CMFAS RES6A Quiz 72

A synthetic short stock position is created to mimic the payoff of directly shorting an underlying asset, offering unlimited downside risk (as the stock price can theoretically rise indefinitely) and potential profit from a decline in the underlying share price. This is achieved by combining a short position in at-the-money call options with a long position in an equal number of at-the-money put options, both having the same expiration date. This strategy effectively creates a position that profits when the underlying asset’s price falls, similar to a direct short sale.

For Category R-CBBCs, when a Mandatory Call Event (MCE) occurs for a Bull contract, the MCE Settlement Price, which is crucial for determining the residual value, is established based on the underlying asset’s trading activity immediately following the event. Specifically, the settlement price is set at a value not lower than the minimum trading price of the underlying asset observed between the period of the MCE and the end of the next trading session. This means that the lowest price reached during this specified period serves as the benchmark for the settlement price. In contrast, for a Bear contract, the MCE Settlement Price would be determined by a value not lower than the maximum trading price during the same period. The closing price on the day of the MCE or a volume-weighted average price are not the specified methods for determining the MCE Settlement Price for residual value calculation in this context; those might apply to different valuation scenarios, such as valuation at maturity.

The question describes a covered call strategy, where an investor buys shares and simultaneously writes call options against them. The maximum profit for a covered call strategy occurs when the underlying share price rises to or above the strike price of the call option. The formula for maximum profit per share in a covered call is: (Strike Price – Original Stock Purchase Price) + Premium Received. In this scenario: Original Stock Purchase Price (S0) = $15.00 Strike Price (X) = $16.00 Premium Received (c0) = $1.20 Number of shares = 500 Maximum profit per share = ($16.00 – $15.00) + $1.20 = $1.00 + $1.20 = $2.20 per share. Total maximum profit = Maximum profit per share × Number of shares = $2.20 × 500 = $1,100. Option 1 is correct as it reflects the total maximum profit from the strategy. Option 2 represents only the total premium received, ignoring the capital gain up to the strike price. Option 3 represents only the capital gain up to the strike price, ignoring the premium received. Option 4, unlimited profit, is incorrect because a covered call strategy has a capped maximum profit; unlimited profit is a characteristic of holding a long stock position without writing calls, or a long call option, but not for a covered call writer.

To reduce the impact of mark-to-market fluctuations and offer investors the potential for earlier capital return in an equity-linked structured product, specific design choices are beneficial. A shorter maturity term inherently reduces the duration over which interest rate changes and market movements can significantly affect the product’s mark-to-market value. It also means the investor receives their capital back sooner. Embedding barrier options, such as ‘up-and-out’ calls, is explicitly mentioned as a method to mitigate investment risk and reduce the impact of mark-to-market fluctuations. These exotic options can be cheaper than conventional options and, in the case of a knock-out event, can lead to early termination and redemption, providing earlier capital return. Therefore, combining a shorter maturity with barrier options directly addresses both objectives. Extending the maturity period would increase exposure to mark-to-market fluctuations. Focusing on higher volatility underlying assets would increase the cost of embedded options, which is not ideal. Removing auto-callable features would eliminate a mechanism for early redemption, contradicting the goal of earlier capital return. Increasing the discount rate on the zero-coupon bond might provide more funds for option purchase but doesn’t directly reduce mark-to-market impact or guarantee earlier capital return as effectively as a shorter maturity. Setting a higher barrier level for knock-out options would make early termination less likely, thus delaying potential capital return.

The product terms state that the fund is call protected for an initial 1.5-year period, meaning it cannot be redeemed prior to 15 June 2016 (Initial Date 16 Dec 2014 + 1.5 years). The Early Redemption Observation Date of 15 December 2017 falls after this call protection period, making the call barrier operative. The Mandatory Call Event (knock-out trigger) occurs if the closing index level of ANY 4 of the underlying indices on an Early Redemption Observation Date is less than 75% of its initial level. In this scenario, all four underlying indices are at 70% of their initial values, which is below the 75% threshold. Therefore, the Mandatory Call Event is triggered. When this event occurs, the fund terminates, and the investor receives the latest quarterly coupon payment and the redemption value, which is explicitly stated as 100% of the invested capital (face value of initial unit price of fund). Option 2 is incorrect because it omits the payment of the latest quarterly coupon. Option 3 is incorrect because the call protection period ended on 15 June 2016, making the fund callable on 15 December 2017. Option 4 is incorrect because the redemption value upon a knock-out event is 100% of the invested capital, not a percentage tied to the index performance at the trigger level.

