INVESTOR
EDUCATION
INVESTOR
EDUCATION
WARRANTS
Warrants are an instrument which gives investors the right – but not the obligation – to buy or sell the underlying asset at a pre-set price on or before a specified date. There are two main types of warrants: equity warrants and derivative warrants, which are subject to different provisions of the Listing Rules in Hong Kong.
Equity warrants
Issued by a listed company and give holders the right to subscribe for equity securities of the issuer. Equity warrants are often issued together with new shares in IPOs, or distributed together with the shares acquired for any dividend payment, bonus issue or rights issue. Equity warrants have a life of one to five years. Upon exercise, the listed company will issue new shares to their holders and collect extra capital. The issuer of a warrant must specify whether it is settled by cash or by physical delivery of the underlying assets.
Derivative warrants
Issued by a third party, generally an investment bank, independent of the issuer of the underlying assets. They have a life of six months to five years. The underlying assets of derivative warrants include ordinary shares, market indices, currencies and baskets of shares. The issuer of derivative warrants may not be the issuer of the underlying assets but should hold or have a right to hold the underlying assets. The right conferred by a derivative warrant may be the right to buy (call warrant) or the right to sell (put warrant).
Derivative warrants can be linked to a single security or a basket of securities, stock indices, currencies, commodities or futures contracts (like crude oil futures). Almost all derivative warrants currently traded in Hong Kong are cash-settled. When a physically settled call derivative warrant on a single stock is exercised, the warrant holder will receive the underlying stock from the issuer. Unlike equity warrants, no new shares will be issued. Furthermore, every derivative warrant has a designated liquidity provider to help improve the liquidity of the instrument in the market.
The price of a derivative warrant at expiry mainly rests with the price of the underlying assets. However, so long as a derivative warrant remains valid, its price will be affected by other factors in addition to the underlying assets’ price. They include the volatility of the underlying assets’ price, the exercise price, the time remaining to expiry, interest rates and expected dividend payments on the underlying assets, etc. Like other securities, the price of a derivative warrant may also be affected the supply of and demand for the derivative warrant itself.
Since derivative warrants can have great product variety, large warrant markets in the world are usually mainly derivative warrant markets. The equity warrant markets are usually of a much smaller scale.
Attributes
Issuer: A warrant can be issued by a listed company (i.e. subscription warrant) or a third party such as a financial institution (i.e. derivative warrant).
Underlying asset: It can be a single stock, a basket of stocks, an index, a currency, a commodity, a futures contract (e.g. oil futures) etc.
Types of rights: Don’t mix up a call warrant with a put warrant. A call warrant gives you the right to buy whereas a put warrant gives you the right to sell the underlying asset.
Exercise price: The price at which you buy or sell the underlying asset in exercising a warrant.
Conversion ratio: This refers to the number of units of the underlying asset exchanged when exercising a unit of a warrant. Normally, in Hong Kong a derivative warrant on shares has the ratio of 1 (i.e.one warrant for one share) or 10 (i.e.10 warrants for one share).
Expiry date: The date on which a warrant will expire and become worthless if the warrant is not exercised.
Exercise style: With an American warrant, you can exercise to buy/sell the underlying asset on or before the expiry date. Whereas a European warrant allows exercise on the expiry date only.
Settlement: A warrant can be settled by cash or physical delivery upon exercise.
Trading policy: Derivative warrants are traded on the Exchange during trading hours in board lot multiples settled on T+2 (T being the transaction day).
Risk disclosure
Derivative warrant trading involves high risks and is not suitable for every investor. Investor should understand and consider the following risks before trading in derivative warrants.
Issuer risk: Derivative warrant holders are unsecured creditors of the issuer and they have no preferential claim to any assets an issuer may hold.
Gearing risk: Although derivative warrants often cost less than the price of the underlying assets, a derivative warrant may change in value to a much greater extent than the underlying assets. Although potential return on derivative warrants may be higher than that on the underlying assets, it should be noted that in the worst case the value of derivative warrants may fall to zero and holders may lose their entire investment amount.
Limited life: Unlike stocks, derivative warrants have an expiry date and therefore a limited life. Unless the derivative warrants are in-the-money, they become worthless at expiration.
Time decay: So long as other factors remain unchanged, the value of derivative warrants will decrease over time. Therefore, derivative warrants should never be viewed as products that are bought and held as long term investments.
