CMFAS RES6A Quiz 68

To create a synthetic long stock position, an investor combines a long call option with a short put option, both having the same strike price and expiration date. This combination replicates the unlimited profit potential and downside risk associated with directly owning the underlying share. A long call provides upside exposure, while a short put obligates the seller to buy the underlying if the price falls below the strike, effectively mimicking the downside risk of holding the stock. Other combinations create different risk-reward profiles: a short call and long put would create a synthetic short stock position. A long call and long put (straddle/strangle) is a volatility play, and a short call and short put (short straddle/strangle) is also a volatility play, betting on low volatility.

The investor’s objective is to profit from a moderate increase in the stock price while simultaneously capping potential losses. A Bull Call Spread is designed precisely for this scenario. It involves buying an in-the-money (ITM) call option and simultaneously selling a higher strike out-of-the-money (OTM) call option with the same expiration date. This strategy results in a net debit, which represents the maximum potential loss. The upside profit is also limited to the difference between the strike prices minus the initial net debit, aligning with the expectation of a moderate price increase rather than an unlimited one. The strategy of purchasing an out-of-the-money call and an out-of-the-money put describes a Strangle, which is used when an investor anticipates significant volatility (either a sharp rise or fall) but is unsure of the direction, and it does not inherently cap losses in the same way a spread does for a directional view. Selling an in-the-money call and buying a higher strike out-of-the-money call describes a Bear Call Spread, which is a bearish strategy designed to profit from a decline in the underlying asset’s price. Purchasing a single out-of-the-money call option is a bullish strategy with unlimited upside potential, but it does not cap losses; the maximum loss is the premium paid for the call, which could be the entire investment if the stock does not rise above the strike price, and it doesn’t involve the ‘balance’ of limiting both profit and loss as effectively as a spread for a moderate view.

The HSI Daily Range Accrual Note’s terms explicitly state that a knock-out event occurs if the HSI trades at or above the knock-out barrier during the investment period. In the given scenario, the HSI briefly traded at 30,050 points, which is above the knock-out barrier of 30,000 points. Once a knock-out event occurs, the accrual coupon accumulation stops. Therefore, no yield is accrued for that specific day, and the accumulation ceases for the remainder of the note’s tenure. The principal, however, is preserved and will be returned at maturity along with any coupons accrued prior to the knock-out event. The fact that the HSI closed within the range is irrelevant once the knock-out condition has been met intraday. The principal is not reduced, nor is the observation period automatically extended.

The Product Highlights Sheet (PHS) is a vital disclosure document for structured notes offered to retail investors in Singapore. Its primary role is to complement the full Prospectus by presenting key terms and risks in a clear, concise, and easily understandable format. According to the guidelines, there are specific requirements for its length: it should not exceed 4 pages. However, if the document incorporates diagrams and a glossary, its total length may extend to 8 pages, provided that the main textual information, excluding the diagrams and glossary, still fits within 4 pages. The PHS is not intended to replace the Prospectus, nor should it contain information that is not already present in the Prospectus. The requirement to provide a PHS applies to retail investors, while an exemption exists for offerings made to institutional or accredited investors.

A bear put spread is a bearish strategy implemented by buying a higher strike in-the-money (ITM) put option and simultaneously selling a lower strike out-of-the-money (OTM) put option, both with the same underlying asset and expiration date. This strategy results in a net debit (cash outlay) to establish the position. The maximum loss for a bear put spread occurs if the underlying asset’s price rises above the strike price of the long (purchased) put option at expiration. In such a scenario, both put options expire worthless, and the investor’s maximum loss is limited to the initial net debit paid to enter the spread. In this case, the investor paid a net debit of $2.50 per share, which represents their maximum potential loss if the market moves unfavorably (i.e., the stock price rises above the higher strike price). The difference in strike prices ($50 – $45 = $5.00) is relevant for calculating maximum profit, not maximum loss in this specific unfavorable scenario. Vertical spreads, like the bear put spread, inherently have limited risk, so an unlimited loss is not possible.

The CMFAS Module 6A syllabus, specifically Chapter 10, explains that while Reverse Convertibles and Discount Certificates can achieve similar risk-return profiles, their underlying compositions differ. According to the provided material, a Reverse Convertible is constructed from a bond (or note) combined with a short put option. In contrast, a Discount Certificate is built using a long zero-strike call option and a short call option. This distinction in their constituent financial instruments, despite leading to comparable payoff structures, is a key application of the put-call parity theory. The other options incorrectly describe the components or misattribute the primary mechanisms of these structured products.

