CMFAS RES6A Quiz 67

Modified duration measures a bond’s price sensitivity to changes in interest rates. The approximate percentage change in a bond’s price can be calculated using the formula: Percentage Change in Price = – Modified Duration × Change in Yield to Maturity. In this scenario, the modified duration is 4.5, and the market interest rates (yield to maturity) increase by 50 basis points. Since 100 basis points equal 1%, an increase of 50 basis points is equivalent to an increase of 0.50%. Plugging these values into the formula: Percentage Change in Price = – 4.5 × (+0.50%) = – 2.25%. Therefore, the bond’s price is expected to decrease by approximately 2.25%. The negative sign indicates an inverse relationship between interest rates and bond prices.

To establish a delta-neutral hedge, a trader must offset the existing delta exposure of their options position. In this scenario, the portfolio manager is short 2,000 call options. Each call option has a positive delta, meaning its price moves in the same direction as the underlying asset. Since the manager is short these calls, their overall delta exposure from the options is negative. The total delta of the short call position is calculated as the number of options multiplied by the delta of each option, then made negative because it’s a short position: -2,000 options 0.60 delta/option = -1,200. To achieve a delta-neutral position, the manager needs to add a positive delta of +1,200 to the portfolio. Buying shares of the underlying stock provides a positive delta, with each share having a delta of approximately 1. Therefore, buying 1,200 shares of the underlying stock will create a positive delta of +1,200, which perfectly offsets the -1,200 delta from the short call options, making the overall position delta-neutral.

To calculate the net profit from the CFD short position, we must account for all transaction costs and financing charges. 1. Initial Sale Value (Short): 5,000 shares $4.50 = $22,500 2. Commission on Sale: $22,500 0.35% = $78.75 3. GST on Sale Commission: $78.75 8% = $6.30 4. Total Transaction Cost (Sell): $78.75 + $6.30 = $85.05 5. Closing Purchase Value (Cover): 5,000 shares $4.20 = $21,000 6. Commission on Purchase: $21,000 0.35% = $73.50 7. GST on Purchase Commission: $73.50 8% = $5.88 8. Total Transaction Cost (Buy): $73.50 + $5.88 = $79.38 9. Financing Interest (Cost for Short Position): The annual financing rate is 4% on the opening value of $22,500. For 7 days, calculated on a 360-day year: ($22,500 0.04 / 360) 7 = $2.50 7 = $17.50. 10. Total Expenses: Sum of all transaction costs and financing interest: $85.05 (Sell) + $79.38 (Buy) + $17.50 (Financing) = $181.93. 11. Gross Profit from Price Movement: The profit from the price drop: $22,500 (Sale) – $21,000 (Purchase) = $1,500. 12. Net Profit: Gross Profit – Total Expenses = $1,500 – $181.93 = $1,318.07.

The CMFAS Module 6A syllabus, specifically Chapter 13 on Extended Settlement Contracts, outlines that 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 when calculating a Member’s overall margin requirement. Therefore, if a Member firm holds 500 long contracts for one client and 400 short contracts for another unrelated client, CDP will sum these positions and require margin for the total of 900 open positions. The concept of netting (Option 1) is not applied across different customer accounts for gross margining. Disregarding smaller positions (Option 3) is incorrect. Spread margining (Option 4) applies when a single investor holds both long and short positions in ES contracts of different contract months for the same underlying security, not for positions held by separate, unrelated clients.

The Constant Proportion Portfolio Insurance (CPPI) strategy is a rule-based, non-discretionary trading strategy designed to ensure a fixed minimum return, typically capital preservation, at a set future date. It achieves this by continuously re-balancing the investment portfolio between a performance asset (risky asset) and a safe asset (e.g., cash or bonds) using a predefined mathematical algorithm. The principal is preserved by dynamically adjusting the exposure to the performance assets. This adjustment ensures that the underlying portfolio can absorb a defined decrease in value before its value falls below the level required to achieve the principal preservation target. This mechanism allows investors to participate in rising markets while protecting their capital during downward trends. Other options describe either a static allocation approach, a discretionary management style, or a different type of derivative-based strategy, none of which accurately represent the core operational mechanism of CPPI as described in the syllabus.