Market forces: In addition to the basic factors that determine the theoretical price of a derivative warrant, derivative warrant prices are also affected by the demand for and supply of the derivative warrants. This is particularly the case when a derivative warrant issue is almost sold out and when there are further issues of an existing derivative warrant.
Turnover: High turnover should not be regarded as an indication that a derivative warrant’s price will go up. The price of a derivative warrant is affected by a number of factors in addition to market forces, such as the price of the underlying assets and its volatility, the time remaining to expiry, interest rates and the expected dividend on the underlying assets.
For the basic knowledge and trading mechanism of warrants, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
CALLABLE BULL/
BEAR CONTRACT (CBBC)
A Callable Bull/Bear Contract (CBBC) is an instrument that tracks the performance of an underlying asset. The trading price of a CBBC tends to mirror the movement in the price of its underlying asset. Like warrants, CBBCs can be issued over a range of eligible underlying assets prescribed by the Exchange from time to time.
A CBBC can be issued as a bull contract or a bear contract
(a) A “bull” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will increase during the term of the CBBC.
(b) A “bear” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will decrease during the term of the CBBC.
Features of CBBCs
CBBC price moves tend to track the price moves of the underlying assets closely:
The price of a CBBC tends to follow closely the price of the underlying assets (ie delta close to one).Thus, if the underlying assets increase in value, a Bull CBBC with entitlement ratio of 1 to 1 generally increases in value by approximately the same amount, whereas a Bear CBBC with entitlement ratio of 1 to 1 generally decreases in value by approximately the same amount. Due to this property, CBBC issuers offer investors a product which tracks the price movement of the underlying assets more closely and with higher price transparency than some other structured products. However, when the underlying assets of a CBBC are trading at a price close to its Call Price, the value of CBBC may become more volatile and the change in its value may be disproportionate to the change in the value of the underlying assets.
Category N CBBC and
Category R CBBC
Category R CBBC refers to a CBBC that has a “residual value” after the mandatory call event. When a Category R CBBC is called, its intrinsic value is generally above HKD0, and therefore it may have residual value to be distributed to its holders.
Category N CBBC refers to a CBBC that has “no residual value” after the mandatory call event, its call price and the exercise price are set at the same level.
Difference between CBBCS and Warrants
| CBBCs | Warrants | |
| Gearing | Gearing effect | Gearing effect |
| Mandatory Call Event | Terminated early when the price of theunderlying asset hits the call price | No mandatory call feature |
| Implied volatility | Insignificant to trading price of CBBCs | Affects trading price of Warrants |
| Time Value | Non-main factors affecting price | Time value reflects |
Risk disclosure
Investors should take into account the following risk factors – among others
Mandatory call
A CBBC will be called by the issuer when the price of the underlying assets hits the Call Price, and that CBBC will expire early. The payoff for Category N CBBC is zero when they expire early. When Category R CBBC expire early the holder may receive a small residual value payment, but there may be no residual value payment in some situations. Dealers may charge their clients a service fee for the collection of the residual value payment from the respective issuers.
Limited life
CBBCs have an expiry date and therefore a limited life. Unless the CBBCs are in-the-money, they become worthless when they expire.
Liquidity
Although CBBC have liquidity providers, there is no guarantee that investors will be able to buy/sell CBBC at their target prices any time they wish.
For the basic knowledge and trading mechanism of Callable Bull/Bear Contract (CBBC), please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
EXCHANGE
TRADED FUNDS(ETFS)
Introduction
Exchange Traded Funds (ETFs) are a rapidly growing investment product that has gained popularity worldwide. The number of ETFs listed on the HKEx (Hong Kong Exchange) currently stands over 170, and this number continues to increase.
Definition of ETFs
ETFs are open-end index funds that are listed and traded on exchanges similar to stocks. They can be bought and sold during regular trading hours through any broker on most trading platforms. Like index funds, ETFs consist of a collection of securities that are designed to track specific indexes.
Benefits of Using ETFs
1. Diversification
ETFs inherently provide diversification as they track indices comprising a variety of securities. By investing in ETFs, you can gain exposure to entire countries or sectors while reducing risk associated with individual stocks.
