CMFAS RES6A Quiz 76

The structured product’s yield calculation is dependent on the number of days (‘n’) the HSI fixes within the specified accrual range (between 22,200 and 22,400). A critical feature is the knock-out barrier: once the HSI fixes above this barrier, the coupon stops accumulating. In this scenario, the HSI fixes within the accrual range for the first 150 trading days, meaning ‘n’ accumulates to 150. On the 151st day, the HSI fixes above the knock-out barrier, which immediately stops further accumulation of ‘n’. Therefore, the final value for ‘n’ is 150. Using the yield formula: Yield = 0.50% + [4.00% x n/N] Substitute n = 150 and N = 250: Yield = 0.50% + [4.00% x 150 / 250] Yield = 0.50% + [4.00% x 0.6] Yield = 0.50% + 2.40% Yield = 2.90% The accrual coupon is calculated on the principal amount: Accrual Coupon = SGD 1,000,000 x 2.90% = SGD 29,000 The total redemption proceeds at maturity include the principal repayment and the accumulated accrual coupon: Total Redemption Proceeds = Principal + Accrual Coupon Total Redemption Proceeds = SGD 1,000,000 + SGD 29,000 = SGD 1,029,000. Other options are incorrect because they either: – Do not account for the knock-out barrier stopping the accrual (e.g., assuming accrual for the full 250 days). – Incorrectly calculate the yield components (e.g., omitting the 0.50% base yield or miscalculating the variable portion). – Misinterpret the effect of the barriers on the ‘n’ value.

The Constant Proportion Portfolio Insurance (CPPI) strategy aims to maintain a minimum floor value for the portfolio while allowing participation in market upside. The allocation to the risky asset is determined by multiplying a fixed multiplier by the ‘cushion’. The cushion is the difference between the current portfolio value and the floor value. It is crucial to note that the floor value is typically defined as a percentage of the initial principal sum, not the current portfolio value, unless explicitly stated otherwise. Here’s the step-by-step calculation: 1. Identify the initial principal: $1,000. 2. Determine the new floor value: The floor is adjusted to 91% of the initial principal. So, 0.91 $1,000 = $910. 3. Identify the current portfolio value: $1,050. 4. Calculate the new cushion: This is the current portfolio value minus the new floor value. Cushion = $1,050 – $910 = $140. 5. Calculate the new allocation to the risky asset: This is the multiplier multiplied by the cushion. Risky Asset Allocation = Multiplier Cushion = 4 $140 = $560. Therefore, the new allocation to the risky asset would be $560. Incorrect options arise from common misinterpretations: One common error is to calculate the cushion using the initial floor value ($900) instead of the new, adjusted floor value ($910), leading to a different risky asset allocation. Another mistake is to calculate the floor value as a percentage of the current portfolio value ($1,050) instead of the initial principal, which would yield a different cushion and risky asset allocation. A further distractor might be the amount allocated to the risk-free asset, or simply the initial risky asset allocation if one assumes no rebalancing.

A covered call strategy involves purchasing the underlying stock and concurrently selling a call option on that stock. The maximum potential gain for an investor employing a covered call strategy is realized when the underlying stock’s price at the option’s expiration date is equal to or greater than the strike price of the sold call option. The calculation for this maximum gain is the strike price of the call option minus the initial purchase price of the stock, plus the premium received from selling the call. In this specific scenario, the investor bought the stock at $25.00, sold a call with a strike price of $27.00, and collected a premium of $1.50. Therefore, the maximum per-share gain is calculated as: $27.00 (strike price) – $25.00 (stock purchase price) + $1.50 (premium received) = $2.00 + $1.50 = $3.50. This gain occurs because the stock will be called away at the strike price, and the investor retains the premium.