An Equity Linked Note (ELN) with physical settlement is designed for investors who are willing to acquire the underlying shares if their price falls below a specified strike price at maturity. This strategy allows the investor to potentially purchase shares at a discount to their current market value, while also earning an enhanced yield (or discount on the purchase price) if the shares perform favorably or remain above the strike. The ELN typically embeds a short put option, obligating the investor to buy the shares if the put is in-the-money at expiry. Options that suggest guaranteed principal protection or fixed interest payments are incorrect, as ELNs are principal-at-risk instruments whose returns are contingent on the underlying asset’s performance. An embedded call option is not the primary mechanism for an investor seeking to acquire shares at a lower price through an ELN; rather, it’s the short put that facilitates this.

A ‘worst of’ Equity Linked Note (ELN) is designed such that its return is contingent on the performance of the poorest performing underlying asset within a specified basket of securities. This means that even if several underlying assets perform strongly and close above their strike prices, the investor’s payout will be determined by the one asset that performs the worst. This characteristic exposes the investor to a higher downside risk compared to a standard ELN linked to a single asset, which is why ‘worst of’ ELNs typically offer a higher yield or a lower strike level to compensate for this increased risk. The other options incorrectly describe the mechanism of a ‘worst of’ ELN, suggesting benefits from average or best performance, or misrepresenting the conditions for yield.

To synthetically replicate the payoff profile of a short stock position, an investor needs to construct a strategy that benefits from a decline in the underlying asset’s price and has unlimited downside risk if the price rises. This is achieved by combining a short position in at-the-money call options with a long position in an equal number of at-the-money put options, both sharing the same expiration date. This combination mimics the profit and loss characteristics of directly shorting the stock. The other options describe different synthetic positions: buying calls and shorting puts would create a synthetic long stock position; buying the underlying stock and buying puts would create a synthetic long call position; and shorting the underlying stock and buying calls would create a synthetic long put position.

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. In this scenario, Client P holds a long position, and Client Q holds a short position. 1. Client P (Long Position): A decline in the valuation price results in a mark-to-market loss for a long position. This loss will increase the Additional Margins required for Client P. 2. Client Q (Short Position): A decline in the valuation price results in a mark-to-market gain for a short position. This gain will reduce the Additional Margins required for Client Q. However, because CDP applies margining on a gross basis, the Member firm cannot net Client Q’s gain against Client P’s loss to reduce its overall margin obligation to CDP. The Member must ensure that the margin requirements for both clients are met individually. Since Client P’s position is larger (700 contracts) and is incurring a loss (which increases Additional Margins), and this increase is not offset by Client Q’s gain for the Member’s total obligation, the Member’s overall margin requirement to CDP would generally increase. The Member is responsible for the sum of the individual margin requirements for all its clients on a gross basis.

The Product Highlights Sheet (PHS) is a crucial document for retail investors in Singapore, designed to provide clear and concise information about structured notes. According to CMFAS Module 6A guidelines, the PHS has specific format requirements to ensure readability and ease of understanding. It must not exceed 4 pages, or 8 pages if diagrams and a glossary are included, with the core information remaining within 4 pages. Additionally, the text must be in a font size of at least 10-points Times New Roman. This ensures that the document is manageable in length and legible for investors. The second option is incorrect because the PHS is primarily for retail investors; institutional or accredited investors are explicitly exempted from receiving both the Prospectus and the Product Highlights Sheet. The third option is incorrect as the PHS must not contain any information that is not already present in the Prospectus, ensuring consistency and preventing misleading information. The fourth option is incorrect because while ongoing disclosures and mark-to-market statements are required periodically, and issuers of unlisted debentures must provide semi-annual reports, the PHS itself is not re-issued to note holders on a semi-annual basis to reflect current market valuations. The PHS is a pre-sale document outlining the product’s features and risks at the time of offer.

The participation rate in an Equity-Linked Structured Note (ELSN) is determined by comparing the ‘discount sum’ from the zero-coupon bond component to the premium of the embedded equity call option. The discount sum is the difference between the face value of the zero-coupon bond and its present value. In this scenario, the discount sum is $1,000 (Face Value) – $920 (Present Value) = $80. The call option premium is $90. The participation rate is calculated as (Discount Sum / Call Option Premium) 100%. Therefore, ($80 / $90) 100% = 88.88…%, which is approximately 88.9%. This indicates that the investor receives less than 100% of the upside performance of the underlying equity, as the discount sum was insufficient to purchase enough options for full participation. If the discount sum were exactly equal to the call option premium, the participation rate would be 100%. If the discount sum were greater than the call option premium, the participation rate could exceed 100%. The other options represent incorrect calculations or misunderstandings of how the participation rate is derived.