2. Low Cost
Compared to comparable index or active mutual funds, ETFs often have lower fees and expense ratios. When trading ETFs, you only need to pay standard brokerage commissions and fees.
3. Liquidity
ETFs offer high liquidity, similar to the underlying basket of securities represented by their respective indexes. When the demand for an ETF increases in the secondary market, new shares are created and introduced into the market.
4. Transparency
ETFs generally provide transparency by disclosing the exact holdings of the fund on a regular basis, often daily. This means you always have up-to-date information about the securities in which you are invested. Additionally, ETFs offer cost transparency through upfront fee disclosure, ensuring that you are aware of the expenses associated with the investment.
Types of Exchange-Traded Funds (ETFs)Types of Exchange-Traded Funds (ETFs)
1. Cash-based ETFs:
– These ETFs hold the underlying securities of the index they track.
– They typically employ a full replication strategy, where they hold all securities within the index.
– In some cases, representative sampling or optimization strategies are used, where only a portion of the underlying securities are held.
2. Swap-based ETFs:
– Swap-based ETFs replicate the performance of an index using total return index swaps.
– They can provide exposure to markets that are not accessible through cash-based funds, such as commodities.
– However, there is some exposure to counterparty risk associated with swap-based ETFs.
Risks of Investing in ETFs
Investing in ETFs carries certain risks, which investors should carefully consider. The following risks are associated with ETF investments:
1. Market Risk:
– ETF prices, like stocks, are subject to fluctuation due to various factors.
– Investors should be aware of the possibility of market volatility and its potential impact on ETF prices.
2. Tracking Error:
– Since ETFs are designed to replicate an index or benchmark, there is a chance that the returns earned by the ETF may differ from the index.
– This divergence, known as tracking error, can be positive (profitable) or negative (returns less than indicated by the index).
3. Foreign Exchange Risk:
– ETFs that invest in assets denominated in foreign currencies are exposed to currency rate fluctuations.
– Fluctuations in currency exchange rates can affect the value of the ETF’s underlying assets and consequently impact the price of ETF shares.
Introduction of leveraged and inverse products
Leveraged and inverse products, also known as L&I Products, are structured as funds and fall under the category of derivative products. However, unlike traditional index tracking exchange traded funds (ETFs), L&I Products have a different approach. These products aim to provide a multiple or opposite return of the underlying index on a daily basis only. Leveraged products seek to achieve a daily return equivalent to a multiple of the index return. This means that if an investor purchases a two-time leveraged product, and the underlying index increases by 10% in a day, the product should deliver a gain of 20% on that day. On the other hand, inverse products aim to deliver the opposite daily return of the underlying index. For instance, when an investor buys a one-time inverse product and the underlying index moves up by 10% on a given day, the inverse product should deliver a loss of 10% on that day.
Major risks
Investment risk
The risk investment results of products are the opposite of traditional investment funds. If the product moves in an unfavorable direction, the product you invest in is likely to lose most or all of its value.
Leverage risk
The use of leverage will magnify both gains and losses of leveraged products resulting from changes in the underlying index or, where the underlying index is denominated in a currency other than the leveraged product’s base currency, from fluctuations in exchange rates.
Passive investments risks
The Product is not “actively managed” and therefore the Manager will not have discretion to adapt to market changes when the Index moves in an unfavorable direction to the Product. In such circumstances the Product will also decrease in value.
Tracking error
Due to fees, expenses, transaction costs as well as costs of using financial derivatives, liquidity of the market and the investment strategy adopted by the Manager, the correlation between the performance of the Product and the Daily inverse performance of the Index may reduce.
Liquidity risk
Rebalancing typically takes place near the end of a trading day (shortly before the close of the underlying market) to minimize tracking difference. The short interval of rebalancing may expose L&I Products more to market volatility and higher liquidity risk.
Long-term holding risk
Leveraged and inverse products are not intended for holding longer than the rebalancing interval, typically one day. Daily rebalancing and the compounding effect will make the L&I Product’s performance over a period longer than one day deviate in amount and possibly direction from the leveraged/inverse performance of the underlying index over the same period. The deviation becomes more pronounced in a volatile market.
