Information regarding financial instruments
1. TRADING IN FINANCIAL INSTRUMENTS
Trading in financial instruments, i.e. shares in limited liability companies and corresponding unit-holders of other types of companies, bonds, depositary receipts, mutual fund shares, money market instruments, financial derivative instruments or other such securities other than means of payment that may be traded on the capital market, is mainly organised at a trading venue. Trading is carried out through the investment firms involved in trading at the trading venue. As a client, you must normally contact such an investment firm to buy or sell financial instruments.
1.1 TRADING VENUES
Trading venues are regulated markets, trading platforms (Multilateral Trading Facility, MTF), systematic internal traders (SI) and where there is trading with investment firms.
On a regulated market, different types of financial instruments are traded. In the case of shares, only shares in public companies can be quoted and traded on a regulated market and there are high demands on such companies, including the size of the company, the history of operations, the distribution of ownership and public accounting of the company’s finances and operations.
A trading platform (MTF) can be described as a trading system organised and provided by a stock exchange or an investment firm. There are typically lower requirements, such as disclosure and business history, on financial instruments traded on a trading platform compared to financial instruments traded on a regulated market.
A systematic internal trader is an investment firm that acts in an organised, frequent and systematic manner on its own account by executing client orders outside a regulated market or trading platform. A systematic internal trader is obliged to publish market bids for the buying and/or selling prices of liquid shares traded on a regulated market for which the systematic internal trader conducts systematic internal trading.
Trading may also take place through an investment firm without the case of systematic internal trading, against the institution’s own stocks or against other clients of the institution.
In Sweden there are currently two regulated markets, OMX Nordiska Börs Stockholm AB (hereinafter “Stockholm Stock Exchange”) and Nordic Growth Market NGM AB (hereinafter “NGM”). In addition, organised trading takes place on other trading venues, e.g. First North and Nordic MTF (trading platforms) as well as on the investment firms’ own lists.
Trading on regulated markets, trading platforms and other trading venues constitutes a secondary market for financial instruments already issued by a company (issued). If the secondary market functions well, i.e. it is easy to find buyers and sellers and the on-demand quotation prices from buyers and sellers and closing prices (price of payment) from commercial trades made, the companies also have an advantage by making it easier to issue new ones if necessary in new instruments and thereby raise more capital for the company’s operations. The firsthand market, or primary market, is the market where the purchase/subscription of newly issued instruments takes place.
1.2 TRADING LISTS
In the case of shares, trading venues usually divide the shares into various lists, which are published, for example, on the website of the trading venue, in newspapers and other media. The market capitalisation of a company on which a company’s shares are traded may be the company’s market capitalisation (e.g. The Stockholm Stock Exchange’s Large, Mid- and Small cap). The most-discussed shares may also be on a special list. Some investment firms also publish their own lists of financial instruments traded through the institution, rates at which the instruments are traded, etc., via the institution’s website. Shares on lists with high requirements and high turnover are normally considered to pose a lower risk than shares on other lists.
Information on prices etc. for shares as well as other types of financial instruments, such as mutual fund shares, options and bonds, is also published regularly via e.g. trading venues’ websites, newspapers and other media.
2. RISKS ASSOCIATED WITH FINANCIAL INSTRUMENTS AND TRADING IN FINANCIAL INSTRUMENTS
2.1 GENERALLY ABOUT RISKS
Financial instruments can yield returns in the form of dividends (shares and funds) or interest (interest-bearing instruments). In addition, the price of the instrument may increase or decrease in relation to the price when the placement was made. In the further description, the word placement also includes any negative positions (negative holdings) taken in the instrument, compare for example what is said about short selling in section 7 below. The total return is the sum of dividends/interest and price change on the instrument.
What the investor is aiming for is, of course, a total return that is positive, i.e. that generates profit, preferably as high as possible. But there is also a risk that the total return will be negative and that there will be a loss on the investment. The risk of loss varies with different instruments. Usually, the chance of a profit on a placement in a financial instrument is linked to the risk of loss. The longer the time of holding the investment, the greater the chance of profit and the risk of loss. In the investment context, the word risk is sometimes used as an expression of both loss risk and profit chance. However, in the further description, the word risk is used solely to denote the risk of loss. There are different ways to place to reduce the risk. It is usually considered better not to place in a single or a few financial instruments but instead to place in several different financial instruments. These instruments should then offer a spread of the risks and not collect risks that can be triggered at the same time. The spread of investments to foreign markets normally also reduces the risk in the overall portfolio, even if trading foreign financial instruments adds a currency risk.