The question describes a scenario where an investor needs to liquidate a structured product before its intended maturity. Structured products are typically designed for investors willing to hold them until maturity, which often results in a limited or non-existent secondary market for early exit. This lack of marketability, coupled with potential lock-up periods, makes it difficult for an investor to find a buyer if they need to sell prematurely. This specific challenge is known as liquidity risk. While other risks like early termination risk (the consequence of selling at a discount), counterparty risk (default by the issuer), and structure risk (complexity of the product) are relevant to structured products, the primary challenge related to ‘market access’ when an investor needs to ‘exit their position’ is the difficulty in finding a market for the sale, which is liquidity risk.

An arbitrageur aims to profit from temporary price discrepancies between related assets. When the equity index futures price is trading substantially above its fair value, it indicates that the futures contract is overpriced relative to the underlying basket of stocks. To capitalize on this, an arbitrageur would simultaneously buy the relatively undervalued underlying equity portfolio (or a representative basket of its constituent stocks) and sell the relatively overvalued equity index futures contract. This strategy, often referred to as a cash-and-carry arbitrage, aims to lock in a risk-free profit. The actions of the arbitrageur—buying the underlying stocks and selling futures—contribute to bringing the futures price back into alignment with its fair value.

A Mandatory Call Event (MCE) is triggered for a Bull Contract when the underlying asset’s spot price falls to or touches the call price at any time before the expiry date. When an MCE occurs, the Callable Bull/Bear Contract (CBBC) expires early, and its trading terminates immediately. For an R-Category CBBC, the call price is distinct from the strike price (for a Bull Contract, the call price is higher than the strike price), and the holder may receive a small amount of cash payment, referred to as the Residual Value, when the CBBC is called. This characteristic differentiates it from an N-Category CBBC, where the call price is identical to the strike price, and no residual value is paid upon an MCE.

The financial cost component of a Callable Bull/Bear Contract (CBBC) is a crucial element in its pricing. It encompasses several factors from the issuer’s perspective, including their cost of borrowing, any necessary adjustments for dividends if the underlying asset is equity-related, and the issuer’s profit margin. A key characteristic of this cost is its relationship with time to maturity: it is generally higher for CBBCs with longer maturities and progressively declines as the CBBC moves closer to its expiration date. This reflects the decreasing period over which the issuer incurs these funding and structuring costs. Other factors like underlying asset liquidity, demand/supply, or market volatility are considered market factors or hedging costs, distinct from the core financial cost as defined in the context of CBBC pricing.

Exchange-Traded Notes (ETNs) are debt instruments issued by banks and typically have a fixed maturity date, at which point investors receive a payment based on the underlying asset’s performance. In contrast, Exchange-Traded Funds (ETFs) are investment funds that hold a proportional stake in the financial products they track. ETFs do not have a fixed maturity date; they can be bought and sold on an exchange much like stocks, offering continuous trading without a predetermined end date. The other options incorrectly describe or reverse these fundamental structural differences between ETNs and ETFs.

Under direct issuance, the bank itself issues the structured notes, and the debt is reflected on its balance sheet. Consequently, investors are directly exposed to the credit risk of the issuing bank. If the bank faces financial difficulties, the investors’ ability to receive their principal and any returns is dependent on the bank’s solvency. In contrast, when a Special Purpose Vehicle (SPV) issues the structured notes, the SPV is a separate legal entity from the bank that set it up. The SPV’s assets and liabilities are not on the bank’s balance sheet. Therefore, noteholders can only make claims against the assets held by the SPV, and they have no recourse to the bank that established the SPV in the event of a default. This means investors bear the credit risk of the SPV and the assets it holds, rather than the credit risk of the parent bank.

For non-cash corporate actions, such as bonus issues, scrip dividends, or rights issues, CFD investors are typically not automatically entitled to receive the underlying entitlements. CFD providers often have specific policies for these situations. A common practice, as outlined in the syllabus, is for the CFD provider to require investors to close their open CFD positions before the ex-date of such a corporate action. This approach simplifies the management of synthetic positions that do not involve actual ownership of the underlying shares. Crediting the investor’s account with bonus shares or a cash equivalent, or simply adjusting the price without affecting the quantity, are generally not the standard procedures for bonus issues in a CFD account.