A Mandatory Call Event (MCE) for a Bull Callable Bull/Bear Contract (CBBC) is triggered when the underlying asset’s spot price touches or falls below the specified call price. In this scenario, the underlying asset’s price declines and touches the call price of $52. When an MCE occurs, the CBBC expires early, and its trading terminates immediately. For an R-Category CBBC, which signifies ‘Residual value’, the call price is different from the strike price, and the holder may receive a small cash payment, known as a residual value, upon the MCE. Therefore, the contract will cease to trade, and the investor might receive a residual payment. The contract does not continue trading once an MCE is triggered, as the call price being touched is the trigger itself. CBBCs are cash-settled derivatives and are not converted into the underlying asset. Issuers do not typically adjust contract terms like the strike price to prevent an MCE.

Structured products are designed to meet specific investor needs, such as principal preservation alongside potential market participation. The syllabus highlights that the principal component of a structured product is typically a fixed income instrument, like a zero-coupon bond. This bond is structured to mature at a value equivalent to the initial investment, thereby protecting the capital. The other options describe different investment strategies or features that do not directly align with the primary mechanism for principal preservation as described for structured products in the syllabus. While derivatives can be used for hedging and issuers might offer guarantees, the fundamental structural element for principal preservation within the product itself, as detailed, is the fixed income component.

The structured fund features an auto-redeemable clause that activates after 1.5 years of inception, and every 6 months thereafter. The condition for this early termination is met if the closing level of any of the underlying indices falls below 75% of its initial level on a specified early redemption observation date. In the given scenario, the EURO STOXX 50 Index is at 70% of its initial level, which is below the 75% threshold. Therefore, the auto-redemption condition is triggered. When this occurs, the product is redeemed, and the investor receives 100% of their initial principal value back, as stated in the product’s terms. The performance of other indices or the overall average is irrelevant for the auto-redemption trigger, as it only requires one index to fall below the threshold. The product’s capital preservation feature ensures the return of 100% principal upon early redemption.

An accumulator agreement with a knock-out barrier is designed such that if the underlying asset’s closing price reaches or exceeds the specified knock-out barrier at any point during the agreement’s tenor, the agreement terminates immediately. In such a scenario, the investor will only acquire the shares that have been accumulated up to the day immediately preceding the knock-out event. This mechanism inherently limits the investor’s potential upside gain, as they are prevented from accumulating the maximum number of shares over the full tenor at the favorable strike price once the barrier is hit. The scenario described, where the price surges above the knock-out barrier, directly triggers this termination clause. Other options are incorrect because: the investor is not obligated to purchase all remaining shares for the full tenor when the knock-out is hit (that would be if the price dropped below the strike and stayed there); the strike price and knock-out barrier are not automatically adjusted upwards to continue the agreement upon hitting the barrier (the agreement terminates); and the investor’s losses are not magnified by buying double the quantity unless it’s a geared accumulator and the price drops below the strike price.

Liquidity risk in CFD trading arises when there are insufficient trades in the market for an underlying asset. As per the syllabus, if there is a lack of liquidity, the CFD provider may decline to fill the investor’s trade or only agree to process it at an inferior price. This can leave an investor with an open CFD position that they are unable to close or can only close at a significant loss. The other options describe different risks or incorrect assumptions: physical delivery is not a feature of CFDs (which are cash-settled), financing costs are separate and not waived due to liquidity issues, and currency risk is distinct from liquidity risk and is not eliminated by the provider in this manner.

An Equity-Linked Structured Note comprises a zero-coupon bond and a call option. The discount sum, which is the difference between the bond’s face value and its present value, is typically used to purchase the embedded call option. The present value of a zero-coupon bond is inversely related to the prevailing interest rate; if interest rates increase, the present value of the bond decreases. Consequently, a lower present value means a larger discount sum (Face Value – Present Value). Since the participation rate is calculated as the discount sum divided by the call premium, a larger discount sum, with a constant call premium, will lead to an increased participation rate. This allows the issuer to purchase more option contracts or provide a higher notional exposure to the underlying asset for the same premium.

Structured products designed to offer a minimum return of principal at maturity commonly achieve this capital preservation by combining a zero-coupon bond with a long-call option strategy. The zero-coupon bond is purchased at a discount and matures at par, ensuring the return of the initial principal. The remaining portion of the investment is then used to purchase a long-call option, which provides the potential for upside participation in the underlying asset’s performance. Conversely, structured products that do not offer a minimum return of principal often employ short options strategies. While Constant Proportion Portfolio Insurance (CPPI) is another strategy that can provide principal protection, it is a framework rather than a specific combination of a zero-coupon bond and a long-call option for the capital preservation component. Investing in high-yield debt instruments or using inverse floating rate notes and credit default swaps are typically related to the return component or other features, not the primary mechanism for guaranteeing principal return.