To hedge an equity portfolio against market risk using index futures, the number of contracts required is determined by considering the portfolio’s value, its beta relative to the index, the current futures price, and the contract’s multiplier. The formula used is: Number of Contracts = (Portfolio Value / (Futures Price × Multiplier)) × Portfolio Beta. Given: Portfolio Value (VP) = SGD 12,000,000 Portfolio Beta (β) = 1.25 Index Futures Price (F) = 3,200 Futures Contract Multiplier = SGD 50 per index point First, calculate the total value of one futures contract: Futures Price × Multiplier = 3,200 × SGD 50 = SGD 160,000. Next, apply the formula for the number of contracts: Number of Contracts = (SGD 12,000,000 / SGD 160,000) × 1.25 Number of Contracts = 75 × 1.25 Number of Contracts = 93.75 Since futures contracts must be traded in whole numbers, the manager would typically round to the nearest whole contract. In this case, 93.75 rounds up to 94 contracts to ensure adequate hedging coverage. Selling 94 contracts would create a short hedge to offset the long equity position’s market risk. Option 2 (75 contracts) would be the result if the portfolio’s beta was assumed to be 1, neglecting the portfolio’s higher volatility relative to the index. Other options represent plausible miscalculations or incorrect application of the formula.

Arbitrage opportunities arise when there is a temporary pricing discrepancy between two financially equivalent instruments. In this scenario, the market price of the Interest Rate Swap (IRS) is lower than the combined value of its equivalent Eurodollar futures strips. This implies that the IRS is relatively undervalued, while the futures strips are relatively overvalued. To execute an arbitrage, a market participant would simultaneously buy the undervalued instrument (the IRS) and sell the overvalued instrument (the Eurodollar futures strips). This locks in a risk-free profit as the prices are expected to converge. Selling the IRS and buying the futures strips would be the correct action if the IRS market price was higher than the strips. Acquiring or liquidating both instruments simultaneously does not constitute an arbitrage strategy for exploiting this specific type of pricing discrepancy.

The question tests understanding of specific regulatory requirements for UCITS-compliant synthetic ETFs in Europe, particularly concerning counterparty risk. According to the provided text, UCITS regulations stipulate that an ETF is not allowed to invest more than 10% of its prevailing Net Asset Value (NAV) in derivative instruments, including swaps, issued by a single counterparty. This means the marked-to-market value of the swaps with any single counterparty cannot exceed 10% of the fund’s NAV on a daily basis. This directly corresponds to the first option. The other options describe plausible but incorrect or non-specific regulatory or risk management practices that are not the precise UCITS counterparty exposure limit detailed in the syllabus material.

To mitigate potential losses on an existing long CFD position, a Stop-Loss order is the appropriate choice. This order automatically triggers a sale if the price falls to a specified level, helping to limit downside risk. For initiating a new short CFD position when the price falls below a critical support level, a Sell-Stop order is used. A Sell-Stop is a contingent order that becomes a market order to sell once the specified stop price is reached or breached, allowing the investor to enter a short position at a price indicating a potential downward trend. Other order types like Market-to-Limit or Market orders are for immediate execution without the contingent trigger, while a Limit order is for transacting at a specific price or better, not typically for contingent entry based on a price breakdown for a new short position. A Trailing Stop is a type of Stop-Loss, suitable for the first objective, but a Limit order for the second objective does not serve as a contingent entry for a new short position upon a price drop.

