Characteristics of financial instruments and risks

Learn about the financial instruments used for your investments

NNEK logo

There are risks associated with all forms of investment. The risks depend on the type of investment and the method of investment. An investment can be more or less speculative. Usually, an investment with a higher expected return carries higher risks.

Investment institutions may hold financial instruments, as a result of which the risks of these financial instruments are also important for determining the risks of those investment institutions. The characteristics of the most common financial instruments as well as the specific investment risks associated with them are briefly discussed below.

The value of an investment may fluctuate. Past performance is no guarantee for the future. You should only invest if you can bear a possible loss. Please note that Curvo only works with these financial instruments listed below in order to passively invest your savings. 

Investment Institutions

Investment firms, also known as investment funds, are a form of collectively managed assets. These collective assets are pooled by a large number of investors to invest in financial instruments such as shares, bonds, alternative investments and money market instruments. Collective investment makes it easier to spread investments and risks, which would otherwise require a significantly larger amount of assets. It also makes it possible to invest in financial instruments which are generally not available to retail investors.

Investment institutions can leverage by (occasionally) borrowing a limited proportion of the fund's assets. The manager of an investment institution invests on behalf of the investment institution with the aim of realising a profit. The investment returns, such as capitalised price gains, dividend and interest, are for the benefit of the price of the investment institution and therefore for the benefit of the participants in the investment institution. Losses and costs, such as price losses and management costs, shall be charged to the price of the investment institution and therefore to the participants in the investment institution.

The value of units in an investment institution, also referred to as net asset value, shall be determined periodically on the basis of, among other things, the total value of the financial instruments and funds held by the investment institution and the total outstanding units.

A distinction may be made between open-ended and closed-end investment undertakings. An open-ended investment institution may, in principle, repurchase and issue units and are, in principle, traded at a price at or around net asset value. A closed-end investment firm shall in principle not be able to repurchase or issue units and shall in principle be traded at a price determined on the basis of supply and demand.

An investment in investment firms carries risks similar to those of the underlying assets. For example, an investment firm investing solely in shares carries the same risks as an investment in shares. Specific risks shall be described in the prospectus of the investment firm concerned.

Difference between index funds and actively managed investment firm

In addition to actively managed investment institutions, there are index funds. The difference between the two is determined by the autonomy of the manager of the investment institution. Using automated processes, an index fund follows an index (the benchmark). An index fund does not try to achieve a better result than that index, but rather to follow the (performance) of the index. With active management, an actively managed investment institution tries to achieve the highest possible return and thus beat its benchmark. Curvo only offers passive investments and there is no active management.

(certificates of) Shares

Shares are participations in the share capital of a company. From an economic point of view, the shareholder may consider himself to be the owner of part of a company's assets. Shares may be registered or bearer shares. Shares are venture capital. In the event of bankruptcy, the value may fall to zero. The development of the value mainly depends on the realised and expected operating results and the dividend policy of the company concerned. Shareholders are only eligible for dividend after all other providers of capital have received the return to which they are entitled. The risks of an investment in shares can therefore be very different, depending on, among other things, the development of the company and the quality of the management.

Depositary receipts for shares are financial instruments representing the underlying shares. The shares themselves are usually managed by a trust office.

Holders of depositary receipts for shares are, as it were, economically (partly) entitled to the underlying shares. Not all rights attached to shares also apply to depositary receipts for shares. For example, the voting rights attached to shares are often limited. In principle, the risks are the same as those associated with ordinary shares.

Bonds

Bonds are negotiable loans issued by a (government) institution. The institution that issued the bond generally pays a pre-agreed interest rate on the debt. Most bonds are redeemable. Bonds belong to the so-called debt capital (borrowed money) of a company.

There are special forms of bonds. These special forms may relate to the method of interest payment, the method of redemption, the method of issue and special loan conditions. For example, the return on the bond can be made (partly) dependent on the prevailing interest rate level (examples are surplus bonds and interest rate index bonds) or on the profit of the issuer (such as profit-sharing bonds and income bonds). There are also bonds on which no interest is paid (zerobonds). The return on these bonds is obtained from the difference between the issue price and the subsequent redemption price.

