CMFAS RES6A Quiz 82

Value at Risk (VaR) is a statistical measure used to quantify the level of financial risk within a firm or investment portfolio over a specific time frame. It estimates the potential loss in value of a portfolio over a specified time horizon at a given confidence level. A VaR statistic comprises three key components: a confidence level (typically 95% or 99%), a time period (e.g., a day, a month, or a year), and an estimate of investment loss (expressed in dollar or percentage terms). If a portfolio has a 5-day 99% VaR of SGD 2 million, it signifies that there is a 1% probability (which is 100% minus the 99% confidence level) that the portfolio’s value will decrease by more than SGD 2 million over a 5-day period. This means that, statistically, on 1 out of every 100 five-day periods, the portfolio is expected to experience a loss exceeding SGD 2 million. It does not imply that the loss will be exactly SGD 2 million, nor does it guarantee that losses will not exceed this amount; rather, it provides a probabilistic threshold for potential downside risk. The other options misinterpret the probabilistic nature, the ‘more than’ aspect, or the confidence level of VaR.

Daily price limits are implemented by exchanges to manage excessive price volatility and prevent dramatic price swings. However, when a futures contract reaches its daily limit, it can impede price discovery and prevent the market from reflecting true supply and demand. To address this, exchanges often have mechanisms to adjust these limits. As stated in the syllabus, when a futures contract settles at its limit bid or offer, the limit may be widened to facilitate transactions for the next trading session. This action allows prices to return to a level reflective of the current market environment, ensuring market functionality. Halting trading for an extended period or automatically liquidating positions are not the typical immediate responses to hitting a daily price limit. While a margin call might be triggered for individual accounts due to losses, it is not the exchange’s direct action to manage the price limit itself. Similarly, the settlement price is usually determined based on the day’s closing price range, not simply fixed at the limit price upon being hit.

The question describes a situation where a securities exchange needs to temporarily suspend trading to manage rapid and severe market declines and widespread panic. This specific action of halting trading is the primary function of circuit breakers. Circuit breakers are systems in cash and derivative markets that trigger trading halts when predefined price thresholds are breached, allowing market participants to reassess the situation and prevent further disorderly movements. Shock absorbers, while also a market disruption mitigation measure, are designed to slow down trading during significant volatility without completely halting it. Session or daily price limits are imposed to restrict price volatility within a trading session but do not stop trading activity. Introducing stricter margin requirements is a general risk management tool aimed at reducing speculative trading and leverage, rather than a direct mechanism for temporarily suspending trading during a market disruption event.

Futures contracts offer several advantages for fund managers seeking to rebalance portfolios efficiently and economically, especially when dealing with illiquid underlying assets. Firstly, futures transactions typically incur lower brokerage costs compared to trading the underlying securities directly. Secondly, futures require only a margin payment, which is a fraction of the notional value of the contract, thereby demanding a smaller initial cash outlay. This allows managers to achieve desired exposure changes without immediately liquidating a large portion of their existing holdings, which is particularly beneficial for illiquid assets. The higher liquidity of futures markets also means that large positions can be adjusted with less market impact and shorter transaction times, as trades are often executed against the exchange’s clearing house. The other options are less accurate: futures markets generally reflect the volatility of their underlying assets, not reduce it; while futures can delay the need to sell underlying assets, they don’t entirely eliminate it if a permanent shift is intended; and while the clearing house mitigates counterparty risk, the primary advantage in this context relates to cost, liquidity, and cash outlay for efficient rebalancing.

When an investor’s margin account balance falls below the maintenance margin level, the exchange’s mark-to-market procedures require the investor to deposit additional funds. This ‘additional margin’ must be sufficient to bring the account balance back up to the initial margin level, not just to the maintenance margin level. This action must be taken immediately or by a stipulated time when the broker issues a margin call. Liquidating a position might be a strategy to avoid future margin calls or reduce exposure, but it is not the direct requirement to meet an existing margin call. Waiting for market recovery is not an acceptable response to a margin call, and converting futures to forwards is not a valid or relevant action in this context.