The structured fund’s auto-redeemable feature is activated 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 provided scenario, the Eurozone bond index is at 70% of its initial level, which is below the 75% threshold. This single instance is sufficient to trigger the auto-redemption. When the product is auto-redeemed, the investor receives 100% of the principal value, as per the product’s terms. The performance of the other indices or the average performance of the basket components does not override this specific trigger condition.

The correct option accurately distinguishes between a Credit-Linked Note (CLN) and a Bond-Linked Note (BLN) based on their embedded derivatives and primary risk drivers, as described in the CMFAS Module 6A syllabus. A CLN involves the sale of a credit default swap (CDS) linked to a specific reference entity, meaning its payout is contingent on a credit event occurring for that reference entity. In contrast, a BLN embeds a short put option on a particular bond, and its payout is determined by the price performance of that bond. The bond’s price can be influenced by various factors, including credit events, interest rate changes, and market spreads, not just a credit default. Option 2 is incorrect because a CLN exposes the investor to two credit risks: that of the note issuer and that of the reference entity. The ‘first to default’ structure is a specific, higher-risk type of CLN, not a characteristic of a BLN. Option 3 is incorrect. The payout of a CLN is tied to a credit event of the reference entity, not primarily interest rate movements. While interest rates can affect bond prices, a BLN’s payout depends on the bond’s price, which is influenced by more than just a credit downgrade; it can also be affected by widening spreads or volatile interest rates. Option 4 is incorrect. Structured deposits, which include CLNs and BLNs, are generally not covered under the Deposit Insurance Scheme, unlike normal fixed deposits. Principal repayment at maturity is contingent on the deposit-taking bank not defaulting. While BLNs are yield-enhancement products, they do not guarantee a higher-than-market coupon regardless of the underlying bond’s performance; returns are tied to the bond’s price.

The question describes a structured product where an investor can gain exposure to an underlying asset at a discount, with a capped upside potential. Specifically, it states that if the underlying’s closing price at expiration is at or above a set exercise price, a fixed cash settlement equal to that exercise price is received. If the price falls below the exercise price, the settlement is the underlying’s value. These characteristics precisely define a Yield Enhanced Security, often marketed as a ‘Discount Certificate’. This type of warrant sacrifices potential upside exposure in exchange for the ability to purchase the underlying asset at a discount or to receive a guaranteed yield if the price stays above the exercise price. Index Warrants are settled based on an index level, Basket Warrants have a group of shares as their underlying, and Currency Translated Warrants involve different underlying and settlement currencies.

The financial cost associated with Callable Bull/Bear Certificates (CBBCs) is charged upfront at the time of issuance and covers the entire period up to the expiry date. This means that regardless of whether the CBBC is held to maturity or terminated early due to a Mandatory Call Event (MCE), the investor bears the full financial cost. There is no pro-rata refund or adjustment for early termination. Therefore, an investor will lose the full cost of funding even if the CBBC was held for a shorter duration.

The Zero Coupon Fixed Income Plus Option Strategy, often referred to as a ‘capital preservation strategy,’ is designed to return the investor’s principal sum at maturity, provided there is no credit event by the issuing bank. This principal preservation is primarily achieved through the zero-coupon fixed income instrument component of the structured product. A zero-coupon bond is purchased at a discount and matures at its face value, effectively guaranteeing the return of the initial capital if held to maturity and the issuer does not default. The call option component is used to generate potential upside returns based on the performance of an underlying asset, but it does not guarantee the principal itself. The strike price defines the level at which participation in the underlying asset’s performance begins, and the participation rate determines the percentage of that upside the investor receives; neither of these directly ensures principal return. While some products might have external guarantees, the inherent mechanism within the ‘Zero Plus’ strategy for capital preservation is the zero-coupon bond.