Investing in bonds also carries risks. The price of a bond generally depends primarily on the level of interest, so that price fluctuations can occur. In addition, the good health of the issuer is important. In the event of the bankruptcy of the issuer, bondholders should be treated as uninsured creditors of the issuer unless special security has been provided for the benefit of the bondholder.

Convertible and perpetual bonds

The convertible bond is a bond that can be exchanged for shares at the conversion price during the so-called conversion period under certain conditions (usually at the investor's request). A perpetual or perpetual bond does not have a fixed redemption date, which may cause it to fluctuate in price differently from a bond with a fixed redemption date.

A convertible bond has characteristics of both a bond and a share. Reference shall therefore be made to the risks associated with those financial instruments.

Reverse convertible

A reverse convertible is a bond that can be redeemed, at the option of the debtor or the issuer, at the principal amount or a number of shares specified in the terms and conditions of the loan. This is the reverse of an ordinary convertible where the choice lies with the investor. A reverse convertible is a high-risk investment because the investor has in fact written a put option. The investor bears the downside risk of the share, without benefiting from a rise in the share price. On the other hand, there is often a relatively high interest rate. For the other characteristics and risks, reference is therefore made to the risks and characteristics of the convertible bond.

Derivatives

Derivatives are financial instruments that derive their value from the value of another asset, such as shares, commodities or currency. The other asset is also called the underlying asset. The main types of derivatives are options and forward contracts. Derivatives can be used to reduce risk or, on the contrary, to speculate.

Options

An option is a contract whereby the party granting the option (the "writer") grants the other party the right to buy (a "call option") or sell (a "put option") an underlying asset, e.g. a package of shares or a set amount of gold, during or at the end of an agreed period at a price which has been determined in advance or the manner in which it will be determined. For this right, the purchaser pays a premium to the writer.

The premium amounts to a fraction of the underlying asset. As a result, a fluctuation in the price of the underlying asset leads to substantially higher profits or losses for the holder of an option (the so-called leverage effect). The price fluctuation mainly depends on the value development of the underlying asset (the "price") of the option. Usually, the option is negotiable in the interim: both call options and put options can then be bought and sold. The counterparty of a buyer of a call option is the writer of the call option and the counterparty of a buyer of a put option is the writer of the put option. The premium to be paid depends, among other things, on the development of the value of the underlying asset, interest rates, expected dividend payments and the duration of the contract.Buying options

An option (contract) gives the buyer the right (not the obligation) during or at the end of a specified period to buy or sell a specified quantity of an underlying asset (e.g. bonds or a specified amount of dollars) at a price agreed in advance. The buyer therefore does not have to make use of the option. The buyer pays a premium for the right acquired by the buyer of an option. The buyer of an option runs the risk of losing the premium paid. The loss of a purchased option is limited to the premium and cannot exceed that premium.

Forward contracts

A forward contract is the obligation (not a right) to buy or sell a certain quantity of a certain underlying asset (such as currency, goods or commodities) at a fixed price with delivery on time. A forward contract can be bought or sold. The buyer of a futures contract (also known as the holder of a "long position") assumes the obligation to receive and pay the agreed quantity. The seller (holder of a short position) has an obligation to deliver. It is generally not the intention to actually receive or deliver the batch of goods or financial securities. Forward trade has a high degree of leverage. When entering into a futures contract, only a small part of the actual value needs to be deposited. A limited exchange rate fluctuation can therefore lead to large losses (or profits).

The loss on futures contracts, as well as options on them, can be considerable. The loss need not be limited to the deposit. Under certain market conditions it may be difficult or even impossible to close/liquidate a position. Losses are then not limited. Issuing a "stop-loss" or "stop-limit" order will not necessarily be able to limit the losses.

Miscellaneous

The above overview cannot describe all the characteristics of all financial instruments and the associated risks. In the event that the characteristics of the financial instruments described above (and in which investments are made) differ, you may be informed of these differing characteristics and specific investment risks at your request. 

Similarly, if financial instruments not described above are traded on your behalf, you may be informed of the characteristics of those financial instruments and the specific risks associated with them on request. 

This page was published on the Curvo website on September 30, 2021.