CMFAS RES6A Quiz 50

The question describes key characteristics of a structured fund. Structured funds are designed to replicate an underlying asset or provide a synthetic return linked to it, primarily by incorporating derivatives. This approach allows for achieving various anticipated market views, including capital preservation or enhanced participation, and often involves a static or rule-based allocation. Crucially, structured funds expose investors to a wider variety of risks, such as credit or counterparty risk, which are more prevalent due to the use of derivatives and additional counterparties. A traditional mutual fund, in contrast, typically relies on a manager’s expertise for active allocation and invests directly in underlying assets without using derivatives. An index tracker fund is passively managed and aims simply to replicate the performance of a chosen benchmark, without the complex derivative strategies for specific market views or capital preservation described. An umbrella fund refers to a single legal entity comprising several distinct sub-funds, which is a structural arrangement rather than a description of the investment strategy itself.

When a corporate treasury department anticipates receiving funds for a future short-term deposit and expects interest rates to decline before the deposit date, they face the risk of earning a lower yield than currently available. To hedge against this risk and effectively lock in a yield closer to the current market rate, the treasurer needs a strategy that generates a profit if interest rates indeed fall. Eurodollar futures prices move inversely to interest rates; specifically, the futures price is calculated as 100 minus the implied LIBOR rate. Therefore, if interest rates decline, the implied LIBOR rate falls, causing the Eurodollar futures price to rise. By buying Eurodollar futures contracts today, the treasurer can profit from this expected price increase. This profit from the futures position will then offset the lower interest income earned on the actual deposit when the funds are eventually placed, thereby achieving the objective of locking in a yield.

The ‘Optimal Yield’ rolling methodology is a dynamic strategy employed by commodity index funds to manage the transition of expiring futures contracts. In a contango market, forward prices are higher than spot prices, leading to an upward-sloping price curve. When futures contracts are rolled over in such a market, it typically results in a loss for the fund. Therefore, the core aim of the ‘Optimal Yield’ strategy during a contango market is to minimize these rolling losses, effectively mitigating the negative impact on the fund’s performance. This contrasts with a backwardation market, where the strategy seeks to maximize rolling profits. The approach specifically avoids fixed roll periods to adapt to market conditions.

A Credit Linked Note (CLN) is a structured product where the investor takes on the credit risk of a ‘reference entity’. In return for taking on this risk, the investor typically receives an enhanced coupon. A key feature of CLNs is the settlement mechanism in the event of a credit default by the reference entity. When the CLN’s terms specify ‘physical settlement’, it means that upon a credit event (such as failure to pay interest or repay principal at maturity), the CLN issuer (who is effectively the seller of credit insurance via a Credit Default Swap) will use the investor’s principal to acquire the defaulted debt obligation of the reference entity. This defaulted debt is then passed on to the CLN investor. The investor then holds the defaulted bond, which is likely trading at a substantial discount to its par value, leading to a loss of principal. The option stating that the investor receives the defaulted bonds of Apex Innovations Inc. directly reflects this physical settlement process. The option describing a cash payment based on the difference between par and market price refers to ‘cash settlement’, which is a different mode of settlement. The idea of principal preservation is incorrect, as CLNs expose investors to the credit risk of the reference entity, and principal can be lost. Conversion to equity shares is not a feature of CLNs upon a credit event.

The Capital Markets and Financial Advisory Services (CMFAS) Module 6A syllabus, specifically Chapter 13 on Extended Settlement Contracts, outlines the principles for Additional Margins and Margining on Gross Basis. Additional Margins are computed daily based on mark-to-market gains and losses, where a loss increases the margin requirement and a gain reduces it for a specific position. Crucially, 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, even though Client X experiences a loss (increasing their Additional Margin) and Client Y experiences a gain (reducing their Additional Margin), these are treated as separate components for Global Securities’ overall obligation to CDP. CDP will require the Member to cover the Additional Margin arising from Client X’s loss, and Client Y’s gain will reduce Client Y’s individual Additional Margin, but it will not be directly offset against Client X’s loss at the Member’s aggregate level for CDP’s calculation. Options suggesting netting of losses and gains across different customers, or netting of positions, are incorrect as they contradict the gross margining principle. Disregarding mark-to-market for Additional Margin is also incorrect, as Additional Margins are specifically derived from these daily valuations.