The structured fund has an initial call protection period of one year. After this period, early redemption observation dates occur every six months. The initial date was 16 March 2014. The first early redemption observation date was 15 March 2015 (one year after inception). The question states that the mandatory call event was not triggered on this date. The subsequent early redemption observation date would be six months later, on 15 September 2015. On this second observation date, the knock-out condition (performance of Nikkei 225 >= performance of S&P 500) was met, triggering an early redemption. To calculate the payout, we use the formula for early redemption: Payout = Redemption Value x Payout Price. The Redemption Value is 100% of the initial investment, which is SGD 100,000. The Payout Price is calculated as Periodic Yield x No. of Observations. The Periodic Yield is 4.25%. Since the early redemption occurred on the second observation date (15 September 2015), two observation periods have passed (15 March 2015 and 15 September 2015). Therefore, the ‘No. of Observations’ is 2. Payout Price = 4.25% x 2 = 8.50%. The total payout to the investor is the initial investment plus the accumulated yield: Total Payout = SGD 100,000 x (1 + 0.0850) = SGD 100,000 x 1.085 = SGD 108,500.

The provided text explicitly highlights a significant risk of the CPPI strategy in a range-bound market. The asset allocation process involves increasing exposure to the risky asset when its value appreciates and decreasing it when its value declines. In a market that experiences prolonged sideways movement with frequent, moderate fluctuations, this rebalancing can compel the investor to ‘buy high’ (increase risky asset allocation after a rise) and ‘sell low’ (reduce risky asset allocation after a fall), leading to suboptimal performance. This is a direct consequence of the strategy’s design in specific market conditions. The text also mentions that prolonged range-bound trading increases the chance of the portfolio dropping to the floor value, forcing allocation into risk-free assets and foregoing future appreciation. The other options describe scenarios that are either contradicted by the text (e.g., low liquidity, floor value approaching 100% of principal at maturity) or represent different, less direct risks than the primary concern for range-bound markets.

An accumulator with a knock-out barrier is designed to terminate immediately if the underlying share’s closing price reaches or exceeds the specified barrier during the agreement’s tenor. This mechanism limits the investor’s potential gains because they can no longer acquire shares at the strike price, even if the market price remains favorable (above the strike but below the barrier). In the given scenario, the closing price of S$3.25 exceeds the knock-out barrier of S$3.20, triggering the immediate termination of the agreement. Consequently, the investor loses the opportunity to accumulate further shares at the advantageous strike price for the remaining duration.

The coupon for an Inverse Floater Note is determined by the formula: Coupon = Max [X% ― Leverage x Floating Rate Index, Min Coupon]. In this specific scenario, the initial fixed rate component (X%) is 6.0%, the leverage factor is 2, the prevailing Floating Rate Index is 3.0%, and the minimum coupon floor is 0.5%. First, we calculate the leveraged impact of the floating rate index: 2 multiplied by 3.0% equals 6.0%. Next, this amount is subtracted from the initial fixed rate component: 6.0% minus 6.0% results in 0.0%. Finally, we apply the minimum coupon floor. The maximum of 0.0% and 0.5% is 0.5%. Thus, the investor would receive a coupon rate of 0.5% for this period. This demonstrates how the inverse relationship works, where an increase in the floating rate index reduces the coupon, but it is protected by the floor.

The investor has implemented a strategy involving a short sale of the underlying stock combined with buying a call option to hedge against potential price increases. The overall profit or loss for this hedged position is calculated using the formula: Profit = Max(0, ST – X) – ST + S0 – c0, where: S0 = Initial short sale price of the stock X = Strike price of the call option c0 = Premium paid for the call option ST = Share price of the underlying asset at expiration Given the scenario: S0 = $25.00 X = $26.00 c0 = $1.50 ST = $24.00 First, evaluate the call option’s value at expiration. Since ST ($24.00) is less than X ($26.00), the call option expires out-of-the-money and worthless. Therefore, Max(0, ST – X) = Max(0, $24.00 – $26.00) = Max(0, -$2.00) = 0. Now, substitute these values into the profit/loss formula: Profit = 0 – $24.00 + $25.00 – $1.50 Profit = $1.00 – $1.50 Profit = -$0.50 This calculation indicates a net loss of $0.50 per share for the investor. A profit of $1.00 would result if the call option premium was not accounted for. A loss of $1.50 would imply only the premium was lost without considering the profit from the short stock position. A profit of $0.50 would be an incorrect calculation or a sign error.