Investments in financial instruments are associated with financial risk, which will be described in more detail in this information. The client is responsible for the risk himself and must therefore acquire knowledge of the conditions, in the form of general terms and conditions, prospectuses or the like, that apply to trading in such instruments and the characteristics and risks associated with the instruments and the risks associated with them. The customer must also continuously monitor their investments in such instruments. This applies even if the customer received individual advice at the time of the placement. The customer should be prepared, in his/her own interest, to take swift action, should this prove necessary, for example by liquidating investments that develop negatively or providing additional collateral for investments financed by loans and where the collateral value has decreased.
It is also important to take into account the risk involved in trading financial instruments on a trading venue other than a regulated market, where the requirements generally lower.
2.2. DIFFERENT TYPES OF RISK CONCEPTS
In connection with the risk assessment that should take place when you as a customer make a placement in financial instruments, and also continuously during the holding period, there are a variety of risk concepts and other factors to consider and balance. Below is a brief description of some of the most common risk concepts.
Market risk – the risk that the market as a whole, or some part thereof where you as a customer have your position, e.g. the Swedish stock market, goes down.
Credit risk – the risk of default on the part of an issuer or counterparty, for example.
Price volatility risk – the risk of large fluctuations in the price of a financial instrument adversely affects the investment.
Rate risk – the risk of a fall in the price of a financial instrument.
Tax risk – the risk that tax rules and/or tax rates are unclear or subject to change.
Currency risk – the risk of a foreign currency to which a holding is related (e.g. mutual fund shares in a fund that invests in US securities listed in USD) weakens.
Leverage risk – the design of derivative instruments that may have a risk that the price evolution of the underlying property will have a greater negative impact on the price of the derivative instrument.
Legal risk – the risk that the relevant laws and regulations are unclear or subject to change.
Company-specific risk – the risk that a particular company will be worse than expected or suffer a negative event and the financial instruments related to the company may thus fall in value.
Industry-specific risk – the risk of a particular industry going worse than expected or experiencing a negative event and the financial instruments related to companies in the industry may fall in value.
Liquidity risk – the risk that you will not be able to sell or buy a financial instrument at a specified time due to low turnover in the financial instrument.
Interest rate risk – the risk that the financial instrument you placed in decreases in value due to changes in the market interest rate.
3. SHARES AND EQUITY-RELATED INSTRUMENTS
3.1 GENERALLY ABOUT SHARES
3.1.1 SHARES AND LIMITED LIABILITY COMPANIES
Shares in a limited liability company entitles the owner to a share of the company’s capital. If the company makes a profit, the company usually pays dividends on the shares. Shares also give voting rights at the Annual General Meeting, which is the highest decision-making body in the company. The more shares the owner has, the greater the share of the capital, dividend and votes belongs to the shareholder. Depending on the series of the shares, voting rights may vary. There are two kinds of companies, public and private. Only public companies may allow the shares to be traded on a trading venue.
3.1.2 SHARE PRICE
The price of a share is primarily affected by the supply and demand for the current share, which in turn, at least in the long term, is guided by the company’s prospects. A share is inflated or devalued primarily based on investors’ analyses and assessments of the company’s ability to make future profits. The future development abroad of economic activity, technology, legislation, competition, etc. determines what the demand will be of the company’s products or services and is therefore of fundamental importance for the price development of the company’s shares.
Current interest rates also play a major role in pricing. Rising market interest rates will result in interest-bearing financial instruments, which are simultaneously issued (newly issued), providing better returns. Normally, the prices of shares that are regularly traded as well as on interest-bearing instruments will lower. The reason is that the increased return on newly issued interest-bearing instruments is relatively better than the return on shares, as well as on outstanding interest-bearing instruments. In addition, share prices are negatively affected by an increase in interest rates on the company’s liabilities as market interest rates go up, which reduces the profit margin in the company.