A butterfly spread is a neutral trading strategy that combines bull and bear spreads across three different delivery months. The strategy involves buying one contract of the nearest delivery month, selling two contracts of the second nearest delivery month, and buying one contract of the furthest delivery month. This specific configuration, known as buying a butterfly spread (or a long butterfly spread), is employed when an investor anticipates that the price difference between the nearest and second-nearest futures contracts (the nearby spread or wing) will strengthen, meaning it will become more positive or less negative, relative to the spread between the second-nearest and furthest contracts (the distant spread or wing). The question describes precisely this market expectation, making a long butterfly spread the appropriate strategy.

A bear put spread is a strategy implemented when an investor anticipates a moderate decline in the underlying asset’s price. It involves buying a higher-strike put option and selling a lower-strike put option, both with the same expiration date. The maximum potential profit for a bear put spread is calculated as the difference between the two strike prices minus the net debit (premium paid) to establish the position. In this scenario, the higher strike price is $50, and the lower strike price is $45. The difference between the strike prices is $50 – $45 = $5. The net debit paid is $2.50. Therefore, the maximum potential profit is $5 – $2.50 = $2.50. The other options represent either the gross difference in strike prices without accounting for the debit, or the strike prices themselves, which do not represent the maximum profit.

When an investor’s Contract for Differences (CFD) account balance, after being marked-to-market, falls below the maintenance margin level, the CFD provider’s immediate action is to issue a margin call. This requires the investor to deposit additional funds to restore the account balance, typically back to the initial margin level. Liquidation, which involves the forced selling of positions, only occurs if the investor fails to meet the margin call within the stipulated timeframe. Increasing margin requirements for existing positions or restricting new trades are not the direct and immediate consequences of a margin shortfall below the maintenance level, although they might be subsequent actions or policy changes under different circumstances.

The Last Trading Day for Euroyen TIBOR Futures is specifically defined as the 2nd Tokyo Financial Exchange (TFX) business day immediately preceding the 3rd Wednesday of the expiring contract month. In contrast, the 3-month Singapore Dollar Interest Rate Futures defines its Last Trading Day as 2 business days preceding the 3rd Wednesday of the expiring contract month, without specifying a particular exchange’s business day. The key distinction lies in the explicit reference to the ‘Tokyo Financial Exchange (TFX) business day’ for Euroyen TIBOR Futures, which is a more specific criterion compared to the general ‘business days’ for the Singapore Dollar Interest Rate Futures.

The trading name of a structured warrant provides key information about its features. Breaking down ‘MNO PQR PW261020’: ‘MNO’ refers to the underlying instrument, which could be shares of MNO Ltd. ‘PQR’ identifies the financial institution that issued the warrant. The absence of a prefix before ‘PW’ indicates an American-style exercise, as a European-style warrant would typically have an ‘e’ prefix. ‘PW’ clearly signifies that it is a Put Warrant. Finally, ‘261020’ represents the expiration date in a YYMMDD format, meaning the warrant expires on 20 October 2026. Therefore, the statement that accurately describes the warrant is that it is an American-style put warrant, with MNO as the underlying instrument, issued by PQR, and it expires on 20 October 2026.

The question tests the understanding of a Mandatory Call Event (MCE) for a Callable Bull/Bear Contract (CBBC), specifically an R-Category Bull Contract. For a Bull Contract, an MCE is triggered when the spot price of the underlying asset touches or falls below its specified call price. In this scenario, the call price is $95.00. Therefore, if the market price of Company Alpha shares decreases to $95.00 or falls below this level, the CBBC will experience an MCE, leading to its early termination. The strike price ($90.00) is a component in the CBBC’s valuation and residual value calculation for an R-Category contract, but it is not the trigger for the MCE itself. Options suggesting an increase in price or using the strike price as the MCE trigger are incorrect for a Bull CBBC.