For the basic knowledge and trading mechanism of Exchange Traded Funds (ETF), please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
Mutual Fund
The mutual fund is a type of collective trust fund that pools funds from multiple investors to purchase and manage various types of assets such as stocks, bonds, and other financial instruments. These funds are managed by professional fund managers who utilize their expertise to ensure that the funds are invested in the most profitable investment opportunities.
The operation of a mutual fund involves the pooling and diversification of funds from investors to spread the risks. This structure allows smaller investors to engage in diversified investments at a lower cost without directly purchasing a large volume of individual assets. Additionally, mutual funds provide a more manageable and supervised investment approach as investors’ funds are concentrated in one fund and managed by a dedicated professional team.
When considering mutual funds, there are several key factors to consider. Firstly, we should focus on the fund’s investment objectives and strategies. Different mutual funds may have diverse investment goals, such as pursuing long-term growth or stable income. These objectives are reflected in the fund’s asset allocation and the selected investment instruments. Therefore, investors should carefully examine the fund’s objectives and strategies to ensure they align with their investment needs and risk tolerance.
Secondly, costs are also an important factor for investors to consider. Mutual funds typically impose management fees and performance fees. The management fee is charged for the fund’s management and operations, while the performance fee is based on the fund’s performance. Investors should evaluate these costs to assess their reasonableness and alignment with expected returns.
Lastly, investors should acknowledge the existence of risks in mutual funds. Like any investment product, investing in mutual funds carries the risk of a decline in value. Factors such as the effectiveness of fund managers and market volatility can influence the fund’s performance. Therefore, investors should conduct appropriate research on their investments and understand the risk characteristics of the funds.
In conclusion, mutual funds serve as an investment tool that provides convenient diversification for investors. However, investors should carefully examine the fund’s objectives, costs, and risks to ensure they meet their investment needs. By undertaking this due diligence, investors can better harness the potential of mutual funds to achieve their financial goals.
The risks associated with mutual funds
Market Risk
Reciprocal funds are subject to market fluctuations, and the performance of the funds involved can be affected by market conditions. If the market performs poorly or experiences significant volatility, the value of the reciprocal fund may decline.
Allocation Risk
The returns of reciprocal funds are adjusted based on the performance of other funds involved in the arrangement. If the performance of these funds is below expectations, it can impact the overall returns of the reciprocal fund.
Liquidity Risk
Reciprocal funds need to have sufficient liquidity to meet investor redemption requests. If there is a large influx of redemption requests that the fund is unable to meet promptly, it can result in delays or restrictions in redeeming funds.
Portfolio Positioning Risk
Reciprocal funds rely on the composition and performance of multiple funds to achieve investment objectives. If one or more of the funds in the arrangement underperform, it can affect the overall investment performance of the reciprocal fund.
Management Risk
The management of reciprocal funds requires expertise in making complex investment decisions and portfolio adjustments. Management risk includes factors such as the competence of the fund management company and potential errors in decision-making.
Investors should be aware of these risks when considering reciprocal funds and assess them based on their investment objectives, risk tolerance, and experience. It is advisable to seek professional advice from investment advisors to obtain comprehensive financial guidance and ensure a thorough understanding and acceptance of the associated investment risks.
For the basic knowledge and trading mechanism of warrants, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
Hedge Funds
What is Hedge Fund?
Ability to short the market, to leverage the portfolio to multiply gains, and to hold high concentrations of positions.
No industry-wide classifications of hedge fund strategies, each major industry group has its own classification system.
Key performance driver is manager skill rather than market returns.
Target consistent returns in the long term rather than outperformance of a benchmark index.
Managers are unrestricted in their choice of investment strategies.
The ability to invest in any asset class or instrument.
Expectation of strong returns (historical data).
Low correlations to traditional asset classes and ability to provide diversification.
Target absolute returns rather than relative return.
Difference Between Mutual Fund and Hedge Fund
Authorization
A mutual fund is usually authorized by authorties, and can be sold to an unlimited number of investors. Most hedge funds are not authorized and can only be sold to carefully defined sophisticated investors. Mutual funds may advertise freely; hedge funds may not.
Flexibility
The hedge fund manager has fewer constraints to deal with; he can sell short, use derivatives, and use leverage. The manager can also make significant changes to the strategy if he thinks it is appropriate. The mutual fund manager cannot be as flexible.