Other conditions directly linked to the company, e.g. changes in the company’s management and organization, production disruptions, etc. may strongly affect the company’s future ability to generate profits in both the short and long term. In the worst case, limited liability companies can go so badly that they have to go bankrupt. The share capital, i.e. the shareholders’ deposited capital is the capital that is then first used to pay the company’s debts. This usually leads to the shares in the company becoming worthless.
The prices on certain major foreign regulated markets or trading venues also have an impact on prices in Sweden, partly because several Swedish limited liability companies are also listed on foreign marketplaces and price exchange rates (arbitrage) take place between the marketplaces. The price of shares in companies belonging to the same industry sector is often affected by changes in the price of other companies in the same sector. This impact may also apply to companies in different countries.
Market participants have different needs to invest cash (cash) or to obtain cash and cash equivalents. In addition, they often have different meanings about how the course should be developed. These circumstances, which also include how the company is valued, contribute to the existence of both buyers and sellers. However, if the investors are consistent in their perceptions of price developments, they either want to buy and then a buying pressure arises from many buyers, or they want to sell and then a sales pressure arises from many sellers. When the price is put on purchase, the price rises and at sales pressure it falls.
Turnover, i.e. how much is bought and sold by a particular share, in turn affects the share price. In the case of high turnover the difference decreases between the rate buyers are prepared to pay (bid price) and the rate requested by the sellers (the selling price), this difference is called spread. A high-turnover share, where large amounts can be traded without much impact on the price, has good liquidity and is therefore easy to buy or sell. The companies on the regulated markets’ lists (e.g. the Stockholm Stock Exchange’s Nordic List and NGM’s NGM Equity) normally have high liquidity. Different shares may during the day or for longer periods show different mobility in the prices (volatility), i.e. ups and downs and the size of the rate changes.
The prices at which the shares have been traded (payment prices), such as the highest/lowest/last paid during the day and last quoted buy/sell prices and further information on the volume traded in SEK are published, inter alia, in most major newspapers, on text-TV and on various internet pages established by marketplaces, investment firms and media companies. The timeliness of these course assignments may vary depending on the way they are published.
3.1.3 DIFFERENT SHARE SERIES
Shares are available in different series, usually A and B shares, which normally have to do with voting rights. Class A shares normally give one vote, while Class B shares give a limited voting right, usually one tenth of a vote. The differences in voting rights are because, among other things, in the case of ownership diversification, there is a will to persevere the influence of the original founders or owners by giving them a stronger right to vote. New shares issued will then have a lower voting value than the original A-series and are denoted by B, C or D, etc.
3.1.4 QUOTIENT VALUE, SPLIT AND AGGREGATION OF SHARES
The quotient value of a share is the proportion that each share represents of the company’s share capital. The quotient value of a share is obtained by dividing the share capital by the total number of shares. Sometimes companies want to change the quotient value, for example because the market price of the share has risen sharply. By dividing each share into two or more shares by a so-called split, the quotient value is reduced and at the same time the price of the shares is lowered. After a split, the shareholder’s capital has remained unchanged, but is divided into more shares with a lower quotient value and a lower price per share.
Conversely, a reverse split can be made if the price has fallen sharply. Then two or more shares are merged into one share. After a consolidation of shares, the shareholder retains the same capital, but this is divided into fewer shares with a higher quotient value and a higher price per share.
3.1.5. MARKET INTRODUCTION, PRIVATISATION AND TAKEOVERS
Market introduction involves the introduction of shares in a company on the stock market, i.e. admitted to trading on a regulated market or trading platform (MTF). The public is then offered to subscribe for (buy) shares in the company. Most often it is an existing company, which has not previously been traded on a regulated market or other trading venue, where the owners decided to broaden the ownership circle and facilitate trading in the company’s shares. If a state-owned company is introduced on the market, this is called privatization.
As a rule, takeovers are made so that one or more investors offer the shareholders of a company to sell their shares under certain conditions. If the collector receives 90 % or more of the number of shares in the acquired company, the purchaser may request the compulsory redemption of outstanding shares from the owners who have not accepted the takeover bid. These shareholders are then obliged to sell their shares to the purchaser for a remuneration determined by arbitration.