An Equity-Linked Structured Note (ELSN) typically comprises a zero-coupon bond and an equity call option. The zero-coupon bond is acquired at a discount to its face value, and the difference between the face value and its present value (known as the ‘discount sum’) is allocated to purchase the equity call option. The present value of a zero-coupon bond is inversely correlated with the discount rate; a higher discount rate leads to a lower present value. Therefore, if the discount rate increases, the present value of the bond decreases, which in turn results in a larger discount sum. With a greater discount sum available to purchase the call option (assuming the call option premium remains constant), the product issuer can acquire more option contracts, thereby enhancing the investor’s potential participation rate in the underlying equity performance.

When a structured warrant issuer commits to making a market for its warrants on SGX-ST, a key regulatory incentive is the reduction in the minimum issue size requirement. This is explicitly stated in the listing requirements, where the minimum issue size is reduced from SGD 5 million to SGD 2 million for issuers who commit to market-making. This commitment also exempts them from the minimum placement and holder size requirements applicable to listed equity securities. The listing document, however, remains a mandatory requirement and must detail the terms and conditions, including the maximum spread and minimum lot size for the market-maker. Warrant holders’ rights regarding settlement type are determined by the warrant’s terms, typically cash settlement for structured warrants on SGX-ST, not a unilateral demand for physical settlement. Furthermore, the issuer commits to market-making through a Designated Market-Maker (DMM) whom they appoint, rather than being exempted from appointing one.

Equity Linked Structured Notes, particularly those involving short puts or short calls, carry a worst-case scenario where the potential loss can extend to the full decline in the underlying asset price, leading to a total loss of the investment capital. This is due to the inherent leverage and unlimited loss potential associated with short options. In contrast, an Equity Linked Exchange Traded Fund (ETF) is designed to track the performance of an underlying asset, basket, or index. Therefore, its worst-case scenario for capital loss is typically limited to the decline in the value of that underlying asset, basket, or index. The ETF itself does not inherently expose the investor to losses beyond the value of the underlying asset it holds, unlike certain structured notes with short option components. The other options either misrepresent the loss potential for one or both products, confuse their risk profiles, or introduce irrelevant factors as the primary worst-case scenario.

A Range Accrual Note (RAN) is a structured product designed to provide an enhanced yield if a reference index remains within a predefined range. A critical feature of many RANs, as described in the CMFAS Module 6A syllabus, is the knock-out barrier. A knock-out event occurs if the reference index trades at or above the knock-out barrier (or at or below an accrual barrier, if specified). Once a knock-out event is triggered, the accumulation of new coupons ceases immediately. However, any coupons that have already been accrued up to the point of the knock-out event are typically still paid to the investor on the scheduled payment dates. The principal amount of a RAN is generally preserved at maturity, meaning the investor’s initial capital is not at risk due to market movements of the reference index, even if a knock-out occurs. In the given scenario, the index trading at 30,600 points, which is above the knock-out barrier of 30,500 points, constitutes a knock-out event. Therefore, coupon accrual would stop at that moment, and only the coupons accumulated before this event would be paid. The subsequent return of the index to the accrual range does not reverse the knock-out event’s effect on future coupon accrual.

A bear put spread is a strategy implemented by buying a higher striking put option and simultaneously selling a lower striking put option, both with the same underlying asset and expiration date. This strategy results in a net debit, meaning the investor pays a net premium to enter the trade. The maximum potential loss for a bear put spread is limited to this initial net debit paid. In the given scenario, the investor pays a premium of $7 for the long put option and receives a premium of $2 for the short put option. Therefore, the net debit incurred is $7 – $2 = $5. This maximum loss occurs if the underlying share price at expiration is above the strike price of the long put option (in this case, above $60), causing both put options to expire worthless.