The question describes a scenario where an Exchange Traded Fund (ETF) consistently trades at a premium to its Net Asset Value (NAV). The provided syllabus material explicitly states that price discrepancies, such as an ETF trading at a premium or discount to NAV, can arise for ETFs tracking specific markets or sectors that are subject to direct investment restrictions (e.g., China A-shares) or for ETFs trading in different time zones from where the underlying assets are domiciled. These restrictions or time zone differences hinder the ability of arbitrageurs to efficiently create or redeem ETF shares by buying or selling the underlying assets, which is the mechanism that normally keeps the ETF’s market price close to its NAV. Therefore, direct investment restrictions in the underlying market are the most probable reason for a persistent premium, as they prevent the arbitrage process from correcting the discrepancy. High liquidity on the secondary market would generally facilitate arbitrage and keep prices closer to NAV. While foreign exchange fluctuations are a risk, they primarily affect the underlying asset value and thus the NAV, rather than causing a persistent premium relative to the NAV itself, unless arbitrage is also impaired. A high tracking error refers to the disparity between the ETF’s performance and its underlying index, which is a different concept from a persistent premium to NAV, although both are risks.

To determine the percentage impact on the investor’s initial margin, first calculate the total value of the ES contract: 1,000 shares $5.00/share = $5,000. The initial margin required is 10% of this value, which is 0.10 $5,000 = $500. If the underlying security’s price increases by 2%, the price change per share is 0.02 $5.00 = $0.10. For 1,000 shares, the total profit from this price increase is 1,000 shares $0.10/share = $100. Finally, to find the percentage impact on the initial margin, divide the profit by the initial margin: ($100 / $500) 100% = 20%. This demonstrates the leverage inherent in ES contracts, where a small percentage change in the underlying asset leads to a magnified percentage change in the initial investment.

The CMFAS Module 6A syllabus on Structured Products highlights several mechanisms for issuer oversight to assure investors of diligent product management. A key mechanism is the establishment of a trust arrangement where an independent trustee is appointed. This trustee’s role is to hold the assets and underlying financial instruments associated with the structured product, thereby providing an independent layer of oversight and safeguarding the assets. Financial auditors are also commonly engaged to verify the fairness of financial statements and valuations. While other options might relate to investor protection or market practices, they do not represent the primary independent issuer oversight mechanism described in the syllabus for holding assets. Issuer guarantees (Option 2) are not a standard independent oversight function for product management. Daily public disclosure of proprietary strategies (Option 3) is generally not required and would compromise competitive advantage. Sales representative indemnification (Option 4) relates to sales conduct and liability, not the independent oversight of the product’s underlying assets and management.

Extended Settlement (ES) contracts are designed to be adjusted for various corporate actions to ensure that the economic value and terms of the contract remain equivalent before and after the event. For a stock split, such as a 1-for-2 split, the number of underlying shares represented by each contract (the contract multiplier) is typically adjusted to double, reflecting the increased number of shares in circulation. Concurrently, the settlement price is adjusted downwards (halved in a 1-for-2 split) to maintain the overall value of the contract. This ensures that the investor’s position retains its original economic exposure. Terminating the contract or requiring additional margin solely due to a stock split would not be the standard procedure, as the total value of the underlying holding generally remains unchanged. Adjusting only the settlement price without altering the contract multiplier would fundamentally change the economic exposure of the contract, which is not the intent of such adjustments.

Structured warrants listed on the SGX-ST are typically issued by third-party financial institutions and are predominantly cash-settled upon exercise. This means the holder receives a cash amount based on the difference between the underlying asset’s price and the strike price, rather than physical shares. In contrast, company warrants are issued directly by the underlying listed company, often as a ‘sweetener’ with other corporate actions. When company warrants are exercised, the company issues new shares, which can lead to a slight dilution of existing shares. The other options contain inaccuracies: Company warrants are issued by the underlying company, not third-party financial institutions, and structured warrants are not always issued by the underlying entity. Company warrants are generally long-dated and American-style, allowing exercise any time until expiry, while structured warrants often have shorter maturities. Neither company warrants nor structured warrants typically entitle their holders to receive dividend payments from the underlying shares.

The question tests the understanding of the fundamental difference in the initial investment structure between a Discount Certificate and a Reverse Convertible, despite their potential for similar risk-return profiles. A Discount Certificate is explicitly stated to be issued at a discount to its face value, meaning the investor pays less than the face value upfront. This discount is a direct benefit passed on to the investor at the time of investment, derived from the premium received from selling call options exceeding the cost of purchasing a zero-strike option. In contrast, a Reverse Convertible typically involves an investment closer to the bond’s par value, combined with a short put option. Therefore, the initial capital outlay for a Discount Certificate is characteristically lower than the face value, providing an immediate ‘discount’ to the investor.