The investor’s stated objectives are to express a strong directional view on an equity index, with high transparency and direct correlation to the underlying’s price movements. A Callable Bull/Bear Contract (CBBC) is specifically designed for investors taking a bullish or bearish position on an underlying asset. CBBCs are known for their transparency and their price changes tend to closely follow the underlying asset’s price changes, as their delta is typically close to 1. This direct correlation and ability to take a strong directional view (Bull or Bear) perfectly align with the investor’s requirements. Conversely, a Barrier Reverse Convertible is primarily suited for investors with a neutral view on the underlying, seeking income generation in a market with limited volatility, rather than a strong directional play with direct correlation. A Bonus Certificate appeals to investors who are generally bullish but are looking for yield enhancement if markets are flat or slightly down, offering a minimum return if a barrier is not breached, which does not fully match the strong directional and direct correlation needs. The option describing a product that offers enhanced yield by selling an out-of-the-money put option, accepting downside risk below the strike price, is a core characteristic of a Barrier Reverse Convertible. While it involves a knock-out feature, its investment view (neutral, income-seeking) does not match the scenario’s requirement for a strong directional view with direct correlation.

Contracts for Differences (CFDs) are derivative products that allow investors to speculate on the price movements of an underlying asset without owning the asset itself. A key feature of equity CFDs is that investors holding a long position are typically entitled to receive cash dividends and participate in corporate actions such as share splits, similar to direct shareholders. However, a crucial distinction is that CFD investors do not possess any voting rights associated with the underlying shares. This is because they do not hold legal ownership of the shares. The other options incorrectly state that CFD investors either have voting rights, no entitlement to dividends/splits, or full shareholder rights.

Extended Settlement (ES) contracts are specifically designed to facilitate the management and transition of positions. According to the SGX framework, each ES series begins trading on the 25th day of the month immediately preceding the spot month. This structure results in a tenor of approximately 35 days for each series. This specific timing and duration are crucial as they provide a consistent overlap period, allowing market participants to ‘roll over’ their positions from an expiring contract to a new one without interruption. The other options present incorrect commencement dates and tenors that do not align with the SGX’s prescribed structure for ES contracts, nor do they effectively support the intended mechanism for position rollover.

A Credit Linked Note (CLN) exposes an investor to the credit risk of a specific ‘reference entity’. When a credit event, such as a default on interest or principal payments, occurs for this reference entity, the CLN’s terms dictate the method of settlement. If the CLN specifies physical settlement, the investor will receive the actual defaulted debt instrument (e.g., a bond) of the reference entity. This bond’s market value will likely be substantially below its original par value, resulting in a loss for the investor. This differs from cash settlement, where the investor would receive a cash payment reflecting the loss, typically the difference between the par value and the market price of the defaulted debt. The other options describe scenarios that are either incorrect for physical settlement, represent cash settlement, or are not the primary direct consequence of a credit event under physical settlement terms.

Company warrants are typically issued by the underlying listed company itself, often as a ‘sweetener’ to a bond or rights issue. Upon exercise, the company issues new shares, leading to potential dilution. Structured warrants, on the other hand, are issued by third-party financial institutions and are generally cash-settled, especially those listed on SGX-ST. This means the holder receives a cash payment rather than physical delivery of the underlying shares. The other options contain inaccuracies: structured warrants typically have shorter maturities (less than 1 year) compared to company warrants (3-5 years); company warrants are issued by the underlying company, not third-party institutions; and neither company nor structured warrant holders are entitled to receive dividends from the underlying instrument.