3.1.6 SHARE ISSUES
If a limited liability company wishes to expand its activities, additional share capital is often required. This is what the company acquires by issuing new shares through a new share issue. In most cases, the old owners receive subscription rights that give preference to subscribe for shares in a rights issue. The number of shares that can be subscribed for is normally set in relation to the number of shares previously held by the owner. The subscriber must pay a certain price (issue price), usually lower than the market price, for the newly issued shares. Immediately after the subscription rights – which normally have a certain market value – have been separated from the shares, the price of the shares usually falls, while the number of shares for the shareholders who have subscribed increases. Shareholders who do not subscribe may, during the subscription period which usually lasts a few weeks, sell their subscription rights on the marketplace where the shares are traded. After the subscription period, the subscription rights expire and thus become unusable and worthless.
Limited liability companies can also carry out a so-called directed share issue, which is carried out as a share issue but only directed to a certain group of investors. Limited liability companies may also issue new shares through a non-cash issue in order to acquire other companies, businesses or assets in a form other than money. Both in the case of a directed share issue and in the case of a non-cash issue, so-called dilution of existing shareholders’ share of the number of votes and share capital in the company takes place, but the number of shares held and the market value of the invested capital are not normally affected.
If the assets or reserved funds of a limited liability company have increased greatly in value, the company can transfer part of the value to its share capital through a so-called bonus issue. Bonus issues take into account the number of shares that each shareholder already has. The number of new shares added by the bonus issue is set in relation to the number of shares previously held by the owner. Through the bonus issue, the shareholder receives more shares, but the owner’s share of the company’s increased share capital remains unchanged. The price of the shares is lowered in the event of a bonus issue, but through the increase in the number of shares the shareholder maintains an unchanged market value of his invested capital. Another way to carry out a bonus issue is for the company to write down the quotient value of the shares. After revaluation, the shareholder has an unchanged number of shares and market value of his invested capital.
3.2 GENERALLY ABOUT EQUITY-RELATED INSTRUMENTS
Closely linked to equities are, stock index bonds, depositary receipts, convertibles, stock and stock index options, stock and stock index futures, warrants and leverage certificates.
3.2.1 INDEX BONDS / STOCK INDEX BONDS
Index bonds/stock index bonds are bonds where yields instead of interest are dependent, for example, on a stock index. If the index develops positively, the return follows. In the event of a negative index development, the return may not happen. However, the bond is always repaid at its nominal amount on the redemption date and thus has a limited risk of loss compared to, for example, shares and mutual fund shares. The risk of placing in a stock index bond may, in addition to any premium paid, be defined as the alternative interest income, i.e. the interest rate the investor would have received on the amount invested with a different investment. Index bonds may have different names such as stock index bonds, SPAX, stock bonds, credit bonds, fixed income bonds, basket bonds, etc., depending on the underlying asset class that determines the bond’s return. When talking about index bonds, these are usually also referred to as capital-guaranteed or capital-protected products. These concepts are intended to describe, as mentioned above, that whether or not the product yields return, the nominal amount, i.e. usually the same as the amount of investment less any premium paid, is repaid.
3.2.2 DEPOSITARY RECEIPT
Swedish Depositary Receipt is proof of the right to foreign shares, which the issuer of the certificate holds on behalf of the holder. SDRs are traded just like shares on a regulated market or trading venue and price developments normally follow price developments on the foreign marketplace where the share is traded. In addition to the general risks involved in trading shares or other types of timeshares, any currency risk should be taken into account.
Convertibles (or convertible bonds) are debt securities (loans to the issuer of the convertible) that can be exchanged for shares within a certain period of time. The return on the convertible bonds, i.e. the coupon rate, is usually higher than the dividend on the exchange shares. The convertible rate is expressed as a percentage of the nominal value of the convertible.
3.2.4 REVERSE CONVERTIBLES
Reverse convertibles are an intermediate between an interest rate and a share investment. The reverse convertible is linked to one or more underlying shares or indices. This investment gives an interest rate, i.e. a fixed, guaranteed return. If the underlying shares or indices develop positively, the amount placed plus the fixed return will be repaid. On the other hand, should the underlying shares or indices fall, there is a risk that the holder may receive one or more shares included in the reverse convertible or the corresponding cash settlement instead of the amount placed.
