CMFAS RES6A Quiz 70

When a client indicates that margins for an Extended Settlement (ES) contract will be received after the T+2 period, the regulatory framework imposes specific restrictions on their trading activities. This is a critical measure to manage and mitigate potential risks for both the client and the Member. In such a scenario, the client is only permitted to engage in activities that reduce their existing risk exposure in the ES contract. This means that trades which would increase the client’s risk, or even those considered risk-neutral (maintaining the current risk level), are prohibited. The intent is to prevent the client from accumulating further risk when their margin commitment is delayed beyond the standard settlement period, thereby protecting market integrity and ensuring prudent risk management. Therefore, only actions that actively decrease the client’s outstanding obligations or exposure are allowed.

The question asks for a strategy to ensure a minimum return of principal at maturity, specifically excluding the use of options. The syllabus material explicitly states that a Constant Proportion Portfolio Insurance (CPPI) strategy can be employed for structured products aiming for a minimum return of principal, and critically, that no options are involved in this approach. Therefore, implementing a CPPI strategy directly addresses the conditions outlined in the question. Other options are incorrect because a short options strategy is typically used when there is no minimum return of principal and inherently involves options. Investing solely in high-yield junk bonds is a method for potentially achieving higher fixed returns in the return component, but it does not guarantee principal preservation and introduces significant credit risk. A first-to-default redemption feature is a type of maturity characteristic related to credit events, not a strategy for ensuring minimum principal return without options.

The Singapore Exchange (SGX) specifications for futures contracts explicitly state that there shall be no price limits on the last trading day of the expiring contract month. This provision allows for unrestricted price discovery as the contract approaches its final settlement. Therefore, even with a significant price movement like an 18% surge, trading would continue without any halts or limits. The daily price limit of 15% and the subsequent 10-minute cooling-off period are applicable on other trading days, but they are waived on the last trading day to facilitate final market adjustments. Suspending the contract or re-establishing limits would contradict this specific rule for the last trading day.

The Interest Rate Parity (IRP) theory states that the forward exchange rate should reflect the interest rate differential between two currencies. The formula for the forward rate (F) is F = S x [1 + Rc(n/360)] / [1 + Rb(n/360)], where S is the spot rate, Rc is the counter currency interest rate, Rb is the base currency interest rate, and n is the number of days. In this scenario, the spot rate (S) for USD/SGD is 1.3500. The base currency is USD, with an interest rate (Rb) of 1.5% (0.015). The counter currency is SGD, with an interest rate (Rc) of 2.5% (0.025). The period (n) is 90 days. Calculating the theoretical forward rate (F_IRP): F_IRP = 1.3500 x [1 + 0.025(90/360)] / [1 + 0.015(90/360)] F_IRP = 1.3500 x [1 + 0.025 0.25] / [1 + 0.015 0.25] F_IRP = 1.3500 x [1 + 0.00625] / [1 + 0.00375] F_IRP = 1.3500 x 1.00625 / 1.00375 F_IRP = 1.3500 x 1.00249068 F_IRP ≈ 1.3534 The market is currently trading the 90-day USD/SGD currency futures contract at 1.3400. Comparing this to the theoretical rate, the market futures rate (1.3400) is lower than the rate predicted by IRP (1.3534). This indicates that the futures contract is undervalued in the market. According to the Interest Rate Parity theory, if the relationship is violated, arbitrageurs will act to exploit the risk-free profit opportunity. To profit from an undervalued futures contract, arbitrageurs would buy the futures contract. This buying pressure in the futures market would then drive the futures price upwards until it aligns with the theoretical rate, eliminating the arbitrage opportunity. Therefore, the most likely market reaction is that arbitrageurs would buy the USD/SGD futures contract, causing its price to rise.

A long butterfly options spread, whether constructed with calls or puts, is a neutral strategy designed for situations where the investor expects the underlying asset’s price to remain relatively stable and not move significantly in either direction by expiration. The maximum profit for this strategy is achieved when the underlying asset’s price at expiration is exactly at the middle strike price (the strike price of the two short options). This is because at this point, the options are optimally positioned to generate the highest net credit or lowest net debit, resulting in the maximum gain. The strategy also features limited risk, meaning the maximum potential loss is capped at the initial net debit paid to enter the trade. It does not offer unlimited profit potential, nor does it expose the investor to unlimited losses. Therefore, it is not suitable for investors anticipating strong directional movements.