When a corporate treasurer expects to receive funds in the future for a fixed deposit and anticipates a decline in interest rates, they face the risk of earning a lower yield. Eurodollar futures contracts can be used to hedge this risk. Eurodollar futures prices are quoted as 100 minus the implied 3-month LIBOR. If interest rates are expected to decline, the implied LIBOR will decrease, causing the Eurodollar futures price to increase. By buying Eurodollar futures contracts, the treasurer can profit from this expected price increase. This profit from the futures position will then offset the lower interest earned on the actual deposit when the funds become available, effectively locking in a higher overall yield. Selling Eurodollar futures would be appropriate if the treasurer expected rates to rise (e.g., to hedge future borrowing costs). Entering into a forward rate agreement (FRA) is another hedging instrument, but the question specifically asks about Eurodollar futures. Delaying the investment decision would expose the company to the full risk of declining rates, which is contrary to the objective of hedging.

The question pertains to the rules governing allowable trading activities for Extended Settlement (ES) contracts in Singapore, specifically when a customer provides an indication regarding margin receipt. According to the SGX Regulatory Note 3.3.12 and 3.3.13 (Customer Margins – Section 4.1 Acceptance of Orders), if a Member or Trading Representative receives an indication from the customer that margins are forthcoming within the T+2 period, all types of trading activities are permitted for the customer. This includes risk-increasing, risk-neutral, and risk-reducing activities. This contrasts with situations where margins are indicated to be received after T+2 or not at all, or beyond the T+2 period, where trading activities are restricted, typically only allowing risk-reducing activities.

A put option grants the buyer the right, but not the obligation, to sell the underlying asset at a specified strike price within a certain period. Conversely, the seller of a put option undertakes the obligation to buy, or take delivery of, the underlying asset at that same strike price if the buyer chooses to exercise their right. This means the put seller is obligated to purchase the shares from the buyer at the contracted price. Delivering the underlying shares at the strike price is the obligation of a call option seller. Paying back the premium is not an obligation upon exercise; the premium is the upfront payment for the option right. Closing out the position is a trading strategy to exit the obligation, not the obligation itself upon exercise.

Contracts for Differences (CFDs) are derivative products that allow investors to speculate on the price movements of an underlying asset without owning the asset itself. A key feature of CFDs, as outlined in the syllabus, is that for equity CFDs, investors holding a long position are entitled to receive cash dividends and participate in corporate actions such as share splits, similar to owning the physical stock. However, a crucial distinction is that CFD investors do not possess voting rights associated with the underlying shares. Therefore, in the given scenario, the investor would benefit from the cash dividend and the stock split through adjustments to their CFD position, but they would not be able to vote on the merger proposal.

Effective gearing is a crucial metric that combines the basic gearing ratio with the warrant’s delta. While the gearing ratio indicates how many more warrants can be bought for the same capital compared to the underlying asset, it doesn’t account for the warrant’s sensitivity to price changes in the underlying asset. Delta, on the other hand, measures this sensitivity (the rate at which the warrant price changes with respect to the underlying asset’s price). By multiplying delta by the gearing ratio, effective gearing provides a more refined measure of the warrant’s actual leverage, reflecting how much the warrant’s value will change for a given percentage change in the underlying asset, considering its specific price sensitivity. Therefore, it quantifies the overall leverage, adjusted for its sensitivity to movements in the underlying asset’s price. The other options describe either basic gearing, a specific outcome of leverage, or time decay, which are related but distinct concepts from effective gearing.

The question tests understanding of two key concepts in Extended Settlement (ES) contract margining: ‘Margining on Gross Basis’ and ‘Margins for Positions Which Have Been Offset’. For ‘Margining on Gross Basis’, the Central Depository (CDP) computes margin requirements on a gross basis. This means that long and short positions belonging to different customers do not cancel each other out in the calculation of a Member’s overall margin requirement. Therefore, for Client A’s 1,000 long units and Client B’s 800 short units in Company P ES contracts, the Member firm would be margined for the full 1,800 open positions (1,000 + 800). For ‘Margins for Positions Which Have Been Offset’, the text states that while trades that offset an existing position will only be settled by CDP on the 3rd market day after the Last Trading Day (LTD+3), Additional Margins will be collected by CDP from Members for all trades. However, positions which have been offset will, under normal conditions, not require Maintenance Margins. The fact that Client C realized a profit from offsetting the position does not immediately negate the requirement for Additional Margins until settlement, though the profit itself can be used to offset other margin requirements. Therefore, the correct approach is to calculate margins for the gross sum of positions for different clients and to understand that while Maintenance Margins are typically waived for offset positions, Additional Margins are still collected until settlement.

