Tutorial: Discount certificates

What are discount certificates?

Discount certificate are debentures through which the investor acquires an underlying instrument at a discount to the direct investment. At the beginning of the term a cap is set which limits the potential return. Upon maturity the current price of the underlying instrument is paid out, with the cap representing the upper limit of the payout.

This is the advantage of discount certificates – since the investor in a discount certificate buys the share at a discount to its current price but gets the full share price (limited by the cap) paid out at maturity, the investor can earn the so-called sideways yield. Please keep in mind the respective exchange ratio.

How do discount certificates work?

The potential return from discount certificates is capped. In return for this cap (and thus, for the unlimited potential return), the investor gets to buy the specific underlying at a discount. This means that you pay a lower price for the discount certificate than you would pay for investing directly in the underlying. Upon maturity the current price of the underlying instrument is paid out (while bearing in mind the exchange ratio), with the cap representing the upper limit of the payout. The cap is set at the beginning of the term, remains constant over time, and marks the maximum return potential.

Your benefits

The discount at the time of acquisition means that you have a risk buffer and can make interesting profits even if markets do not move. This is the so-called sideways yield: the underlying has not moved, but you are still making a profit.

Your advantages

A positive return at the end of the term is possible, even if the underlying is below the initial price (sideways yield).
The difference between the price of the underlying and the initial acquisition price serves as risk buffer against losses.
Short terms reduce the risk further and allow the investor to change the investment strategy in the medium run.

Risks you should be aware of

With a discount certificates, the potential return is capped.
If the underlying falls, losses are possible.
During the term price fluctuations are possible, which means premature sale may result in a loss.
Investors bear the risk of the issuer (Erste Group Bank AG).
Discount certificates are not covered by any deposit guarantee scheme. Investors are exposed to the risk that Erste Group Bank AG may not be able to meet its obligations arising from the certificate in the event of insolvency or over-indebtedness or from an official order (bail-in regime). A total loss of invested capital is possible.

How do discount certificates react to…

… rising underlying prices?
With rising underlying prices the discount certificate tends to rise as well, with the cap marking the maximum possible return. This means that in the case of rising underlying prices, the discount certificate approaches its cap.

… stable underlying prices?
With stable underlying prices the discount certificate rises over the course of time while approaching maturity. This happens because the discount of the certificate decreases until maturity, at which point the price of the certificate equals the price of the underlying. This is a prime example of the sideways yield.

… falling underlying prices?
With falling underlying prices, the certificate falls as well. However, since the discount certificate was bought at a discount to the underlying, the loss is lower by the amount of the discount then it would be for the underlying.

Payoff-Chart

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