The financial cost component of a Callable Bull/Bear Contract (CBBC) includes various elements, such as the issuer’s cost of borrowing and adjustments for dividends, assuming the underlying asset is equity-related. According to the guidelines, regular share dividends are typically already factored into the issuer’s funding cost at the time of issuance. Therefore, they do not usually necessitate a separate capital adjustment to the CBBC’s terms (like strike price or conversion ratio) after the CBBC has been issued. In contrast, corporate actions such as bonus issues, rights issues, share splits, reverse share splits, and special or extraordinary dividends generally do require specific adjustments to the CBBC’s terms to reflect the change in the underlying asset’s structure or value.

Index-Linked Notes (ILNs) are debt securities where the coupon payments and/or the principal are linked to the movements of a market index or an asset price. For ILNs designed with principal preservation, a key feature is that the investor’s original capital is protected at maturity. The return mechanism typically involves a comparison: the investor receives either a pre-defined minimum total return or a return based on their participation in the underlying index’s performance, whichever is higher. This structure allows for potential upside linked to the index while providing a safety net for the principal and a minimum return. Options suggesting fixed coupon payments, full principal exposure to market fluctuations, or a simple fixed annual yield do not accurately describe the typical return mechanism of an Index-Linked Note with principal preservation as outlined in the CMFAS 6A syllabus.

To maintain market exposure beyond the immediate expiry month, a long-term investor holding a futures position would typically ‘roll’ their position. This involves simultaneously closing out the expiring contract by selling it (if long) and opening a new position in the next available contract month by buying it. This process ensures continuous market exposure without a break. Allowing the contract to expire would result in cash settlement, ending the current exposure rather than extending it. Submitting separate orders to close and re-open, while achieving a similar outcome, does not describe the standard, simultaneous ‘rolling’ procedure. Futures contracts have fixed expiry dates set by the exchange, and these cannot be deferred by individual investor requests to the exchange’s trading or clearing divisions.

The Factsheet is specifically designed to be a concise document that highlights key information related to a fund. As outlined in the CMFAS Module 6A syllabus, it typically includes the fund’s launch date, investment manager information, key features of the product, asset allocation, performance figures, and the various applicable fees. This makes it the most appropriate document for an investor seeking a quick, high-level summary of these specific details. The Semi-annual Accounts and Reports to Unitholders provide detailed financial statements such as the Statement of Net Assets and Statement of Investments, which are more comprehensive and less of a summary. The Investment Manager Report focuses on the performance of underlying assets, AUM figures, and a performance outlook. The Monthly Performance Report offers detailed performance metrics and risk analysis (e.g., YTD returns, Sharpe Ratio, VaR), which goes beyond a high-level overview of key characteristics.

Contracts for Differences (CFDs) are characterized by financing costs that are explicitly calculated and added for the duration an investor holds a position. Furthermore, investors holding a long position in a CFD are generally entitled to receive dividend adjustments corresponding to the underlying shares. This contrasts with equity futures, where financing costs are typically implicit and embedded in the quoted price, and investors are generally not entitled to receive dividends. Therefore, the statement accurately describing CFDs must reflect both the explicit nature of their financing costs and the entitlement to dividends for long positions.

The Trust Deed is a crucial legal document for a structured fund. It formally establishes the terms and conditions that govern the relationship between the investors, the fund manager, and the trustee. This document explicitly outlines the fund’s investment objectives, as well as the specific obligations and responsibilities of both the fund manager and the independent trustee. The trustee’s role, as defined in the Trust Deed, is to act as the custodian of the fund’s assets and to ensure that the fund is managed in strict accordance with the provisions of the Trust Deed, thereby mitigating the risk of mismanagement by the fund manager. Other documents like the Product Highlights Sheet provide a summary for investors, the annual financial report details past performance, and internal compliance manuals guide the manager’s operations, but none serve the primary legal function of defining the independent oversight and governance structure like the Trust Deed.

