Discount Certificates with Barrier: How they work
Discount certificates with a barrier add an additional feature to conventional discount certificates: the knock-in barrier. As a result of the barrier, repayment at maturity now depends on whether or not a barrier event has occurred during the term period. Similar to conventional discount certificates, discount certificates with a barrier are also suitable for investors who expect a sideways or slightly positive performance of the underlying asset. However, price setbacks to or below the barrier should generally be ruled out.
Functionality of discount certificates with barrier
Discount certificates with a barrier are issued at a discount, just like conventional discount certificates. This lower issue price serves as a certain buffer in the event of price losses in the underlying asset. In contrast to conventional discount certificates, the value of the redemption only depends on whether a barrier event has occurred during the term.
If the barrier is not touched or breached by the price of the underlying asset during the term period, the nominal value is repaid at maturity. However, if a barrier event has occurred, the investor receives the physical delivery of a fixed number of underlyings or a cash settlement corresponding to the final fixing price of the underlying at maturity.
Advantages & Risks
Advantages
- If market expectations are correct, discount certificates with a barrier can generate a higher return than a direct investment in the underlying asset
- The level of the barrier serves as a buffer against price losses in the underlying asset
- The risk of loss is somewhat lower compared to a direct investment in the underlying due to the lower issue price
Risks
- If the underlying rises sharply, the return is limited upwards (maximum return determined by the cap)
- No participation in dividends or other distributions on the underlying asset
- Currency risk for underlyings in foreign currencies
- Issuer risk
FAQ
What are the benefits of adding a barrier to a discount certificate?
By adding a knock-in barrier to a discount certificate, the probability of maximum repayment is higher, as an investor receives the nominal value repayment if no barrier event has occurred during the term period. However, the amount of the discount is lower in direct comparison to a conventional discount certificate (without a barrier).
What happens if the barrier is touched?
If the barrier is touched during the term, the discount certificate with barrier becomes a conventional discount certificate. Repayment then takes place in the same way as for a discount certificate without a barrier.
Are discount certificates with a barrier on individual shares or several underlyings more suitable?
The question of whether a single or several underlyings should be favoured depends on the investor's risk profile. In principle, several underlyings also mean a higher risk, as in the negative case of a barrier being touched, the ‘worst-of’ underlying, i.e. the underlying with the worst performance, is delivered. At the same time, several underlyings also allow either a higher discount (rebate) or a lower barrier due to the higher risk.
Should I have an opinion on the volatility of discount certificates with a barrier?
Before investing in a discount certificate with a barrier, investors should ask themselves whether the volatility (fluctuation range) of the underlying asset is expected to rise or fall during the term of the product. In principle, falling volatility is favourable for discount certificates with a barrier, as the risk of a barrier event is lower with lower fluctuations.