When an investor’s Customer Asset Value for Extended Settlement (ES) contracts falls below the Required Margins, a margin call is triggered. The investor is then obligated to deposit additional funds or collateral to bring their Customer Asset Value up to at least the sum of their Initial Margins and any Additional Margins. This action must typically be completed within two market days to avoid further restrictions on their account, such as being disallowed from placing new trades (except for risk-reducing trades) or facing forced liquidation of positions. The other options contain inaccuracies regarding the components of the required margin or the stipulated timeframe for meeting the margin call.

Indirect Investment Policy Funds, often referred to as Swap-based Funds, are structured to deliver returns linked to an underlying asset, such as an equity index, without directly holding the constituent securities of that asset. Instead, these funds achieve their investment objective by entering into derivative transactions. A common approach involves using total return swaps, where the fund exchanges the return from a hedging asset (or a predetermined rate) for the total return of the underlying index, encompassing both capital gains and any dividends. This synthetic replication allows the fund to track the performance of the index effectively, consistent with a strategy that avoids direct ownership of the underlying stocks.

The question describes a rolling mechanism used in commodity-linked structured funds. This mechanism aims to maximize profits in backwardation markets (where forward prices are lower than spot prices) by strategically rolling contracts, and to minimize losses in contango markets (where forward prices are higher than spot prices) by similarly optimizing the roll. This dynamic adjustment of roll periods to exploit or mitigate market conditions, rather than adhering to a fixed schedule, is characteristic of an ‘Optimal Yield’ rolling strategy, as detailed in the provided syllabus material regarding formula funds with commodity indices. A fixed-period rolling mechanism would not adapt to market conditions, while investing in physical commodities or simply extending maturities are different strategies altogether.

In a Constant Proportion Portfolio Insurance (CPPI) strategy, the floor value represents a minimum threshold for the portfolio’s value. If the total portfolio value declines to this floor, the strategy’s core mechanism dictates that the entire risky asset allocation must be liquidated. This action is taken to protect the remaining capital, which is then re-allocated into risk-free assets. The consequence is that the investor will no longer participate in any potential upside market movements of the risky asset, effectively locking in the principal sum at maturity. The multiplier is a fixed parameter and is not automatically recalibrated in this scenario. Selling risk-free assets to buy more risky assets would contradict the capital protection objective of CPPI. The strategy does not typically enter a suspension phase requiring investor consent upon hitting the floor; rather, it executes predefined rebalancing rules.

In a First-to-Default Credit Linked Note (CLN), the note holder effectively sells credit protection for a basket of underlying reference entities. The defining characteristic of this structure is that the credit protection is ‘first-to-default’. This means that if any single entity within the referenced basket experiences a credit event and defaults, the note holder is exposed to a loss of principal up to the specified protection amount. Furthermore, upon this first default, the credit protection provided by the note for all other remaining entities in the basket immediately terminates. The note does not continue to provide protection for the non-defaulted entities, nor does the principal remain intact or convert into equity. The enhanced yield received by the investor is compensation for taking on this specific credit risk, not a payout after a default.

An Equity Linked Exchange Traded Fund (ETF) is designed to be traded on an exchange, allowing investors to buy and sell units throughout the trading day. This provides a direct and readily available mechanism for liquidation, offering high liquidity under normal market conditions. In contrast, early redemption for Equity Linked Structured Notes and Structured Funds is often conditional, depending on specific structural features like barrier options or callability, meaning it may not always be at the investor’s discretion or as immediate. An Equity Linked Investment-Linked Policy (ILP) can be surrendered, but this process is governed by policy terms and frequently involves penalties, particularly if surrendered early, which reduces the net proceeds and makes it a less straightforward exit compared to selling an ETF.

To determine if a Knock-Out Event has occurred, we must check if any individual index’s observed level falls below 75% of its initial level. We calculate the 75% threshold for each index: – For Index P: 75% of 1200 = 900. The observed level is 910, which is above 900. – For Index Q: 75% of 800 = 600. The observed level is 590, which is below 600. – For Index R: 75% of 2500 = 1875. The observed level is 1900, which is above 1875. – For Index S: 75% of 180 = 135. The observed level is 145, which is above 135. Since Index Q’s observed level (590) is below its 75% threshold (600), a Knock-Out Event has indeed occurred. The condition for a Knock-Out Event is met if any index falls below its threshold, not necessarily all or a majority. The overall fund performance or weighted average return is relevant for calculating maturity payouts, not for determining a Knock-Out Event.