Buyers of Discount Certificates may receive shares at a lower price compared to the market price of the shares when the Discount Certificates are launched – thus the term discount. In return for this, the investor must be prepared to accept a fixed maximum return on the Discount Certificate. Each Discount Certificate has its own related underlying share and a maximum price (called the cap strike). The buyer will receive one underlying share per Discount Certificate if the final reference price of the underlying share at maturity is lower than the cap strike. However, if the final reference price of the underlying share is higher than or equal to the cap strike at maturity, the buyer will receive a cash settlement amount per Discount Certificate equivalent to the cap strike. Discount Certificates are appropriate for those investors who think the market will remain flat or rise only slightly.

ABC share is trading at $10. A 6-month Discount Certificate on ABC with a cap strike at $9.50 costs $8.80. Investors may get the share at a discount of 12% (of the initial share price) but in return, they have to accept a maximum payout of $9.50 which will give a maximum return of 7.95%.

Risk and Return Profile At Expiry

Value of the discount certificate throughout the lifetime

The Discount Certificate will not precisely mirror the performance of the underlying share during its lifetime, although its market value largely depends on the performance of the share. Because of other valuation factors (and in particular the cap strike), the Certificate tracks upward movements to a lesser degree and only up to the cap strike. Conversely, when the price of the share falls the Certificate price will also fall.

At expiry, only the price of the underlying share matters and one of two possible scenarios could occur:

Scenario 1: The underlying share is trading at or above the cap strike
The Discount Certificate pays the cap strike of $9.50. As investors have paid $8.80 on the Certificate, this represents a return of 7.95% [(9.5/8.8 – 1) x100%] (or an annualized return of 15.90% pa).

Scenario 2a: The underlying share is trading below the cap strike and higher than the original invested amount
The investor will get one underlying share. As long as the share is trading above the original invested amount, investors will receive the share at a price lower than the current market price (when the Certificate is launched), thus still realizing a return at maturity.

Scenario 2b: The underlying share is trading below the cap strike and the original invested amount

The investor will get one underlying share, and will have a valuation loss on his investment. However, the loss will always be lower than that of a direct investment on the underlying share at launch.