To achieve the first objective of acquiring CFDs only if the price drops to $12.50 or below, a Limit Order is the appropriate choice. A buy limit order ensures execution at the specified limit price or a lower, more favorable price. For the second objective, which is to automatically initiate a purchase if the price rises above $13.20 to capture upward momentum, a Buy-Stop Entry order is suitable. This type of contingent order becomes active and triggers a buy once the market price reaches or surpasses the specified stop price, allowing the investor to enter the market on a breakout.

The question requires the application of the formula for hedging equity risks using futures contracts, which is a key concept in the CMFAS Module 6A syllabus under Appendix D – Formulae Sheet. The objective is to achieve a delta-neutral hedge, meaning to eliminate the systemic market risk (beta risk) of the portfolio. The formula to calculate the number of futures contracts (N) needed is: N = (VP β) / (F T), where VP is the current value of the portfolio, β is the portfolio’s beta, F is the current futures quote, and T is the value per tick or contract multiplier. Given values: Portfolio Value (VP) = S$15,000,000 Portfolio Beta (β) = 1.2 Current Futures Quote (F) = 3,000 points Multiplier per index point (T) = S$50 First, calculate the total value of one futures contract: Value of one futures contract = F T = 3,000 points S$50/point = S$150,000 Next, substitute the values into the formula for the number of contracts: N = (S$15,000,000 1.2) / S$150,000 N = S$18,000,000 / S$150,000 N = 120 contracts Since the manager holds a long equity portfolio and aims to mitigate market risk, they should sell futures contracts. Therefore, 120 futures contracts need to be sold.

Arbitrage opportunities between Interest Rate Swaps (IRS) and Eurodollar futures strips arise when there is a temporary discrepancy between their prices. If the market price of the IRS is significantly higher than the implied rate from the futures strip, it indicates that the IRS is relatively overvalued and the futures strip is relatively undervalued. To profit from this, an arbitrageur would simultaneously sell the overvalued instrument (the IRS) and buy the undervalued instrument (the strip of Eurodollar futures contracts). This locks in a risk-free profit, as the arbitrageur benefits from the convergence of these prices. Buying the IRS and selling the futures strip would be the correct action if the IRS was undervalued relative to the strip. Holding existing positions or initiating speculative positions do not constitute arbitrage, which is characterized by exploiting simultaneous price discrepancies for a risk-free profit.

The question explores how an investor’s market outlook and risk appetite directly influence the structural design of a structured fund, particularly concerning the balance between capital protection and growth potential. The ‘Anticipated View on Market Scenarios’ component is fundamental here. An investor’s perspective on market direction (e.g., bullish, bearish, or neutral) coupled with their risk tolerance (e.g., a strong desire for capital preservation) is the primary determinant for how the fund’s assets are strategically allocated. For instance, a desire for partial capital protection, as described in the scenario, would lead to a significant allocation to fixed-income instruments, while the desire for upside participation would necessitate an allocation to derivatives linked to a specific index. The other components, such as the specific ‘Choice of the Underlying Asset’, define the actual instruments or indices used; the ‘Degree of Payout Schedule’ determines how returns are distributed (e.g., fixed coupons or participative returns); and the ‘Choice of Maturity’ sets the fund’s duration. While all are crucial elements, it is the ‘Anticipated View on Market Scenarios’ that dictates the strategic blend of these elements to align with the investor’s overarching objectives and risk profile.

MAS guidelines for the Product Highlights Sheet (PHS) specify that the text should be in a font size of at least 10-points Times New Roman. Therefore, using a 9-point font size for the main text constitutes non-compliance. The other options describe compliant practices: a PHS can be up to 8 pages if it includes diagrams and a glossary, provided the core information does not exceed 4 pages. Emphasizing the risk of total principal loss with bold or italicised formatting is a mandatory requirement. Including a glossary to explain unavoidable technical terms is also permitted and encouraged by the guidelines.

The final settlement price for the 5-year Singapore Government Bond Futures is determined using a selected basket of Singapore Government Bonds. The eligibility criteria for bonds to be included in this basket are clearly defined. Specifically, a bond must have a minimum issuance size of SGD 1 billion and its term-to-maturity must fall within the range of 3 to 6 years, as assessed on the first calendar day of the contract month. The other options present incorrect or irrelevant criteria for inclusion in this specific bond basket.

The scenario describes a portfolio manager seeking to simultaneously acquire an equally weighted position across four consecutive quarterly Eurodollar futures contracts, aiming to manage yield curve exposure and minimize partial fills. According to the CMFAS Module 6A syllabus, a futures pack is specifically defined as a type of futures order enabling the purchase or sale of a predefined number of futures contracts in four consecutive delivery months, often equally weighted, and executed in a single transaction to eliminate the inconvenience of partial fills. This directly matches the requirements outlined in the question. A futures bundle, while similar, involves a series of contracts for two or more years, not just four consecutive months. Calendar spreads and inter-commodity spreads are general futures strategies but do not specifically refer to the predefined, single-transaction instrument for four consecutive months as described for a pack.