The CMFAS Module 6A syllabus highlights that independent oversight functions, such as the appointment of an independent trustee and the engagement of financial auditors, are crucial for structured products. The fundamental purpose of these mechanisms is to provide investors with assurance that their products are managed with due care. An independent trustee is typically appointed to hold the assets and underlying financial instruments, ensuring their security and proper management. Financial auditors are engaged to ascertain that the structured product’s financial statements are true and fair, and to ensure the fair valuation of the product and its underlying components. These roles collectively contribute to the transparency and integrity of the structured product, safeguarding investor interests. Other options describe activities that are either part of product design, market operations, or specific compliance aspects, rather than the overarching independent oversight function of ensuring due care and accurate reporting of the product’s assets and financials.

The trading name of a structured warrant provides key information about its features. According to the standard interpretation, if there is no prefix before the ‘Type of Warrant’ (such as ‘CW’ for Call Warrant or ‘PW’ for Put Warrant), it signifies an American-style warrant. If it were a European-style warrant, it would typically have an ‘e’ prefix (e.g., ‘ePW’). The ‘PW’ notation explicitly indicates that it is a Put Warrant. Therefore, the absence of a prefix and the ‘PW’ notation together signify an American-style Put Warrant. The other options are incorrect because a European-style warrant would have an ‘e’ prefix, and a Call Warrant would be denoted by ‘CW’.

An Inverse Floater Note is characterized by coupon payments that are inversely linked to a floating interest rate index. This means that if the underlying interest rate index rises, the coupon rate paid to the investor will decrease. Conversely, if the index falls, the coupon rate will increase. Therefore, a key risk for an investor holding such a note is that an upward trend in interest rates will lead to reduced coupon payments. The other options describe risks associated with different types of structured notes: principal not being guaranteed is a feature of some daily range accrual equity-linked structures, reinvestment risk is associated with callable notes like the Multi-Callable RAN, and the risk of not accruing coupons due to multiple underlying assets is specific to certain variations of Range Accrual Notes.

The effectiveness of a hedge, and thus its optimal ratio, is influenced by dynamic market factors. The CMFAS Module 6A syllabus material explicitly states that ‘changes in volatilities and yield spread relationships, for instance, may necessitate changing the hedge ratio.’ Volatility refers to the degree of variation of a trading price series over time, and changes in it can alter the risk profile of both the underlying asset and the hedging instrument. Yield spread relationships, particularly relevant for interest rate hedges but also applicable to other asset classes where rates influence pricing, reflect the difference in yields or prices between different financial instruments or maturities. Shifts in these relationships can impact the relative pricing and effectiveness of futures contracts used for hedging. Therefore, monitoring these market conditions is crucial for maintaining an effective hedge. Other factors, such as unexpected changes in dividend payouts, regulatory capital requirements, or the discovery of new contracts, while relevant to overall portfolio strategy or operational considerations, do not directly represent the market conditions that would necessitate an adjustment to the existing hedge ratio itself during its active period, as described in the syllabus for managing the hedge’s effectiveness.

The scenario describes a proprietary trading firm seeking to mitigate risks specifically related to poor liquidity in longer-dated futures contracts, which are noted for higher volatility and difficulty in unwinding during adverse market conditions. A maturity limit is precisely designed to address this concern. It restricts the firm’s exposure to contracts with distant expiry dates, where liquidity is typically lower, thereby reducing the risk of losses from illiquidity. An open contracts limit, while controlling overall position size, does not specifically target the maturity aspect of liquidity risk. A maximum loss limit serves as a reactive measure to cap financial losses once they are incurred, rather than proactively managing the risk of illiquid long-dated contracts. A stress test limit is used to assess the portfolio’s resilience under hypothetical extreme market movements, but it is not a direct mechanism for limiting exposure to specific contract maturities for liquidity management.