Liquidity
The mutual fund often offers daily liquidity (you can withdraw at any time); the hedge fund usually has some sort of “lockup” provision. You can only get your money periodically
Absolute vs. Relative
The hedge fund aims for absolute return (it wants to produce positive returns regardless of what the market is doing); the mutual fund is usually managed relative to an index benchmark and is judged on its variance from that benchmark.
Self-Investment
The hedge fund manager is expected to put some of his own capital at risk in the strategy. The mutual fund does not face this same expectation.
Fees Paid to Hedge Fund
Hedge fund typically charge both a management fee and a performance fee.
Management fees are calculated as a percentage of the fund’s net asset value and typically range from 1% to 4% per annum, with 2% being standard.
The performance fee is typically 20% of the fund’s return during any year, though they range between 10% and 50%. Performance fees are intended to provide an incentive for a manager to generate profits.
Almost all hedge fund performance fees include a “high water mark” (or “loss carryforward provision”), which means that the performance fee only applies to net profits (i.e., profits after losses in previous years have been recovered).
Some performance fees include a “hurdle”, so that a fee is only paid on the fund’s performance in excess of a benchmark rate (e.g. LIBOR) or a fixed percentage. A hurdle is intended to ensure that a manager is only rewarded if the fund generates returns in excess of the returns that the investor would have received if they had invested their money elsewhere.
Some hedge funds charge a redemption fee (or withdrawal fee) for early withdrawals during a specified period of time (typically a year). The purpose of the fee is to discourage short-term investing, reduce turnover and deter withdrawals after periods of poor performance.
Side Pockets
A side pocket is a mechanism whereby a fund compartmentalizes assets that are relatively illiquid or difficult to value reliably. When an investment is side-pocketed, its value is calculated separately from the value of the fund’s main portfolio.
Because side pockets are used to hold illiquid investments, investors do not have the standard redemption rights with respect to the side pocket investment.
Profits or losses from the investment are allocated on a pro rata basis only to those who are investors at the time the investment is placed into the side pocket and are not shared with new investors.
Funds typically carry side pocket assets “at cost” for purposes of calculating management fees and reporting net asset values. This allows fund managers to avoid attempting a valuation of the underlying investments, which may not always have a readily available market value.
Side pockets allowed fund managers to lay away illiquid securities until market liquidity improved, a move that reduced losses. Despite these benefits, some investors complained that the practice was abused and not always transparent.
Types of Hedge Fund
Market Trend (Directional / Tactical) Strategies Hedge Funds
Event Driven Strategies Hedge Funds
Arbitrage Strategies Hedge Funds
Quant Funds
Hedge Fund Key Risk Factors
- A Hedge Fund may employ a distinctive strategy which may not have a readily ascertainable comparative benchmark or index.
- Hedge Fund documents are not reviewed or approved by regulators.
- Hedge Funds may be leveraged (including highly leveraged) and a Hedge Fund performance may be volatile.
- Hedge Funds may use benchmarks or targets for measurement purposes. There is no guarantee that a Hedge Funds’ goals, objectives, benchmarks or targeted returns will be achieved or reached.
- Hedge Funds may have little or no operating history or performance and may use hypothetical or pro forma performance which may not reflect actual trading done by the manager or advisor and such history or performance should be reviewed carefully.
- A Hedge Fund is not required to provide periodic pricing or valuation information to investors and it may be the Hedge Fund’s practice to not provide such information.
- Some Hedge Funds may use a single advisor or employ a single strategy, which could mean a lack of diversification and higher risk.
- An investment in a Hedge Fund may be illiquid and there may be significant restrictions on transferring interests in a Hedge Fund. There is no secondary market for an investor’s investment in a Hedge Fund and none is expected to develop.
- A Hedge Fund’s fees and expenses, which may be substantial regardless of any positive return, will offset the Fund’s trading profits.
- A Hedge Fund may involve a complex tax structure (which should be reviewed carefully) and delays in distributing important tax information.
- A Hedge Fund may not provide any transparency regarding its underlying investments (including sub-funds in a Fund of Funds structure) to investors. In such a case, there will be no way for an investor to discover or monitor the specific investments made by the Hedge Fund or, in a Fund of Funds structure, to know whether the sub-fund investments are consistent with the Hedge Fund’s investment strategy or risk parameters.