The Index-Linked Note (ILN) described includes a 100% principal preservation feature, meaning the investor will at least get their initial capital back. Additionally, it offers a return on the principal that is determined by the ‘greater of’ two conditions: a specified minimum total return or the participation in the underlying index’s average performance. In this scenario, the minimum total return over the term is 28%, while the actual average performance of the index resulted in a 22% gain. Since the note pays the ‘greater of’ these two figures, the investor will receive the 28% minimum total return on their principal, in addition to the preserved principal.

When an investor buys a put option, they have the right, but not the obligation, to sell the underlying asset at the exercise price. The option will only be exercised if the underlying asset’s price at expiration is below the exercise price, as this would result in a positive intrinsic value. In this scenario: Exercise Price (X) = $70 Option Premium = $5 Underlying Stock Price at Expiration (ST) = $60 1. Determine if the option is in-the-money at expiration: Since the underlying stock price ($60) is below the exercise price ($70), the option is in-the-money and will be exercised. 2. Calculate the payoff from exercising the option: The payoff is the difference between the exercise price and the underlying stock price: $70 – $60 = $10. 3. Calculate the net profit or loss: The net profit or loss is the payoff minus the premium paid for the option: $10 (payoff) – $5 (premium) = $5. Therefore, the investor realizes a net profit of $5 on this put option contract. The maximum loss for a put option buyer is always the premium paid, which would occur if the option expired out-of-the-money (i.e., if the stock price was at or above $70 at expiration).

A Range Accrual Note (RAN) is structured such that the investor receives interest only when a specified reference index (e.g., an interest rate benchmark) trades within an agreed-upon range. If the reference index moves outside this range, the interest accrual is either reduced or stops entirely. A key feature of the RANs described in the CMFAS Module 6A syllabus is that they typically offer principal preservation. This means that even if the interest payout is negatively affected by the index trading outside the range, the investor’s initial capital is returned at maturity. Therefore, the most probable consequence of the benchmark consistently trading outside the range is a reduction or cessation of interest earnings, with the principal remaining protected.

The Capital Protected Portfolio Insurance (CPPI) strategy requires periodic rebalancing to maintain the desired exposure to risky assets while protecting a capital floor. The allocation to risky assets is determined by multiplying a predefined multiplier by the ‘cushion’, which is the difference between the current portfolio value and the capital floor. In this scenario: 1. Initial State: Total Portfolio Value: $100 Floor: $86 Multiplier: 5 Initial Risky Asset: $70 Initial Risk-Free Asset: $30 2. After Market Movement (Before Rebalancing): New Total Portfolio Value: $105 Risky Asset component: $75 Risk-Free Asset component: $30 3. Calculate the New Cushion: Cushion = New Total Portfolio Value – Floor Cushion = $105 – $86 = $19 4. Calculate the Target Risky Asset Allocation: Target Risky Asset Allocation = Multiplier × Cushion Target Risky Asset Allocation = 5 × $19 = $95 5. Calculate the Target Risk-Free Asset Allocation: Target Risk-Free Asset Allocation = New Total Portfolio Value – Target Risky Asset Allocation Target Risk-Free Asset Allocation = $105 – $95 = $10 6. Determine the Rebalancing Action: Current Risky Asset: $75 Target Risky Asset: $95 Change in Risky Asset: $95 – $75 = +$20 (Need to buy $20 more risky assets) Current Risk-Free Asset: $30 Target Risk-Free Asset: $10 Change in Risk-Free Asset: $10 – $30 = -$20 (Need to sell $20 from risk-free assets) Therefore, the portfolio manager should sell $20 from the risk-free asset and use these proceeds to purchase $20 worth of the risky asset.

When the market-quoted fixed rate for an Interest Rate Swap (IRS) is lower than the fixed rate implied by a strip of Eurodollar futures contracts, it indicates that the IRS is relatively undervalued compared to the futures market. To execute an arbitrage strategy, one must buy the relatively cheap instrument and sell the relatively expensive one. In this scenario, the arbitrageur would enter the IRS as a fixed-rate receiver (effectively ‘buying’ the fixed rate) because it is cheaper. Simultaneously, they would sell the Eurodollar futures strip, which is relatively more expensive, to lock in the higher implied rate. This combination allows the arbitrageur to profit from the pricing discrepancy without taking significant market risk.