For Category R-CBBCs, when a Mandatory Call Event (MCE) occurs for a Bull contract, the Mandatory Call Event Settlement Price for the underlying asset is established with a specific floor. According to the guidelines, this settlement price must be a value not lower than the minimum trading price of the underlying asset observed between the period of the MCE up to the next trading session. This ensures that the residual value calculation considers the lowest point the asset traded at during that critical period as a benchmark. Option 1 is incorrect because it states the price is ‘set at’ the minimum, which is a simplification; the rule specifies ‘not lower than’ the minimum, allowing for a potentially higher settlement price. Option 2 describes the condition for a Bear contract’s MCE settlement price, which uses the maximum trading price as a floor. Option 3 describes how the underlying asset’s price is determined for valuation at maturity, not for an MCE.

When a portfolio manager seeks to hedge the systematic risk of an equity portfolio using futures contracts, the primary objective is to offset potential losses in the portfolio with gains from the futures position. To achieve this, the number of futures contracts must be carefully calculated. The two critical factors for this calculation, as outlined in the CMFAS 6A syllabus, are the portfolio’s beta and its modified portfolio value. Beta measures the portfolio’s sensitivity to market movements, indicating how much the portfolio’s value is expected to change for a given change in the market. The modified portfolio value accounts for the current value of the portfolio adjusted for any specific characteristics relevant to the hedging instrument. Together, these two factors allow the manager to determine the appropriate hedge ratio and thus the number of contracts required to neutralize the portfolio’s market exposure.

The scenario describes a fund manager who plans to acquire shares in the future but is concerned about a potential price increase before funds are available. To mitigate this risk, the manager buys Extended Settlement (ES) contracts. This strategy is known as a long hedge. The primary objective of a long hedge is to lock in a future purchase price for the underlying shares, thereby protecting against an adverse upward price movement. The manager is not aiming to profit from a price decrease, generate short-term trading profits by liquidating the contracts before settlement (though that is possible, it’s not the primary hedging objective described), or primarily postpone transaction charges. The core purpose is price certainty for a future acquisition.

The question describes an investor’s dual objective: seeking consistent periodic income and potential capital growth tied to a specific market benchmark. The ‘consistent periodic income’ aspect directly corresponds to the ‘Degree of Payout Schedule’ component of a structured fund, which allows for fixed or variable coupons distributed at regular intervals. The ‘potential capital growth tied to a specific market benchmark’ relates to two components: firstly, the ‘Degree of Payout Schedule’ again, specifically the participative returns based on the outcome of the underlying asset(s); and secondly, the ‘Choice of the Underlying Asset,’ as the growth is explicitly linked to a ‘specific market benchmark.’ Therefore, the Payout Structure (which encompasses both fixed coupons and participative returns) and the Choice of the Underlying Asset are the two fundamental components most directly tailored to meet these combined requirements. Other components like Maturity and Anticipated View on Market Scenarios, while crucial for the fund’s overall design, do not directly define the mechanism for generating both types of returns in the same way. Fund management fees are an operational cost, not a structural component for defining return generation.

The question asks for the document that provides a detailed account of a structured fund’s assets, liabilities, Net Asset Value (NAV) per share, and a comprehensive list of its investment portfolio. According to the syllabus, the Semi-annual Accounts and Reports to Unit holders are specifically designed to provide this information. These reports include the ‘Statement of Net Assets,’ which details assets, liabilities, and NAV per share, and the ‘Statement of Investments,’ which lists the full investment portfolio. Other options like the Monthly Performance Report, Investment Manager Report, and Factsheet provide different types of information, such as performance figures, fund overview, manager’s commentary, or concise key features, but not the detailed financial statements and full portfolio breakdown found in the semi-annual and annual reports.

When a Constant Proportion Portfolio Insurance (CPPI) strategy’s total portfolio value declines to its pre-defined floor value, the fundamental principle of capital protection is triggered. At this critical point, the entire allocation to the risky asset is liquidated and subsequently re-allocated into the risk-free asset. This action is crucial to ensure that the investor’s principal is preserved, as the floor represents the minimum acceptable value. A direct consequence of this full liquidation is that the portfolio loses its exposure to the risky asset and, therefore, can no longer participate in or benefit from any potential future market appreciation of that asset. Options suggesting an increase in the multiplier, partial liquidation, or maintaining the existing risky allocation contradict the core mechanism of CPPI designed to protect capital once the floor is reached.