When an Exchange Traded Fund (ETF) tracks an index composed of thinly traded and illiquid underlying securities, the process of creation and redemption of ETF units becomes less efficient for authorized participants. This inefficiency leads to wider bid-ask spreads for the underlying assets, which subsequently translates to a wider bid-ask spread for the ETF itself. Furthermore, the impaired creation and redemption mechanism can cause the ETF’s market price to deviate significantly from its Net Asset Value (NAV), resulting in it trading at a premium or discount. These factors collectively contribute to an increased tracking error, which is the divergence between the ETF’s performance and that of its underlying index. Therefore, a wider bid-ask spread and frequent deviation from NAV are direct consequences of illiquid underlying assets.

The question tests the understanding of the daily price limit mechanisms for Nikkei 225 Index Futures and MSCI Singapore Index Futures, as specified in the CMFAS Module 6A syllabus. For Nikkei 225 Index Futures, the daily price limit mechanism involves a tiered approach: an initial 7% limit for 10 minutes, followed by trading within a 10% intermediate limit (with a 10-minute cooling-off period if this limit is reached), and finally a 15% limit that applies for the remainder of the trading day. In contrast, for MSCI Singapore Index Futures, the mechanism is simpler: a 15% price limit is applied for 10 minutes, and after this cooling-off period, there are no further price limits for the rest of the trading day. The correct option accurately describes these distinct processes for both contracts. The incorrect options contain misrepresentations of these rules, such as suggesting identical limits for both contracts, incorrect percentages, or misstating the duration or effect of the limits and cooling-off periods.

When a warrant issuer commits to making a market for its structured warrants on SGX-ST, they receive specific regulatory concessions. One such concession is that the minimum issue size requirement for the structured warrants is reduced. This is explicitly stated as a reduction from SGD 5 million to SGD 2 million. The commitment to market-making involves the issuer appointing a Designated Market-Maker (DMM) to provide liquidity by posting competitive bid and offer prices, not an exemption from appointing one. Structured warrants trade and settle like ordinary shares, implying they are subject to standard trading hour restrictions. Furthermore, market-making commitments do not grant exclusive rights over underlying securities.

The question describes a scenario where an investor wants to maintain market exposure in a futures contract beyond its current expiry date without physical settlement. This strategy is known as ‘rolling a position’. To achieve this, the investor simultaneously sells their expiring contract (to close out the current position) and buys a new contract for a future month (to re-establish market exposure). This effectively transfers the investor’s position from the near-month contract to a deferred-month contract. Allowing the contract to expire and then opening a new position would result in a temporary loss of market exposure. Simply offsetting the position would close it entirely, ending market exposure. Requesting the central counterparty to defer the settlement date is not a standard or available option for individual investors in futures markets.

The scenario describes a situation where client investment instructions were not executed promptly due to a new staff member misinterpreting internal trading protocols, leading to missed market opportunities. This directly aligns with the definition of operational risk, which encompasses risks arising from human errors or the breakdown of internal procedures and systems within a firm’s operations. Examples provided in the syllabus include ‘Failure to make timely investment or redemption on financial instruments due to cumbersome internal procedures’ or ‘Failure to renew investments due to change of staff,’ both of which are similar to the described situation. Concentration risk relates to lack of diversification in a portfolio. Basis risk is specific to futures contracts and the difference between cash and futures prices. Leverage risk pertains to the magnified gains or losses in leveraged products like futures due to small price movements.

A long call butterfly spread is a neutral options strategy designed for situations where the investor expects the underlying asset’s price to remain relatively stable, not rising or falling significantly, until expiration. This strategy involves buying one in-the-money call, selling two at-the-money calls, and buying one out-of-the-money call. Its key features include limited potential profit, which is maximized if the underlying price stays at the middle strike, and limited potential loss, capped at the initial debit paid to enter the trade. This aligns perfectly with an investor’s view of minimal price movement and a desire for defined risk and reward. In contrast, a long straddle is a volatility strategy, entered when an investor expects a significant price movement (either up or down), not minimal movement. While it has limited risk, its profit potential is theoretically unlimited. A long put option is a bearish strategy, anticipating a decline in the underlying asset’s price. A short strangle is also a neutral strategy, expecting minimal price movement, but it carries theoretically unlimited risk, which contradicts the requirement for limited potential loss.