The Capital Protected Pure Investment (CPPI) strategy dictates that the allocation to the risky asset component is determined by multiplying a fixed multiplier by the cushion value. The cushion value itself is calculated as the difference between the total portfolio value and the floor value. Therefore, if the total portfolio value declines, even if it remains above the floor, the cushion value will necessarily decrease. With a constant multiplier, a smaller cushion value directly results in a reduced allocation to the risky asset during the subsequent rebalancing. This mechanism is designed to protect the principal by reducing exposure to risk as the portfolio value approaches the floor.

A cash-and-carry arbitrage strategy is executed when an investor identifies that the futures price is sufficiently higher than the spot price, factoring in the cost of carry, to generate a risk-free profit. The core steps involve borrowing money to finance the purchase of the underlying asset in the spot market. Simultaneously, the investor sells a futures contract for that same asset. At the futures contract’s maturity, the investor delivers the purchased underlying commodity against the sold futures contract. The proceeds from the futures sale are then used to repay the initial loan, with any remaining amount representing the arbitrage profit. This sequence ensures that the investor locks in a profit by exploiting the temporary mispricing between the spot and futures markets.

The investor’s market view is that the share price will remain relatively stable, experiencing minimal fluctuation. Additionally, they wish to cap both their potential gains and losses. A long butterfly spread, whether constructed with calls or puts, is a neutral market strategy designed for situations where the investor expects the underlying asset’s price to stay within a narrow range until expiration. This strategy inherently features both limited profit potential and limited risk, aligning perfectly with the investor’s stated objectives of capping both gains and losses. In contrast, a short straddle profits from stability but exposes the investor to unlimited risk if the price moves significantly in either direction, which contradicts the desire to cap losses. A long strangle is a volatility strategy, meaning it profits from large price movements, which is the opposite of anticipating minimal fluctuation. A bull call spread is a directional strategy, designed to profit from a moderate upward movement in the underlying asset, not from price stability.

Futures contracts offer several advantages for portfolio managers seeking to adjust asset allocation efficiently and economically. As highlighted in the CMFAS Module 6A syllabus, these benefits include lower brokerage costs compared to trading underlying cash securities. Additionally, the futures market is generally more liquid, meaning large transactions have less impact on market prices, which is crucial for rebalancing large portfolios without causing significant price movements. The use of margining also means a smaller initial cash outlay is required, and transactions can be completed more quickly as they are traded against the exchange as a counterparty. Therefore, the combination of lower costs and reduced market impact due to liquidity makes futures a preferred instrument for rapid portfolio adjustments. Other options are incorrect because futures typically involve smaller cash outlays due to margin, not larger ones. Index futures are often cash-settled, and even when physically settled, the primary advantage for rebalancing is not the physical delivery itself but the efficiency of exposure adjustment. Furthermore, futures provide significant flexibility for both long-term strategic and short-term tactical adjustments, contrary to the idea of limited flexibility.

Contracts for Differences (CFDs) are derivative instruments that enable investors to speculate on the price movements of an underlying asset without taking direct ownership. While a CFD investor holding a long position gains exposure to the asset’s price performance and typically receives cash dividends and participates in corporate actions like share splits, they do not hold the actual shares. Therefore, a key distinction is that CFD investors are not considered legal shareholders of the underlying company and consequently do not possess the right to exercise voting rights at the company’s general meetings. The other listed options represent benefits or exposures that a CFD investor with a long position would generally experience, mimicking many aspects of direct share ownership except for the legal ownership and associated voting rights.

The fair value of an equity index futures contract is typically expected to be positive, meaning the futures price is higher than the spot price of the underlying index. This phenomenon, known as a positive basis, primarily arises because, under normal market conditions, the cost incurred to finance the purchase and holding of the constituent stocks in the underlying index (financing costs) generally outweighs the dividend income received from those stocks. This net cost of carry is reflected in the futures price, making it higher than the current spot price. Other options describe market sentiment, specific index characteristics, or operational aspects that do not represent the fundamental reason for the typical positive basis as explained by the cost-of-carry model.

The question requires the application of the dividend adjustment formula for warrants, as specified in the CMFAS Module 6A syllabus. The formula for the adjustment factor 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 values: Old Exercise Price = $4.50 P (last cum-date closing price) = $5.00 SD (Special Dividend) = $0.20 ND (Normal Dividend) = $0.10 First, calculate the Adjustment Factor: Adjustment Factor = (P – SD – ND) / (P – ND) Adjustment Factor = ($5.00 – $0.20 – $0.10) / ($5.00 – $0.10) Adjustment Factor = ($4.70) / ($4.90) Adjustment Factor ≈ 0.95918367 Next, calculate the New Exercise Price: New Exercise Price = Old Exercise Price × Adjustment Factor New Exercise Price = $4.50 × 0.95918367 New Exercise Price ≈ $4.3163265 Rounding to two decimal places, the adjusted exercise price is $4.32.