When a Mandatory Call Event (MCE) is triggered for an R-category Callable Bull/Bear Certificate (CBBC), the CBBC is immediately terminated. The investor receives a residual value, which can be small, but the contract ceases to exist. A crucial aspect of the MCE is its irrevocability; once called, the CBBC cannot be reinstated, and the investor cannot benefit from any subsequent recovery or rebound in the underlying asset’s price, even if it moves favorably. Therefore, the investor receives the residual value, but their exposure to the underlying asset through that specific CBBC ends, preventing them from profiting from any later price appreciation. The other options are incorrect because an MCE is not a temporary suspension, an R-category investor does receive a residual value (unlike an N-category investor who gets zero), and the termination is mandatory, not subject to the investor’s choice to hold to maturity.

An arbitrage opportunity arises when there is a discrepancy between the market price of an Interest Rate Swap (IRS) and the implied rate derived from a strip of Eurodollar futures contracts. In this scenario, the fixed rate of the IRS is trading significantly lower than the implied fixed rate from the futures strip. This means the IRS is relatively ‘cheap’ or undervalued compared to the futures contracts. To profit from this undervaluation, an arbitrageur would simultaneously ‘buy’ the cheap asset and ‘sell’ the relatively expensive asset. ‘Buying’ the fixed rate in an IRS means entering the swap as a fixed-rate receiver, where you receive the fixed rate and pay the floating rate. Since the IRS fixed rate is lower than the implied futures rate, the futures contracts are relatively ‘expensive’ or overvalued. Therefore, the arbitrageur would sell the Eurodollar futures contracts to lock in the higher implied rate. Thus, the correct strategy is to enter into the IRS as a fixed-rate receiver and simultaneously sell the corresponding Eurodollar futures contracts. This locks in a risk-free profit by exploiting the price differential.

The Interest Rate Parity (IRP) theory establishes a relationship between the spot exchange rate, the forward exchange rate, and the interest rates of two currencies. The formula for calculating the forward rate (F) based on the spot rate (S) and the respective interest rates is: F = S x [1 + Rc(n/360)] / [1 + Rb(n/360)], where Rc is the interest rate of the counter currency, Rb is the interest rate of the base currency, and n is the number of days in the forward period. In this scenario, the AUD is the base currency and SGD is the counter currency. Given values: Spot rate (S) = 0.9500 SGD/AUD Counter currency (SGD) interest rate (Rc) = 2.50% or 0.0250 Base currency (AUD) interest rate (Rb) = 1.50% or 0.0150 Number of days (n) = 90 First, calculate the interest rate factors for the 90-day period: For SGD: 0.0250 (90/360) = 0.0250 0.25 = 0.00625 For AUD: 0.0150 (90/360) = 0.0150 0.25 = 0.00375 Next, substitute these values into the IRP formula: F = 0.9500 x [1 + 0.00625] / [1 + 0.00375] F = 0.9500 x [1.00625] / [1.00375] F = 0.9500 x 1.00249068 F = 0.952366146 Rounding to four decimal places, the 90-day forward rate is 0.9524 SGD/AUD. This indicates a forward premium for SGD against AUD, which is expected when the interest rate of the counter currency (SGD) is higher than that of the base currency (AUD).