When designing an equity-linked structured note, the issuer aims to optimize the components to offer attractive terms to investors. The text highlights that an ideal scenario at the time of issuance, which allows for a more favorable participation rate, involves high prevailing interest rates and low volatility of the underlying asset price. High interest rates reduce the present value of the zero-coupon bond component, thereby increasing the ‘discount sum’ available. This larger discount sum provides more capital to purchase the embedded call option. Simultaneously, lower volatility in the underlying asset price makes the cost of the equity option cheaper. The combination of more funds available for the option and a lower cost for the option allows the issuer to allocate more towards the investor’s participation in the underlying asset’s upside, leading to a higher participation rate.

The ‘Optimal Yield’ rolling mechanism, as described for commodity index funds, is specifically designed to enhance returns by intelligently managing the rollover of expiring futures contracts. In backwardation markets, where forward prices are lower than spot prices, the mechanism aims to maximize the profits generated from rolling over contracts. Conversely, in contango markets, where forward prices are higher than spot prices, the mechanism seeks to minimize the losses incurred during the rollover process. This adaptive approach distinguishes it from a fixed roll period, which can be detrimental to returns. The other options describe different features of structured funds or general investment strategies: ensuring fixed coupons relates to certain payout structures, reducing derivative exposure contradicts the nature of many structured funds, and automatic reinvestment of distributions describes capitalized funds.

The Trust Deed is a fundamental legal document for a structured fund. It explicitly outlines the terms and conditions governing the relationship between investors, the fund manager, and the trustee. Crucially, it describes the fund’s investment objectives and the obligations and responsibilities of both the fund manager and the trustee. The trustee, being independent of the fund manager, is tasked with ensuring that the fund is managed strictly according to the provisions of the Trust Deed, thereby safeguarding investor interests and minimising the risk of mismanagement. Therefore, any significant shift in investment strategy must align with the objectives defined in this document, and the trustee’s oversight role is derived from it. The Product Highlights Sheet is a summary for investors, the audited financial statements provide historical data, and while the offering prospectus contains comprehensive information, the Trust Deed is the underlying legal instrument that establishes the governance framework and empowers the trustee’s oversight function.

A Credit Linked Note (CLN) is a structured product where the investor takes on the credit risk of a specified reference entity. If a credit default event occurs for this reference entity and the CLN’s terms stipulate physical settlement, the investor will receive the defaulted debt obligation (such as a bond) of the reference entity. It is highly probable that this defaulted debt will trade at a significant discount to its original par value in the market, resulting in a substantial loss for the investor. CLNs are designed for yield enhancement and do not typically offer principal protection against the default of the reference entity. Cash settlement, if chosen, would involve a cash payment reflecting the loss, not the full principal. The product is not designed for conversion into equity shares.

The question asks for the specific sections within the standard reports that provide details on the fund’s investment portfolio and the reconciliation of share movements. According to the syllabus, the ‘Statement of Investments’ lists out the details of the investment portfolio. The ‘Changes in the Number of Shares for Each Share Class of the Fund’ statement shows the number of shares issued, redeemed, and reconciles the opening and closing number of shares for each class. Therefore, these two sections together provide the requested information. Other options refer to different reports or sections that do not collectively provide both specific pieces of information.

An Inverse Floater Note’s coupon payment is determined by the formula: Coupon = Max [X% ― Leverage x Floating Rate Index, Min Coupon]. In this scenario, the initial fixed rate (X%) is 6.0%, the leverage factor is 2, the Floating Rate Index is 3.0%, and the minimum coupon floor is 0.5%. First, calculate the leveraged reduction: Leverage x Floating Rate Index = 2 x 3.0% = 6.0%. Next, subtract this from the initial fixed rate: X% ― (Leverage x Floating Rate Index) = 6.0% ― 6.0% = 0.0%. Finally, apply the minimum coupon floor: Max [0.0%, 0.5%] = 0.5%. Therefore, the coupon payment for this period would be 0.5%. The other options represent common misunderstandings, such as ignoring the minimum floor (resulting in 0.0%), misinterpreting the inverse linkage or leverage (leading to 3.0%), or assuming the coupon remains at the initial fixed rate regardless of index movement (6.0%).