This question tests the understanding of using Eurodollar futures to hedge against interest rate risk for a future deposit. The treasurer expects to receive funds in the future and invest them in a 3-month Eurodollar deposit. The key risk identified is that interest rates are expected to decline. A decline in interest rates would mean the future deposit earns a lower yield than currently available, reducing the investment’s profitability. Eurodollar futures prices move inversely to interest rates. If interest rates are expected to fall, the Eurodollar futures price (which is 100 minus the implied LIBOR rate) is expected to rise. To hedge against the risk of falling interest rates on a future deposit, the treasurer needs a position that will generate a profit if rates indeed fall. By buying Eurodollar futures contracts today, if interest rates fall as predicted, the futures prices will rise. The treasurer can then sell these contracts at a higher price, realizing a profit. This profit from the futures position will help to offset the lower interest income earned on the actual deposit when it is placed at the lower prevailing market rates, thereby effectively locking in a yield closer to the current rate. Selling Eurodollar futures (Option 2) would be appropriate if the treasurer expected rates to rise and wanted to hedge a future borrowing cost, or if they were hedging an existing floating-rate liability. Entering into an interest rate swap (Option 3) is a different hedging instrument, and the direction (paying floating, receiving fixed) would typically be for a borrower hedging against rising rates, not a depositor hedging against falling rates. Taking no action (Option 4) would leave the deposit unhedged and exposed to the risk of lower yields.

The scenario describes an institutional investor requiring an option contract with ‘highly specific, non-standard terms’ to manage a ‘unique portfolio risk.’ This need for customisation is the defining characteristic of Over-The-Counter (OTC) options, as opposed to exchange-traded options. OTC contracts are not standardised; their terms, including strike prices and expiration dates, can be fully customised to suit the specific needs of the parties involved, and transactions are private. Exchange-traded options, conversely, have standardised terms and are traded on organised exchanges. Therefore, the ability to fully customise the contract’s terms is the fundamental characteristic differentiating this type of option (OTC) from exchange-traded ones. The other options describe features of exchange-traded options (centralised clearing house, consistent daily mark-to-market pricing) or incorrectly attribute stronger performance guarantees to OTC options, which actually carry higher counterparty risk due to the absence of a clearing house.

The scenario describes an Exchange Traded Fund (ETF) that achieves its investment objective by entering into agreements with counterparties to receive the performance of an index, rather than directly holding all the underlying securities. This method is characteristic of synthetic replication. Synthetic replication ETFs use derivative and/or Over-The-Counter (OTC) transactions, such as swap agreements, to replicate an index’s performance without physically owning the underlying assets. In contrast, full replication involves directly purchasing all the securities that constitute the underlying index. Representative sampling is a variant of direct replication where the ETF holds a subset of the index’s securities to approximate its performance. Cash-based replication is another term for direct or physical replication, where the ETF holds the actual underlying assets. Therefore, the approach outlined in the scenario aligns with synthetic replication.

To determine if a knock-out event has occurred, we must calculate 75% of the initial level for each index and compare it to its observed level. A knock-out event is triggered if any index’s observed level falls below this 75% threshold. 1. Index Alpha: Initial Level = 1200. 75% of 1200 = 0.75 1200 = 900. The Observed Level is 920. Since 920 is greater than 900, Index Alpha has not triggered a knock-out. 2. Index Beta: Initial Level = 800. 75% of 800 = 0.75 800 = 600. The Observed Level is 580. Since 580 is less than 600, Index Beta has triggered a knock-out. 3. Index Gamma: Initial Level = 4000. 75% of 4000 = 0.75 4000 = 3000. The Observed Level is 3050. Since 3050 is greater than 3000, Index Gamma has not triggered a knock-out. Because Index Beta’s observed level fell below its 75% threshold, a knock-out event has occurred. The condition for a knock-out event is that any index breaches the threshold, not necessarily all or a specific number of indices. Therefore, the statement that a knock-out event has occurred because Index Beta’s observed level is below 75% of its initial level is correct. The other options either miscalculate the threshold, misunderstand the ‘any index’ condition, or incorrectly state that no event occurred.