For the basic knowledge and trading mechanism of Hedge Funds, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
WARRANTS
Warrants are an instrument which gives investors the right – but not the obligation – to buy or sell the underlying asset at a pre-set price on or before a specified date. There are two main types of warrants: equity warrants and derivative warrants, which are subject to different provisions of the Listing Rules in Hong Kong.
Equity warrants
Issued by a listed company and give holders the right to subscribe for equity securities of the issuer. Equity warrants are often issued together with new shares in IPOs, or distributed together with the shares acquired for any dividend payment, bonus issue or rights issue. Equity warrants have a life of one to five years. Upon exercise, the listed company will issue new shares to their holders and collect extra capital. The issuer of a warrant must specify whether it is settled by cash or by physical delivery of the underlying assets.
Derivative warrants
Issued by a third party, generally an investment bank, independent of the issuer of the underlying assets. They have a life of six months to five years. The underlying assets of derivative warrants include ordinary shares, market indices, currencies and baskets of shares. The issuer of derivative warrants may not be the issuer of the underlying assets but should hold or have a right to hold the underlying assets. The right conferred by a derivative warrant may be the right to buy (call warrant) or the right to sell (put warrant).
Derivative warrants can be linked to a single security or a basket of securities, stock indices, currencies, commodities or futures contracts (like crude oil futures). Almost all derivative warrants currently traded in Hong Kong are cash-settled. When a physically settled call derivative warrant on a single stock is exercised, the warrant holder will receive the underlying stock from the issuer. Unlike equity warrants, no new shares will be issued. Furthermore, every derivative warrant has a designated liquidity provider to help improve the liquidity of the instrument in the market.
The price of a derivative warrant at expiry mainly rests with the price of the underlying assets. However, so long as a derivative warrant remains valid, its price will be affected by other factors in addition to the underlying assets’ price. They include the volatility of the underlying assets’ price, the exercise price, the time remaining to expiry, interest rates and expected dividend payments on the underlying assets, etc. Like other securities, the price of a derivative warrant may also be affected the supply of and demand for the derivative warrant itself.
Since derivative warrants can have great product variety, large warrant markets in the world are usually mainly derivative warrant markets. The equity warrant markets are usually of a much smaller scale.
Attributes
Issuer: A warrant can be issued by a listed company (i.e. subscription warrant) or a third party such as a financial institution (i.e. derivative warrant).
Underlying asset: It can be a single stock, a basket of stocks, an index, a currency, a commodity, a futures contract (e.g. oil futures) etc.
Types of rights: Don’t mix up a call warrant with a put warrant. A call warrant gives you the right to buy whereas a put warrant gives you the right to sell the underlying asset.
Exercise price: The price at which you buy or sell the underlying asset in exercising a warrant.
Conversion ratio: This refers to the number of units of the underlying asset exchanged when exercising a unit of a warrant. Normally, in Hong Kong a derivative warrant on shares has the ratio of 1 (i.e.one warrant for one share) or 10 (i.e.10 warrants for one share).
Expiry date: The date on which a warrant will expire and become worthless if the warrant is not exercised.
Exercise style: With an American warrant, you can exercise to buy/sell the underlying asset on or before the expiry date. Whereas a European warrant allows exercise on the expiry date only.
Settlement: A warrant can be settled by cash or physical delivery upon exercise.
Trading policy: Derivative warrants are traded on the Exchange during trading hours in board lot multiples settled on T+2 (T being the transaction day).
Risk disclosure
Derivative warrant trading involves high risks and is not suitable for every investor. Investor should understand and consider the following risks before trading in derivative warrants.
Issuer risk: Derivative warrant holders are unsecured creditors of the issuer and they have no preferential claim to any assets an issuer may hold.
Gearing risk: Although derivative warrants often cost less than the price of the underlying assets, a derivative warrant may change in value to a much greater extent than the underlying assets. Although potential return on derivative warrants may be higher than that on the underlying assets, it should be noted that in the worst case the value of derivative warrants may fall to zero and holders may lose their entire investment amount.
Limited life: Unlike stocks, derivative warrants have an expiry date and therefore a limited life. Unless the derivative warrants are in-the-money, they become worthless at expiration.
Time decay: So long as other factors remain unchanged, the value of derivative warrants will decrease over time. Therefore, derivative warrants should never be viewed as products that are bought and held as long term investments.