The question tests the candidate’s understanding of the specific Last Trading Day conventions for different futures contracts as outlined in the CMFAS Module 6A syllabus. For the 3-month Singapore Dollar Interest Rate Futures, the Last Trading Day is explicitly stated as ‘2 business days preceding the 3rd Wednesday of the expiring contract month’. This matches the condition in the question directly. Other contracts have similar but distinct specifications: the 3-month Euroyen TIBOR Futures specifies ‘2nd Tokyo Financial Exchange (TFX) business day immediately preceding the 3rd Wednesday’, introducing a specific exchange’s business day. The Full-sized 10-year Japanese Government Bond Futures has its Last Trading Day as ‘1 business day preceding the TSE’s 10-year JGB futures last trading day’, which is a different number of days and reference point. The specific Euroyen interest rate futures contract settled based on BBA rates (the first contract described without a specific header) states ‘2 London business day immediately preceding the 3rd Wednesday’, which, while similar in number of days, specifies ‘London business day’ as a qualifier, making it distinct from a general ‘business days’ definition.

The question requires the application of the dividend adjustment formula for equity warrants, as specified in the CMFAS Module 6A syllabus. The adjustment factor is calculated to account for the reduction in the underlying share’s value due to dividend payouts, ensuring the warrant’s terms are fairly adjusted. 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. Given: Last cum-date closing price (P) = S$8.00 Normal Dividend per share (ND) = S$0.15 Special Dividend per share (SD) = S$0.30 Substitute these values into the formula: Adjustment Factor = (8.00 – 0.30 – 0.15) / (8.00 – 0.15) Adjustment Factor = (8.00 – 0.45) / (7.85) Adjustment Factor = 7.55 / 7.85 Adjustment Factor ≈ 0.961783439 Rounding to four decimal places, the adjustment factor is 0.9618.

The adjustment of a warrant’s exercise price following a dividend declaration is crucial to maintain fairness for warrant holders. This adjustment accounts for the reduction in the underlying share price due to the dividend payout. According to the CMFAS 6A guidelines, the Adjustment Factor for dividends is calculated using the formula: (P – SD – ND) / (P – ND). Subsequently, the New Exercise Price is determined by multiplying the Old Exercise Price by this Adjustment Factor. Given the values: Old Exercise Price = $5.00 Last cum-date closing price (P) = $10.00 Special Dividend per Share (SD) = $0.50 Normal Dividend per Share (ND) = $0.20 First, calculate the Adjustment Factor: Adjustment Factor = ($10.00 – $0.50 – $0.20) / ($10.00 – $0.20) Adjustment Factor = ($9.30) / ($9.80) Adjustment Factor ≈ 0.94897959 Next, calculate the New Exercise Price: New Exercise Price = Old Exercise Price × Adjustment Factor New Exercise Price = $5.00 × 0.94897959 New Exercise Price ≈ $4.74489795 Rounding to two decimal places, the new exercise price for the warrant is $4.74. Incorrect options often arise from misapplying the adjustment factor formula. For instance, using only the cum-date closing price (P) in the denominator without subtracting the normal dividend, or incorrectly omitting one of the dividends from the numerator or denominator, would lead to different results. The correct application ensures that the warrant’s value is appropriately adjusted for both normal and special dividends.