When an investor writes a naked call option, they sell a call option without owning the underlying asset. If the price of the underlying asset rises significantly above the strike price, the option holder will exercise the option. The writer is then obligated to deliver the underlying asset. Since they do not own it, they must purchase it from the open market at the current, higher price. As there is theoretically no upper limit to how high an asset’s price can go, the potential financial loss for the naked call writer is unlimited. The premium received from selling the option is typically small and does not significantly mitigate this risk in a rapidly rising market.

For an investor anticipating a modest upward movement in the underlying share price and seeking to amplify gains through a call warrant, the optimal strategy involves selecting a warrant that balances leverage with sensitivity to price changes. A call warrant with a delta around 0.5 is typically at-the-money or slightly in-the-money. According to the syllabus, investors expecting a small move in the underlying asset price should buy warrants which are at-the-money or slightly in-the-money. This type of warrant offers a good balance, as its price will change significantly with a moderate move in the underlying asset, providing the desired amplification through gearing without requiring a very large underlying price movement to become profitable. While a high gearing ratio might seem appealing, if the warrant is deeply out-of-the-money (very low delta), its effective gearing for a modest price change would be low, as the warrant price would not react substantially to the underlying’s movement. Conversely, a delta approaching 1 indicates a deeply in-the-money warrant, which moves almost one-for-one with the underlying, thereby reducing the leverage effect that the investor seeks to amplify gains. Lastly, call warrants inherently have positive deltas, meaning their price moves in the same direction as the underlying asset. A negative delta is characteristic of put warrants, which profit from a decline in the underlying asset’s price, and is therefore incorrect for a call warrant strategy aiming to benefit from an upward movement.

A Credit Linked Note (CLN) is a structured product where the investor’s return is linked to the creditworthiness of a reference entity. In the event of a credit default by the reference entity, the CLN’s terms dictate how the settlement occurs. If the CLN specifies physical settlement, the CLN investor will receive the defaulted debt obligation (e.g., a bond) of the reference entity. This bond will likely be trading at a substantial discount to its par value due to the default, resulting in a loss for the investor. The investor then has the choice to hold this defaulted bond or sell it in the market at its prevailing, reduced value. Receiving the full principal amount in cash from the issuer is not the outcome for physical settlement; the issuer uses the collateral to fulfill its obligation to the CDS buyer, and the CLN investor receives the defaulted asset. A cash payment representing the difference between par and market value is characteristic of cash settlement, not physical settlement. While a credit default does lead to a loss and early termination of the CLN, the investor does not simply forfeit the entire principal without any recovery; they receive the defaulted asset.

The question describes an investor’s objective to replicate the profit and loss characteristics of a long put option by combining a short position in the underlying equity with a specific option contract. According to the CMFAS Module 6A syllabus, a synthetic long put is precisely constructed by taking a short position in the underlying asset and simultaneously acquiring a long call option. This combination effectively mimics the payoff profile of directly owning a put option, providing potential gains as the underlying asset’s price declines. The other options describe different synthetic positions with distinct construction methods and corresponding payoff profiles. A synthetic short stock is formed by shorting at-the-money calls and buying an equal number of at-the-money puts. A synthetic long call is created by holding a long position in the underlying asset and a long put. A synthetic short put is established by holding a long position in the underlying asset and selling a call option.

A synthetic long stock position is constructed by acquiring a call option and simultaneously writing (selling) a put option on the same underlying asset, provided both options share the same strike price and expiration date. This combination replicates the profit and loss profile of directly owning the underlying stock, offering unlimited profit potential if the stock price rises and significant downside risk if it falls. The other options represent different strategies: selling a call and buying a put creates a synthetic short stock position; buying both a call and a put creates a long straddle, which profits from large price movements in either direction; and selling both a call and a put creates a short straddle, which profits from the underlying asset remaining stable.

The fund trustee’s primary role is to act in a fiduciary capacity, safeguarding the interests of the unit holders. This includes ensuring that the fund manager operates the Collective Investment Scheme (CIS) strictly in accordance with the investment objectives and restrictions stipulated in the trust deed and prospectus. If the trustee becomes aware of any breaches of these guidelines by the fund manager, it is a critical responsibility to inform the Monetary Authority of Singapore (MAS) within three business days. Other options describe actions that are either incorrect responsibilities for the trustee, or are secondary actions that might occur after the primary regulatory reporting obligation has been met.