Capital protection certificates, also known as guaranteed certificates, are suitable for investors who want to participate in capital market trends but also want to play it safe in the event of adverse price movements. It is important to them that the entire face value is repaid at maturity.
How do capital protection certificates work?
With capital protection certificates, investors can secure their invested capital secured at maturity. In addition, they benefit from a clearly defined payout opportunity established in advance. Capital protection certificates have a specific term.
Capital protection certificates can be either coupon-oriented or growth-oriented:
Coupon-based capital protection certificates
Coupon-based capital protection certificates offer 100 percent capital protection and sometimes a fixed interest rate. In most cases, the interest rate is based on the current interest rate of a conventional bond with a comparable maturity. The coupon – whether fixed and/or dependent on the performance of the underlying asset (variable) – is set by the bank upon issuance of the certificate.
In addition to capital protection and a possible fixed interest rate, coupon-oriented capital protection certificates include one or more options. These offer the opportunity to earn a return on the invested capital that is significantly higher than the bond market rate. The potential additional return is then paid out together with any fixed interest. If the conditions for this additional opportunity are not met, the fixed interest rate (if any) and the capital protection remain in effect at the end of the term regardless.
Coupon payments are typically made annually. The additional return may apply when the price of the underlying asset rises, moves sideways, or even falls, depending on the certificate’s structure at the start of the term.
Growth-oriented capital protection certificates
With growth-oriented capital protection certificates, investors have the opportunity to participate in the price performance of the underlying asset without risking their invested capital. For example, investors can benefit from the growth of European stocks without risking a loss of their invested capital.
Investors participate in the positive price performance of the underlying asset in accordance with the participation rate. This rate indicates the extent to which the investor participates in the price performance of the underlying asset. Generally speaking, the higher the participation rate, the greater the potential for profit.
There are several possible structures for participation, including the following:
- For some capital protection certificates, the prices of the underlying asset are recorded on specific reference dates, and an average is then calculated. This average price offers investors the advantage that a sudden price decline at the end of the term has a lower impact on the return. Price fluctuations can thus be smoothed out. Averaging can increase the participation rate, but it may reduce the chances of a profit over the period during which the average is calculated.
- So-called high-point guarantees entitle the investor to a certain percentage of the highest value of the underlying asset observed during the term, once that high point has been reached. The value determined in this way is then factored into the calculation of the redemption amount at the end of the term. High-point guarantees slightly reduce the participation rate but offer an optimized “exit.”
- When structured according to the “Best of …” principle, investors can participate most strongly in the “best” underlying asset out of several. Underlying assets are specified at the beginning of the term. At the same time, the participation rates are defined for the best performing underlying asset (e.g. 50 percent), the second-best (e.g. 30 percent), and so on. Capital protection certificates with “best-of” participation are often combined with average calculations.
- Some capital protection certificates are equipped with a cap. The cap is the maximum amount up to which investors participate in the positive performance of the underlying asset. Gains beyond this amount no longer benefit the investor; however, the participation rate at which the investor shares in gains up to the cap is higher than it would be without a cap.
What to keep in mind
A capital protection certificate can eliminate the risk of loss at maturity. However, investors also forgo higher potential returns because a portion of the invested capital is used to finance the protection. Capital protection applies only at maturity. During the term, the certificate’s value may fall below the issue price.