The Constant Proportion Portfolio Insurance (CPPI) strategy is designed to maintain a minimum capital floor while providing exposure to a risky asset. However, it has specific vulnerabilities. According to the syllabus, in market situations such as a prolonged period of range-bound prices, after a major deleveraging event, or when there has been a sharp drop in asset prices, there is a higher chance that the portfolio value may drop to its floor value. When this occurs, the strategy mandates that the manager allocates the entire fund into the risk-free asset. Once this allocation to the risk-free asset is complete, the portfolio loses its ability to participate in any subsequent appreciation in the value of the underlying asset, as it is no longer exposed to the risky asset. Therefore, the portfolio will be entirely reallocated to the risk-free asset, precluding future participation in potential appreciation. The other options describe outcomes contrary to the mechanics and risks of CPPI under these specific adverse market conditions.

An Equity Linked Note (ELN) with physical settlement means that if the underlying share price falls below the strike price at maturity, the investor receives the actual shares instead of a cash equivalent. This gives the investor direct ownership of the shares. While this might mean receiving shares worth less than the initial investment at that moment, it also provides the opportunity to hold onto those shares and benefit if their price recovers in the future. In contrast, a cash-settled ELN in the same scenario would provide a cash amount based on the underlying share’s market price at maturity, effectively closing the position and preventing the investor from directly participating in any subsequent share price recovery without making a new investment.

Yield Enhanced Securities, also known as Discount Certificates, have a specific payout structure at maturity. If the underlying asset’s closing price on the expiration or valuation date(s) is at or above the exercise price, the holder receives a cash settlement equal to the exercise price. However, if the closing price is below the exercise price, the holder receives a cash settlement equal to the value of the underlying asset on that expiration or valuation date. The initial reference spot price and the warrant’s issue price are not the settlement amounts in this specific scenario.

CFDs are derivative products that allow investors to speculate on price movements of an underlying asset without owning the asset itself. A key characteristic of equity CFDs is that while a long position holder benefits from certain corporate actions, such as receiving cash dividends and participating in share splits, similar to direct share ownership, they do not possess the voting rights associated with the underlying shares. This is because the investor does not actually own the physical stock, but rather a contract based on its price performance. Therefore, an investor holding a CFD position would be entitled to the financial benefits of corporate actions but would not have a say in shareholder decisions.

For SGX to implement full corporate action adjustments to an Extended Settlement (ES) contract, the crucial condition is that the Book Closure Date of the corporate event affecting the underlying security must occur before the settlement day of the ES contract. This ensures that the corporate action’s impact on ownership is determined prior to the ES contract’s final settlement. While the corporate action needs to be of a type that SGX adjusts for (like share splits or dividends), the timing relative to the ES contract’s settlement is the primary determinant for whether an adjustment will be made. The Last Trading Day (LTD) or ex-date are relevant for the corporate action itself but not the specific condition for ES contract adjustment. Member firms do not apply for these adjustments; SGX makes them automatically if the condition is met.

The question specifically addresses the management of potential losses stemming from sudden shifts in market volatility impacting an options portfolio. Vega is the option Greek that quantifies the sensitivity of an option’s price to changes in the volatility of the underlying asset. Therefore, when aiming to control risk directly related to market volatility, a risk manager would primarily focus on Vega by setting limits based on the maximum tolerable loss for anticipated volatility movements. Delta measures the sensitivity of the option price to changes in the underlying asset’s price, not its volatility. Gamma measures the rate of change of the option’s delta, indicating how much delta will change for a given change in the underlying price. Theta measures the rate at which an option’s value decays over time. While all these Greeks are crucial for comprehensive options risk management, Vega is the direct and most relevant parameter for managing volatility risk.

For Contracts for Differences (CFDs), investors do not own the underlying asset directly. Instead, they trade on the price movement. When a corporate action like a cash dividend occurs, its impact is reflected in the CFD position. For a long CFD position, the investor receives a dividend credit, mirroring the benefit of owning the underlying share. Conversely, for a short CFD position, the investor is effectively borrowing the shares to sell, and therefore must compensate for the dividend paid out by the underlying company. This means the investor’s account will be debited the equivalent dividend amount. The dividend is not disregarded, nor does the investor receive a direct payment from the company’s registrar, as CFDs are cash-settled derivatives.