Discount certificates
A discount certificate is quoted at a price that is lower than the price of the underlying asset (divided by the issue ratio). This means that the certificate is purchased for a price that is lower than the underlying portfolio (e.g. Telefónica is priced at CZK 540 but the TELEDIS discount certificate is CZK 52). This means that it is sold at a discount (CZK 2, 3.8%). The investor buys the certificate for the current offer price for the certificate and sells it for the current bid price. This is the same as for index certificates. The amount of the discount for the duration of the certificate decreases and the price of the certificate continuously approaches the price of the underlying asset until the expiration date when the prices are the same.
If held until maturity, an investor must consider the limits of the certificate in terms of the maximum possible return. The maximum possible return is defined by the CAP value.
Two situations occur on the maturity date:
- The current price of the underlying asset (expressed as the issue ratio) is higher or equal to CAP. In this case the certificate holder is paid the CAP value and profit is limited.
- The current price of the underlying asset (expressed as the issue ratio) is lower than CAP. In this case the certificate holder is paid the current price for the certificate (which is equal to the price of the underlying asset expressed as the issue ratio).
Example:
Telefónica currently is priced at CZK 540, TELEDIS can be purchased for CZK 52. Discount rate is 3.8%. CAP is set at CZK 65.
- At the expiration date, Telefónica is priced at CZK 690 and TELEDIS is CZK 69. The owner will not be paid CZK 69, rather only the CAP, which is CZK 65. Profit is limited.
- At the expiration date, Telefónica is priced at CZK 480 and TELEDIS is CZK 48. The owner will be paid CZK 48.
Profit is limited but losses are unlimited; however if the drop in the underlying asset is lower than the discount rate at the moment the certificate is purchased, the certificate holder is not harmed by the decline in the value of the underlying asset (see the following example).
Example:
Telefónica currently is priced at CZK 540, TELEDIS can be purchased for CZK 52. Discount rate is 3.8%. CAP is set at CZK 65.
At the expiration date, Telefónica is priced at CZK 520 and TELEDIS is CZK 52. The certificate holder receives CZK 52, which is the price at which it purchased the certificate and the profit/loss is CZK 0 as the underlying asset declined by 3.8%.
A discount certificate is best for investors that anticipate the value of the underlying asset will stagnate, increase slightly (up to the CAP) or decline slightly (to the level of the discount). It is anticipated that the certificate is held to expiration and that the purchase is made when the discount is the largest.