The premium of a structured warrant is calculated as the difference between its market price and its intrinsic value. First, we determine the intrinsic value. For a call warrant, intrinsic value exists only if the underlying asset’s market price is higher than the exercise price. In this scenario, the underlying share price is $10.00 and the exercise price is $9.00, making the intrinsic value $10.00 – $9.00 = $1.00. Since the warrant is trading at $1.50, the premium is then calculated by subtracting the intrinsic value from the warrant’s market price: $1.50 (Warrant Price) – $1.00 (Intrinsic Value) = $0.50. It is important to note that for warrants, the premium represents the time value, unlike options where the term ‘premium’ refers to the total price of the option itself.

When a company declares dividends, the terms of outstanding warrants (specifically the exercise price or conversion ratio) need to be adjusted to reflect the dilution of the underlying share’s value due to the dividend payout. The adjustment factor is designed to compensate warrant holders for this reduction in value. The formula for the Adjustment Factor is (P – SD – ND) / (P – ND), where ‘P’ represents the last cum-date closing price of the underlying share, ‘SD’ is the Special Dividend per Share, and ‘ND’ is the Normal Dividend per Share. The numerator subtracts both the special and normal dividends from the cum-date price, as both reduce the value of the share. The denominator only subtracts the normal dividend from the cum-date price, as special dividends are typically considered a non-recurring event that warrants a full adjustment, while normal dividends are part of the expected yield and only partially factored into the adjustment for ongoing value. Therefore, the correct calculation involves subtracting both types of dividends from the cum-date price in the numerator and only the normal dividend in the denominator.

Futures contracts are standardised agreements traded on regulated exchanges. A key feature is that a clearing house acts as the counterparty to every trade, effectively eliminating counterparty default risk for the individual participants. This structure, combined with the high volume of trading on exchanges, ensures significant market liquidity, allowing investors to easily offset or close out their positions before the contract’s expiration. In contrast, forward contracts are over-the-counter (OTC) agreements negotiated directly between two parties. They are customised, not standardised, and inherently carry counterparty risk as there is no clearing house guarantee. Furthermore, forward contracts typically lack an active secondary market, making it difficult to unwind a position before maturity. Options and swap agreements are other types of derivatives, but they do not inherently offer the same level of counterparty risk elimination and secondary market liquidity as exchange-traded futures, especially when considering OTC versions.

This question tests the understanding of hedging a short stock position using a long call option. When an investor short sells a stock and simultaneously buys a call option, their potential loss is capped. The maximum loss occurs when the underlying stock price (ST) rises above the call option’s strike price (X). In this scenario, the loss from the short stock position (ST – S0) is offset by the gain from the call option (ST – X), but the premium paid for the call option (c0) is a fixed cost. The net profit/loss for the hedged position when ST > X is calculated as: (S0 – ST) + (ST – X – c0) = S0 – X – c0. Given: Short sell price (S0) = $25.00 Call strike price (X) = $26.50 Call premium (c0) = $1.20 Maximum Loss = S0 – X – c0 = $25.00 – $26.50 – $1.20 = -$1.50 – $1.20 = -$2.70. Therefore, the maximum potential loss for the investor in this hedged position is $2.70 per share. The other options represent either the premium, the difference between the strike and short price, or the maximum potential gain.

To determine the adjusted exercise price of a call warrant following a dividend announcement, the Adjustment Factor formula is applied. The formula for the Adjustment Factor when both special and normal dividends are declared is (P – SD – ND) / (P – ND), where P is the last cum-date closing price of the underlying, SD is the Special Dividend per Share, and ND is the Normal Dividend per Share. The New Exercise Price is then calculated by multiplying the Old Exercise Price by this Adjustment Factor. Given: Old Exercise Price = $10.00 Last cum-date closing price (P) = $12.00 Special Dividend (SD) = $0.50 Normal Dividend (ND) = $0.20 First, calculate the Adjustment Factor: Adjustment Factor = (12.00 – 0.50 – 0.20) / (12.00 – 0.20) Adjustment Factor = (11.30) / (11.80) Adjustment Factor ≈ 0.9576271186 Next, calculate the New Exercise Price: New Exercise Price = Old Exercise Price x Adjustment Factor New Exercise Price = $10.00 x 0.9576271186 New Exercise Price ≈ $9.576 Rounding to two decimal places, the adjusted exercise price is $9.58.