Market forces: In addition to the basic factors that determine the theoretical price of a derivative warrant, derivative warrant prices are also affected by the demand for and supply of the derivative warrants. This is particularly the case when a derivative warrant issue is almost sold out and when there are further issues of an existing derivative warrant.
Turnover: High turnover should not be regarded as an indication that a derivative warrant’s price will go up. The price of a derivative warrant is affected by a number of factors in addition to market forces, such as the price of the underlying assets and its volatility, the time remaining to expiry, interest rates and the expected dividend on the underlying assets.
For the basic knowledge and trading mechanism of warrants, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
Callable Bull/
Bear Contract (CBBC)
A Callable Bull/Bear Contract (CBBC) is an instrument that tracks the performance of an underlying asset. The trading price of a CBBC tends to mirror the movement in the price of its underlying asset. Like warrants, CBBCs can be issued over a range of eligible underlying assets prescribed by the Exchange from time to time.
A CBBC can be issued as a bull contract or a bear contract
(a) A “bull” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will increase during the term of the CBBC.
(b) A “bear” CBBC may be invested in by an investor who holds a view that the price of the underlying asset will decrease during the term of the CBBC.
Features of CBBCs
CBBC price moves tend to track the price moves of the underlying assets closely:
The price of a CBBC tends to follow closely the price of the underlying assets (ie delta close to one).Thus, if the underlying assets increase in value, a Bull CBBC with entitlement ratio of 1 to 1 generally increases in value by approximately the same amount, whereas a Bear CBBC with entitlement ratio of 1 to 1 generally decreases in value by approximately the same amount. Due to this property, CBBC issuers offer investors a product which tracks the price movement of the underlying assets more closely and with higher price transparency than some other structured products. However, when the underlying assets of a CBBC are trading at a price close to its Call Price, the value of CBBC may become more volatile and the change in its value may be disproportionate to the change in the value of the underlying assets.
Category N CBBC and Category R CBBC
Category R CBBC refers to a CBBC that has a “residual value” after the mandatory call event. When a Category R CBBC is called, its intrinsic value is generally above HKD0, and therefore it may have residual value to be distributed to its holders.
Category N CBBC refers to a CBBC that has “no residual value” after the mandatory call event, its call price and the exercise price are set at the same level.
Category N CBBC and Category R CBBC
| CBBCs | Warrants | |
| Gearing | Gearing effect | Gearing effect |
| Mandatory Call Event | Terminated early when the price of theunderlying asset hits the call price | No mandatory call feature |
| Implied volatility | Insignificant to trading price of CBBCs | Affects trading price of Warrants |
| Time Value | Non-main factors affecting price | Time value reflects |
Risk disclosure
Investors should take into account the following risk factors – among others
Mandatory call
A CBBC will be called by the issuer when the price of the underlying assets hits the Call Price, and that CBBC will expire early. The payoff for Category N CBBC is zero when they expire early. When Category R CBBC expire early the holder may receive a small residual value payment, but there may be no residual value payment in some situations. Dealers may charge their clients a service fee for the collection of the residual value payment from the respective issuers.
Limited life
CBBCs have an expiry date and therefore a limited life. Unless the CBBCs are in-the-money, they become worthless when they expire.
Liquidity
Although CBBC have liquidity providers, there is no guarantee that investors will be able to buy/sell CBBC at their target prices any time they wish.
For the basic knowledge and trading mechanism of Callable Bull/Bear Contract (CBBC, please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.
Exchange
Traded Funds (ETFs)
Introduction
Exchange Traded Funds (ETFs) are a rapidly growing investment product that has gained popularity worldwide. The number of ETFs listed on the HKEx (Hong Kong Exchange) currently stands over 170, and this number continues to increase.
Definition of ETFs
ETFs are open-end index funds that are listed and traded on exchanges similar to stocks. They can be bought and sold during regular trading hours through any broker on most trading platforms. Like index funds, ETFs consist of a collection of securities that are designed to track specific indexes.
Benefits of Using ETFs
1. Diversification
ETFs inherently provide diversification as they track indices comprising a variety of securities. By investing in ETFs, you can gain exposure to entire countries or sectors while reducing risk associated with individual stocks.