The question focuses on the unique suitability of Extended Settlement (ES) contracts for achieving an immediate and near-perfect hedge compared to warrants. The provided text explicitly states that ES contracts offer an ‘Immediate, near 100% hedge (delta = 1.0)’, meaning they directly and fully offset movements in the underlying share price. This characteristic makes them highly effective for investors seeking comprehensive protection against short-term price declines. Option 2 is incorrect because while warrants do involve an initial premium, the question is about the completeness and immediacy of the hedge, not primarily the initial capital outlay. The text highlights that the cost for ES contracts is the cash to maintain margin, which forms part of settlement, whereas warrants involve an initial premium subject to time decay. Option 3 is partially true in that ES contracts do not require selecting a strike price, unlike warrants. However, the core of the question is about the effectiveness of the hedge in terms of offsetting price movements (‘immediate and near-perfect’), which is best described by the delta characteristic, not merely the absence of a strike price. The absence of a strike price contributes to simplicity but not directly to the 100% hedge effectiveness. Option 4 is incorrect. The text states that for warrants, a ‘Synthetic short of long put and short call (delta = 1.0) involved 2 transactions & costs’, implying that achieving a delta of 1.0 with warrants is a more complex, multi-transaction process, whereas ES contracts inherently provide this immediate 1.0 delta. Furthermore, warrants’ hedge effectiveness (delta) generally depends on the strike price and time to expiry, with an at-the-money warrant having a delta of approximately 0.5, not 1.0.

The 5-year Singapore Government Bond futures (SB) are cash-settled. The final settlement price is not a fixed value or solely based on the futures contract’s own trading activity. Instead, it is meticulously derived from a basket of underlying Singapore Government Bonds. Specifically, prices for these bonds are contributed to the Monetary Authority of Singapore (MAS) by Singapore Government Securities Dealers. From these contributed prices, an arithmetic mean of bid and offer prices is calculated for each bond, but only after the three highest and three lowest bids and offers have been discarded to mitigate outliers. These adjusted prices are then converted to yields. A final yield for the entire selected basket is then determined by applying a weighting, where the benchmark bond’s yield receives a 60% weighting, and the remaining weighting is equally distributed among the other bonds in the basket. This final yield is then used in a specific formula to calculate the final settlement price. Therefore, the process involves a weighted average of yields from a selected bond basket, with an initial filtering of extreme bid and offer prices.

The Fund Trustee’s core responsibilities include acting in a fiduciary capacity, being accountable to investors, and ensuring the fund manager adheres to the investment objectives and restrictions specified in the trust deed and prospectus. Crucially, the trustee takes legal ownership of all assets within the Collective Investment Scheme (CIS) and ensures these assets are held independently from the fund management company, thereby protecting the unit holders’ interests. The fund manager is responsible for investment decisions and performance, the administrative agent handles operational tasks, and the external auditor conducts periodic audits, but none of these roles encompass the primary fiduciary oversight and independent legal ownership functions that the trustee performs.

The scenario describes a need for hedging a highly customized and non-standardized commodity exposure for a unique future delivery date. Forward contracts are specifically designed for such situations, as they are private agreements negotiated directly between a buyer and a seller on mutually agreed terms, allowing for customization in terms of underlying asset, quantity, quality, and delivery schedule. Futures contracts, in contrast, are standardized contracts traded on regulated exchanges, which makes them highly liquid and reduces counterparty risk through the clearing house, but also means they cannot be tailored to specific, non-standardized needs. Therefore, a forward contract is the appropriate instrument for customized requirements. Futures contracts do not eliminate counterparty risk for forwards; rather, futures contracts themselves have virtually no counterparty risk due to the clearing house. Forwards typically do not have interim partial settlements or daily mark-to-market procedures, and they are exposed to counterparty risk.

A Credit Linked Note (CLN) is a structured product whose performance is tied to the credit risk of a specific reference entity. When a credit event, such as a default, occurs for the reference entity, the CLN’s settlement terms dictate the investor’s outcome. If the CLN specifies physical settlement, the issuer of the CLN (who is effectively the seller of credit protection via a Credit Default Swap) will deliver a debt obligation (bond) of the now-defaulted reference entity to the CLN investor. Since a defaulted bond’s market value is typically significantly below its par value, the investor holding this bond will likely incur a substantial loss on their initial principal investment. The other options describe outcomes inconsistent with physical settlement in a default scenario: receiving principal in cash (incorrect for physical settlement), receiving a cash difference (describes cash settlement), or continuing coupon payments and full principal return (describes a scenario without a credit event).

When an investor sells a put option, they are taking on an obligation. The buyer of a put option has the right, but not the obligation, to sell the underlying asset at the strike price. Therefore, if the put option buyer chooses to exercise this right, the seller of the put option is obligated to purchase the underlying asset from the buyer at the agreed-upon strike price. This is a fundamental concept of option contracts, distinguishing the seller’s obligation from the buyer’s right. The other options describe the rights of an option buyer or the obligation of a call option seller.