Tracking error refers to the disparity in performance between an Exchange Traded Fund (ETF) and its underlying index. Factors directly contributing to tracking error include transaction fees and expenses incurred by the ETF, changes in the composition of the underlying index, costs associated with replicating the index due to liquidity or ownership restrictions on the underlying assets, and ‘cash drag’ where a portion of the fund’s assets is held in cash rather than invested in the index constituents. The first three options describe these direct causes of tracking error. However, an ETF’s market trading price frequently diverging from its Net Asset Value (NAV) due to secondary market supply and demand dynamics is a separate risk known as ‘NAV trading at a discount or premium’. While this discrepancy affects the investor’s actual return, it is a divergence between the ETF’s market price and its intrinsic value (NAV), not a direct cause of the ETF’s underlying portfolio failing to replicate the performance of its benchmark index. Arbitrage mechanisms are typically in place to minimize these price-to-NAV discrepancies, but they are distinct from the factors that cause the ETF’s NAV itself to deviate from the index’s performance.

Extended Settlement (ES) contracts are considered a superior tool for immediate hedging of an existing long position in physical shares primarily because they offer a near 100% hedge (delta = 1.0). This means the ES contract’s price movements closely mirror those of the underlying share, providing direct and effective protection against adverse price changes. Furthermore, ES contracts do not require the selection of a strike price, simplifying the hedging process and ensuring the hedge is effective regardless of the underlying asset’s price level. In contrast, warrants have a delta that depends on their strike price and time to expiry (e.g., at-the-money delta = 0.5), meaning they do not provide a full, immediate hedge. Warrants also necessitate selecting a strike price and are subject to time decay, which can diminish their value over time, making them less suitable for a direct and immediate hedge of an existing physical share position. The other options either describe characteristics that are incorrect for ES contracts or do not represent the primary reason for their superior immediate hedging capability compared to warrants.

The scenario describes a multinational corporation seeking to hedge a ‘highly specific, non-standardized foreign currency exposure’ for a ‘unique settlement date’ and prioritizes ‘direct negotiation’ to ‘avoid daily cash flow fluctuations from margin calls’. A forward contract is a private agreement negotiated directly between two parties, allowing for customization in terms of underlying asset, quantity, and delivery date, which perfectly suits a ‘highly specific, non-standardized’ exposure and ‘unique settlement date’. Crucially, forward contracts typically do not involve interim partial settlements or mark-to-market procedures, thereby avoiding the daily margin calls that are characteristic of futures contracts. Futures contracts, while offering counterparty risk mitigation through the exchange, are standardized and subject to daily mark-to-market, which would lead to the very cash flow fluctuations the corporation wishes to avoid. Interest rate swaps are primarily used to exchange interest rate payments and do not directly address a single, specific future delivery of a non-standard currency exposure in this context. Exchange-traded options provide the right, but not the obligation, to buy or sell, and while they can be used for hedging, they do not offer the same level of customization for a non-standardized underlying asset or the direct avoidance of daily margin calls in the same manner as a forward contract for a specific future delivery.

The fund trustee’s role is to act in a fiduciary capacity, safeguarding the interests of unit holders and ensuring the fund manager adheres to the investment objectives and restrictions outlined in the trust deed and prospectus. Upon discovering a breach, such as the fund manager consistently investing beyond stipulated limits, a critical and time-sensitive responsibility of the trustee is to inform the Monetary Authority of Singapore (MAS). According to CMFAS Module 6A guidelines, the trustee must notify MAS within three business days of becoming aware of any such breach. This action is paramount for regulatory compliance and to address potential mismanagement. Amending the trust deed retrospectively to cover a breach would compromise the trustee’s oversight role. While reporting to unit holders is important for transparency, the immediate regulatory obligation for a breach is to inform MAS. The trustee does not assume direct control over investment decisions; that remains the fund manager’s responsibility, albeit under the trustee’s oversight.