2. Low Cost
Compared to comparable index or active mutual funds, ETFs often have lower fees and expense ratios. When trading ETFs, you only need to pay standard brokerage commissions and fees.
3. Liquidity
ETFs offer high liquidity, similar to the underlying basket of securities represented by their respective indexes. When the demand for an ETF increases in the secondary market, new shares are created and introduced into the market.
4. Transparency
ETFs generally provide transparency by disclosing the exact holdings of the fund on a regular basis, often daily. This means you always have up-to-date information about the securities in which you are invested. Additionally, ETFs offer cost transparency through upfront fee disclosure, ensuring that you are aware of the expenses associated with the investment.
Types of Exchange-Traded Funds (ETFs)
1. Cash-based ETFs:
– These ETFs hold the underlying securities of the index they track.
– They typically employ a full replication strategy, where they hold all securities within the index.
– In some cases, representative sampling or optimization strategies are used, where only a portion of the underlying securities are held.
2. Swap-based ETFs:
– Swap-based ETFs replicate the performance of an index using total return index swaps.
– They can provide exposure to markets that are not accessible through cash-based funds, such as commodities.
– However, there is some exposure to counterparty risk associated with swap-based ETFs.
Risks of Investing in ETFs
Investing in ETFs carries certain risks, which investors should carefully consider. The following risks are associated with ETF investments:
1. Market Risk:
– ETF prices, like stocks, are subject to fluctuation due to various factors.
– Investors should be aware of the possibility of market volatility and its potential impact on ETF prices.
2. Tracking Error:
– Since ETFs are designed to replicate an index or benchmark, there is a chance that the returns earned by the ETF may differ from the index.
– This divergence, known as tracking error, can be positive (profitable) or negative (returns less than indicated by the index).
3. Foreign Exchange Risk:
– ETFs that invest in assets denominated in foreign currencies are exposed to currency rate fluctuations.
– Fluctuations in currency exchange rates can affect the value of the ETF’s underlying assets and consequently impact the price of ETF shares.
Introduction of leveraged and inverse products
Leveraged and inverse products, also known as L&I Products, are structured as funds and fall under the category of derivative products. However, unlike traditional index tracking exchange traded funds (ETFs), L&I Products have a different approach. These products aim to provide a multiple or opposite return of the underlying index on a daily basis only. Leveraged products seek to achieve a daily return equivalent to a multiple of the index return. This means that if an investor purchases a two-time leveraged product, and the underlying index increases by 10% in a day, the product should deliver a gain of 20% on that day. On the other hand, inverse products aim to deliver the opposite daily return of the underlying index. For instance, when an investor buys a one-time inverse product and the underlying index moves up by 10% on a given day, the inverse product should deliver a loss of 10% on that day.
Major risks
Investment risk
The risk investment results of products are the opposite of traditional investment funds. If the product moves in an unfavorable direction, the product you invest in is likely to lose most or all of its value.
Leverage risk
The use of leverage will magnify both gains and losses of leveraged products resulting from changes in the underlying index or, where the underlying index is denominated in a currency other than the leveraged product’s base currency, from fluctuations in exchange rates.
Passive investments risks
The Product is not “actively managed” and therefore the Manager will not have discretion to adapt to market changes when the Index moves in an unfavorable direction to the Product. In such circumstances the Product will also decrease in value.
Tracking error
Due to fees, expenses, transaction costs as well as costs of using financial derivatives, liquidity of the market and the investment strategy adopted by the Manager, the correlation between the performance of the Product and the Daily inverse performance of the Index may reduce.
Liquidity risk
Rebalancing typically takes place near the end of a trading day (shortly before the close of the underlying market) to minimize tracking difference. The short interval of rebalancing may expose L&I Products more to market volatility and higher liquidity risk.
Long-term holding risk
Leveraged and inverse products are not intended for holding longer than the rebalancing interval, typically one day. Daily rebalancing and the compounding effect will make the L&I Product’s performance over a period longer than one day deviate in amount and possibly direction from the leveraged/inverse performance of the underlying index over the same period. The deviation becomes more pronounced in a volatile market.
For the basic knowledge and trading mechanism of Exchange Traded Funds (ETF), please refer to the information provided by Investor and Financial Education Council. You should pay careful attention to the Liability Statement section on the homepage of the website of The IFEC at (www.ifec.org.hk) when referring to information using this link.