. While the leverage of a knock-out certificate (long position) becomes more and more diluted when the price of the underlying asset rises and becomes stronger as the price falls, it remains constant with the factor certificate. Conversely, this also applies to the short positions.
example
- Underlying DAX; Initial price 10,000 pts.
- Factor certificate 2x; Subscription ratio 0.01; 100 EUR
- Knock-out certificate with strike level 5,000 points; Subscription ratio 0.01; (10,000-5,000) x0.01 = EUR 50
(corresponds to a leverage of 2 at the beginning; premium and fees omitted).
| Initial course | day 1 | day 2 | Day 3 | Day 4 | Day 5 | total | |
|---|---|---|---|---|---|---|---|
| DAX | 10,000 pts. | 10.100 | 10,605 | 10,923 | 11,469.3 | 12,157.5 | |
| +1% | + 5% | + 3% | + 5% | + 6% | + 21.6% | ||
| Factor certificate 2x | 100 EUR | 102 | 112.20 | 118.93 | 130.83 | 146.52 | |
| + 2% | + 10% | + 6% | + 10% | + 12% | + 47% | ||
| Knock-out certificate | 50 EUR | 51 | 56.05 | 59.23 | 64.70 | 71.57 | |
| + 2% | + 9.9% | + 5.7% | + 9.2% | + 10.6% | + 43% |
This shows that the knock-out certificate achieved 5% less profit compared to the factor certificate, despite the same leverage. If prices fall, the leverage in the knock-out certificate would increase to the detriment of the investor.
Other risks
The issuer has a daily right of termination. In the event of a trigger, this may come at an unfavorable time for the investor if the certificate is currently in the red.
The higher the leverage, the higher the chances of winning, but also the possible losses for the investor.
At the same time, the higher the leverage, the higher the financing costs.
Due to the daily adjustment transactions that are required to maintain the constant factor, each factor certificate will trade close to zero at some point. (If the price of the underlying asset falls, it must be sold and if it rises, it must be bought back.)
If the underlying is quoted in a foreign currency, there is also the currency risk. This particularly applies to raw materials as an underlying asset.