When an investor takes a short Extended Settlement (ES) position and fails to deliver the required shares by the settlement due date, the Central Depository Pte Ltd (CDP) initiates a buying-in process. The settlement due date for an ES contract is the third business day after the Last Trading Day (LTD). Therefore, the buying-in process commences on the day immediately following the settlement due date, which is the fourth business day after the LTD. The starting price for this buying-in action is determined by taking two minimum bids above the highest of three reference points: the closing price of the previous day, the current last done price, or the current bid price.

Contracts for Differences (CFDs) are derivative products that allow investors to speculate on the price movements of an underlying asset without actually owning the asset. When an investor holds a long CFD position and the underlying company declares a cash dividend, the CFD investor is typically credited with a cash equivalent of that dividend. This is because CFDs aim to replicate the economic exposure of owning the underlying asset. However, a crucial distinction is that CFD investors do not hold the physical shares and therefore do not possess any voting rights associated with the underlying company. CFDs are also cash-settled products, meaning there is no physical delivery of shares, and they generally do not have an expiry date, allowing positions to be held as long as desired without automatic closure due to corporate actions like dividends.

Bond-Linked Notes (BLNs) and Credit-Linked Notes (CLNs) are both structured products, but they differ fundamentally in their underlying risk exposure and payout triggers. A CLN’s payout is directly dependent on whether a credit event occurs for a specified reference entity, as it essentially involves the investor selling a Credit Default Swap (CDS). In contrast, a BLN’s payout is primarily determined by the market price of an underlying bond, as it involves the investor selling a put option on that bond. While a bond’s price can be influenced by credit events, it is also affected by other factors such as interest rate movements and widening credit spreads, meaning a BLN investor can be exposed to losses even without a formal credit event. The other options incorrectly describe the mechanisms or make absolute statements about risk protection or sole influences on valuation, which are generally not true for these complex financial instruments.

The correct option accurately describes the unique characteristics of a Discount Certificate’s initial investment and return structure as presented in the syllabus. The text states that a Discount Certificate is ‘issued at a discount to face value, so that the investment sum he puts in is less than the amount an investor pays for a similar reverse convertible.’ It also clarifies that ‘At maturity or redemption, he will not receive a full a coupon payout but receives the face value of the certificate.’ This means the investor pays less than face value initially and receives the face value at maturity, without the periodic coupon payments typically associated with the bond component of a Reverse Convertible. Option 2 is incorrect because the syllabus explicitly states that both Reverse Convertibles (due to the short put) and Discount Certificates (due to the short call) expose the investor ‘to the full decline of the stock price, with the entire amount of the investment capital at risk’ on the downside, meaning neither offers guaranteed full capital protection in all scenarios. Option 3 is incorrect because the syllabus highlights that returns for structured products involving option selling come from both participation in the underlying asset’s performance and from premiums received in writing options. The discount in a Discount Certificate is derived from the premium received from selling calls. Reverse Convertibles also generate returns from the bond component and the premium from the short put. Option 4 is incorrect as it misrepresents the construction of both products. The syllabus clearly states that a Reverse Convertible is composed of a ‘Bond (Note) + Short Put,’ while a Discount Certificate is composed of a ‘Long Call (Zero strike) + Short Call.’

The question pertains to how Extended Settlement (ES) contracts are adjusted in response to corporate actions on their underlying securities, specifically when the corporate event leads to a change in the number of shares held by shareholders. According to the CMFAS Module 6A syllabus, when a corporate event results in shareholders obtaining an increase or decrease in the number of shares, this change is reflected by a similar increase or decrease in the contract multiplier for the respective ES contracts. This method ensures that the contract value after the event remains, as far as practicable, equivalent to its value before the event. Adjusting the settlement price is another method, but it is typically applied when a corporate event directly affects the share value or price, rather than the number of shares. Modifying margin requirements or bringing forward the Last Trading Day are other mechanisms, but not the primary method for adjusting for a change in the number of underlying shares due to a corporate action.