Discount Certificates enable investors to purchase an instrument at a discount. Their gain is capped at a certain level. Discount certificates are particularly convenient in a neutral or slightly bullish/bearish market.
Advantages
- The ability to acquire an instrument at a discount compared to the underlying assets’ market price
- Discount received can offset potential losses if the underlying asset price slightly declines
- Short term structure
Price Behaviour
When Discount Certificates are purchased, investors acquire an underlying instrument at a discount and agree on a cap on the potential profit (Cap level). If the price of the underlying is above the Cap level at expiry, investors receive a cash amount corresponding to the Cap level. By limiting the upside potential of the investment, the instrument can be offered at a discount compared to the underlying assets’ market price.
Discount Certificates offer two possible payouts at maturity:
- Underlying price is equal to or larger than the Cap level Investors receive a cash amount equal to Cap level at maturity
- Underlying price is smaller than the Cap level. Investors receive a cash amount equal to the underlying price at maturity
Structure Components
- Long Zero Coupon Bond
- Short Put (Strike at Strike price)
Risks
If at maturity the underlying fixes below the Strike price, redemption will be below Par. In the worst case, the investor can lose their entire investment.