3.2.5 SHARE OPTIONS
Share options are available of various kinds. Acquired call options gives the holder the right to within a certain period of time buy already issued shares to a price set beforehand. Put options inversely gives the holder the right to within a certain period of time sell shares to a price set beforehand. To each acquired option, there is a corresponding issued option. The risk of the acquirer of an option, unless risk mitigation measures are taken, is that it decreases in value or is worthless on the final date. In the latter case, the premium paid for the option paid at the time of acquisition is fully exhausted. The issuer of an option runs a risk which in some cases, unless risk mitigation measures are taken, may be unlimited. The price of options normally follows the price of the corresponding underlying shares or indices, but with larger price fluctuations.
The most extensive trading in share options takes place on the regulated markets. There is also trading in share index options. These index options provide a profit or loss directly in cash (cash settlement) based on the development of an underlying index.
3.2.6 SHARE FUTURES AND SHARE INDEX FUTURES
A future means that the parties enter into a mutually binding agreement with each other on the purchase or sale of the underlying property at a pre-agreed price and with delivery or other enforcement, such as cash settlement, of the contract at a date specified in the contract (closing date). No premium is paid because the parties have equivalent obligations under the contract.
Trading also occurs with certain buy and sell options with longer terms, in Sweden commonly referred to as warrants. Warrants may be used to buy or sell underlying shares or in other cases provide cash if the price of the underlying share develops correctly in relation to the warrant’s strike price. Subscription warrants relating to shares may be exercised within a certain period of time for subscription of the corresponding newly issued shares.
3.2.8 LEVERAGE CERTIFICATES
Leverage certificates, often referred to as certificates, are often a combination of for example a buy and a sell option and depend on an underlying asset, such as a share, index, or commodity. A certificate has no nominal amount. Leverage certificates should not be confused with, for example, commercial paper, which is a type of debt securities that can be issued by companies when the company borrows money on the capital market.
A characteristic feature of leverage certificates is that relatively small changes in exchange rates in the underlying asset can lead to significant changes in the value of the holder’s placement. These changes in value may be to the investor’s advantage, but they can also be to the investor’s disadvantage. Holders should pay particular attention to the fact that leverage certificates may decrease in value and lapse completely without value, with the result that all or part of the amount invested may be lost. Similar reasoning may in many cases also apply to options and warrants.
4. INTEREST BEARING INSTRUMENTS
An interest-bearing financial instrument is a right of claim on the issuer of a loan. Returns are normally provided in the form of interest. There are different forms of interest-bearing instruments depending on the issuer, the security that the issuer may have provided for the loan, the term up to the repayment date and the form of payment of the interest. The interest (coupon) is usually paid on an annual basis.
Another form of interest payment is to sell the instrument at a discount (discount paper). During the sale, the price of the instrument is calculated by discounting the loan amount including estimated interest at present value. The present value or rate is less than the amount received at the time of repayment (nominal amount). Certificates of deposit and treasury bills are examples of discount paper, as well as bonds with so-called zero coupon construction.
Another form for fixed income bonds is the state’s premium bonds, where the loan interest rate is raffled among the holders of premium bonds. There are also interest rate instruments and other forms of saving where the interest rate is protected against inflation and the placement therefore gives a fixed real interest rate.
The risk in an interest-bearing instrument consists partly of the rate change (rate risk) that may arise during the term due to changes in market interest rates and, on the other hand, that the issuer may not be able to repay the loan (credit risk). Loans for which adequate security has been provided for the repayment are typically less risky than unsecured loans. In general, however, the risk of loss on interest-bearing instruments can be considered lower than for shares. An interest-bearing instrument issued by an issuer with a high credit rating can thus be a good option for those who want to minimize the risk of a decrease in value in savings and may be preferable in short-term savings. Even in long-term savings where capital should not be compromised, e.g. for pension liabilities, elements of interest-bearing investments are very common. The disadvantage of an interest-bearing investment is that it usually produces a low increase in value. Examples of interest-bearing investments are savings accounts, private bonds and fixed income funds.
Rates are set daily on both short-term instruments (less than one year) such as treasury bills and on instruments with longer terms such as bonds. This is done in the money and bond markets. Market interest rates are influenced by analyses and assessments made by the Swedish National Bank (swe. Riksbanken) and other major institutional market participants regarding how the development of a number of economic factors such as inflation, economic activity, interest rate developments in Sweden and other countries, etc. will develop in the short and long term. The Swedish National Bank also conducts so-called monetary policy operations in order to steer the development of market interest rates so that inflation does not rise above a certain target. Financial instruments traded on the money and bond markets (e.g. government bonds, treasury bills and mortgage bonds) are often traded in very large posts (multi-million amounts).
If market interest rates go up, the rate of already issued interest-bearing financial instruments will fall if they have fixed interest rates, as new loans are issued at an interest rate that follows the current market rate and thus yields higher interest rates than the already issued instrument. Conversely, the rate of outstanding instruments rises when the market rate goes down.
Loans issued by the state and the municipality are considered risk-free in terms of repayment, which thus applies to government and municipal bonds. Issuers other than the state and the municipality may sometimes, in the case of the issue of obligations, provide collateral in the form of other financial instruments or other property (property or real collateral).
There are also other interest-bearing instruments that involve a higher risk than bonds if the issuer would have difficulty repaying the loan, such as debentures.
One form of interest-rate-related instrument is covered bonds. These are subject to a special preferential right under specific legislation. The covered bond framework aims to ensure that an investor is fully paid in accordance with the agreed timetable even if the issuer of the bond goes bankrupt, provided that the property that secures the bond worth enough.
5. DERIVATIVE INSTRUMENTS
Derivative instruments such as options, futures, etc. are present with various types of underlying assets, such as shares, bonds, commodities and currencies. Derivative instruments can be used to reduce the risk in a placement.
A particular factor to take into account when placing in derivative instruments is that the design of derivative instruments makes the price development of the underlying asset has an impact on the price of the derivative instrument. This price impact is often stronger in relation to the stake (premium paid) than the change in value on the underlying asset. The price breakthrough is therefore called leverage effect and may lead to more profit on deposited capital than if the investment had been made directly in the underlying asset. On the other hand, the leverage effect may as well result in a higher loss on derivative instruments compared to the change in the value of the underlying asset if the price evolution of the underlying property is different from the expected one. The leverage effect, i.e. the possibility of profit and the risk of loss, varies depending on the design and use of the derivative instrument. Great demands are therefore placed on monitoring the price development of the derivative instrument and on the underlying asset. The investor should be prepared to act quickly, often during the day, should the investment in derivative instruments develop in an unfavorable direction. It is also important to consider in the risk assessment that the possibility of liquidating a holding may be more difficult in the event of a negative price trend.
For further information on derivative instruments, see INFORMATION ON TRADING IN OPTIONS, FUTURES AND OTHER DERIVATIVE INSTRUMENTS.
6. FUNDS AND FUND SHARES
A fund is a “portfolio” of different types of financial instruments, such as shares and bonds. The fund is jointly owned by all those who save in the fund, the holders, and is managed by a fund management company. There are different types of funds with different investment directions. Investment direction means the type of financial instrument in which the fund invests. Below is a brief account for some of the most common types of funds. For further information, please see the website of the Swedish Consumer Banking and Finance Agency, www.konsumentbankbyran.se, and the Swedish Investment Fund Association’s website, www.fondbolagen.se.
An equity fund invests all or mainly all the capital paid into shares by the holders. Mixed funds with both equities and interest-bearing instruments also exist, as do pure fixed income funds where capital is invested mainly in interest-bearing instruments. There are also, for example, index funds that are not actively managed by a manager but instead invest in financial instruments that follow the composition of a particular index.
One of the ideas of a mutual fund is that it invests in several different shares and other equity-related financial instruments, which reduces the risk of the holder compared to the risk of a shareholder who only places in one or a few shares. The holder also avoids selecting, buying, selling and monitoring the shares and other management work around this.
The principle for fixed income funds is the same as for equity funds – investments are carried out in various interest-bearing instruments to spread risk in the fund and the management of the fund takes place after analysis of future interest rate beliefs.
A fund-in-fund is a fund that invests in other funds. A fund-in-fund can be seen as an alternative to choosing to invest in several different funds. This will allow for the risk diversification that a well-composed own fund portfolio may have. There are fund-in-funds with different investment directions and risk levels.
An additional type of fund is the hedge fund. Hedge means protect. Although hedging is intended to protect against unexpected changes in the market, a hedge fund can be a high-risk fund, as such funds are often highly mortgaged. However, there are large differences between hedge funds. There are also low-risk hedge funds. Hedge funds are trying to provide a positive return regardless of whether the equity or fixed income markets go up or down. A hedge fund has much more freedom in its investment opportunities than traditional funds. The investment focus can range from shares, currencies and interest-bearing instruments to various arbitrage strategies (speculation in changes in e.g. interest rates and/or currencies). Hedge funds use derivatives more often than traditional funds in order to increase or reduce the fund’s risk. Short selling (see below) is also a common feature.
Funds can also be divided into securities funds (also known as UCITS funds) and special funds. The collective name for these is investment funds and both types are governed by the Swedish Law on Investment Funds. Investment funds are funds that meet the requirements of the UCITS directive, mainly in regard to investment rules and risk diversification. Both Swedish and foreign mutual funds (authorized in their home country within the EEA), may be sold and marketed freely in all EEA countries. Special funds (e.g. hedge funds) are funds that in any way deviate from the rules of the UCITS Directive, and it is therefore particularly important for you as a customer to find out what investment rules the special fund you intend to invest in will comply with. This is reflected in the fund’s information brochure and fact sheet. Each fund management company is obliged to offer potential investors the fact sheet relating to the fund. Special funds may not be marketed and sold freely outside Sweden. Funds that invest in foreign financial instruments also have a currency risk (see also section 2.2 above).
The holders receive the number of units in the fund corresponding to the proportion of capital deposited in relation to the fund’s total capital. The units can be purchased and redeemed through investment firms that sell units in the fund or directly with the fund management company. However, it is important to take into account that some funds may have predetermined dates when the fund is “open” to purchases and redemptions, so regular trading is not always possible. The current value of the units is calculated regularly by the fund manager and is based on the price development of the financial instruments included in the fund. The capital invested in a fund can both increase and decrease in value and it is therefore not certain that the investor will receive back all the deposited capital.
7. SHORT SELLING
Short selling means that the loaner, while also undertaking to return instruments of the same kind to the lender at a later date, sells the borrowed instruments. At the time of sale, the borrower expects to be able to acquire the instruments on the market at a lower price than that at which the borrowed instruments were sold at the time of return. Should the price instead have gone up, there would be a loss, which in the event of a sharp price increase can be considerable.
Financial instruments can in many cases be purchased for partly borrowed capital. Since both own and borrowed capital affect the return, the loan financing allows you to get a greater profit if the investment develops positively compared to an investment with only your own capital. The debt associated with borrowed capital is not affected by whether the prices of purchased instruments develop positively or negatively, which is an advantage in the event of a positive price trend. If the prices of purchased instruments develop negatively, a corresponding disadvantage arises because the debt remains at 100 percent, which means that the decrease consumes the capital krona-by-krona. Therefore, in the event of a fall in prices, the capital may be used in whole or in part, while the debt has to be paid in whole or in part through the sales income from the financial instruments that have fallen in value. The debt must be paid even if the sales revenue does not cover the entire debt.
YOU AS A CUSTOMER MUST UNDERSTAND, AMONG OTHER THINGS:
- that investments or other positions in financial instruments are at the customer’s own risk
- that you as a client must carefully familiarize yourself with the investment firm’s general terms and conditions for trading financial instruments and, where appropriate, information in the prospectus and other information about the relevant financial instrument, its characteristics and risks
- when trading in financial instruments it is important to check the sales note and other reporting regarding your investments and to promptly complain about errors
- that it is important to continuously monitor changes in the value of holdings and positions in financial instruments
- that you as a customer must initiate the measures necessary to reduce the risk of losses on your investments or other positions
Information on different types of financial instruments and trading in financial instruments, together with proposals for further literature in this area, can also be found, for example, on the website of the Consumer Banking and Finance Office, www.konsumentbankbyran.se, and on SwedSec’s website, www.swedsec.se.