Credit Linked Notes (CLNs) and Bond Linked Notes (BLNs) are both structured products that offer yield enhancement, but they achieve this through different embedded derivatives and thus have distinct payout triggers. A CLN incorporates a Credit Default Swap (CDS), where the investor essentially sells credit protection on a specified ‘reference entity’. The investor receives periodic payments (like an insurance premium) and faces the risk of a payout if a credit event (e.g., default) occurs for the reference entity. The payout of a CLN is therefore directly dependent on the creditworthiness and credit events of the reference entity. In contrast, a BLN embeds a short put option on a specific bond. The investor receives a premium for selling this put option. The payout or potential obligation for a BLN investor is tied to the price movement of the underlying bond. The investor may end up owning the bond at maturity if its price falls below the strike price of the put option, even if no credit default has occurred, as bond prices can be affected by other factors like credit downgrades or interest rate changes. The other options describe different types of derivatives or structured products, or misrepresent the fundamental mechanics of CLNs and BLNs.

The provided text explicitly states that entities involved in various fund functions, especially affiliates of the fund management company acting as counterparties, may have interests that conflict with fund investors. It highlights that these affiliates do not have a fiduciary role to act in the best interests of unit holders. To address such conflicts, the fund manager is responsible for implementing measures like Chinese walls or different reporting lines. Crucially, the independent trustee’s main role is to look after the interests of the unit holders and ensure the fund manager carries out duties in accordance with the trust deed, including managing conflicts fairly. Therefore, the combination of the fund manager’s internal controls and the trustee’s independent oversight and fiduciary duty is the most effective approach to safeguard unit holders’ interests. Prioritizing investment performance alone does not address the conflict of interest itself. While administrative agents perform operational checks and auditors conduct annual audits, these are not the primary mechanisms for proactively resolving related-party conflicts of interest. The swap counterparty’s internal controls are for their own risk management, not for protecting the fund’s unit holders from a conflict of interest with an affiliate.

Barrier options are inherently conditional, meaning their payoff is contingent on the underlying asset’s price reaching or not reaching a specific barrier level. This conditionality, which includes the possibility of a knock-out option terminating early or a knock-in option never becoming active, reduces the probability of a payoff for the option holder compared to a standard option. Consequently, this increased risk for the holder translates into a lower premium cost for barrier options. This lower initial investment allows investors to achieve higher potential returns on their capital if their market view is correct and the barrier conditions are met without the option being knocked out or failing to knock in. The other options are incorrect because barrier options are typically OTC products, meaning they carry counterparty risk and generally have lower liquidity than exchange-traded instruments. They do not offer guaranteed capital protection, and while they do provide leverage, the primary reason for their lower premium is their conditional nature, not merely their complex structure.

To roll a long futures position from an expiring contract month to a future contract month, the investor must simultaneously close out their existing position in the expiring contract and open a new, equivalent position in the desired future contract month. For a long position, this means selling the current (e.g., June) contract to offset the existing buy, and concurrently buying the next (e.g., September) contract to establish the new long position. This action allows the investor to maintain continuous market exposure without taking physical delivery or allowing the position to expire. Allowing the June contract to expire and then opening a new position would result in a gap in market exposure and potential delivery obligations if it were a physically settled contract. Buying additional September contracts without selling the June contracts would increase the overall exposure, not roll the existing one. Selling the June contract and waiting to buy the September contract would temporarily remove the investor from the market, defeating the purpose of rolling to maintain exposure.

In a First-to-Default Credit Linked Note (CLN), the yield offered to note holders is influenced by several factors, including the correlation among the underlying reference entities in the basket. When the default events of the companies in the basket exhibit very low correlation, it implies that their defaults are largely independent of each other. This independence increases the overall probability of at least one company defaulting within the basket, thereby increasing the risk assumed by the note holder. To compensate for this higher risk, the note holders would typically demand, and the CLN would offer, a higher yield. Conversely, if the companies are highly correlated, their default events are more likely to occur together or not at all, effectively reducing the number of independent risk factors. This scenario presents a comparatively lower risk of a ‘first-to-default’ event than a low-correlation basket, leading to a lower required yield.

Effective gearing is a crucial metric for warrants, combining the warrant’s gearing (leverage) with its delta (sensitivity to the underlying asset’s price). It is calculated by multiplying the delta of the warrant by its gearing. In this scenario, with a gearing of 7.5 and a delta of 0.70, the effective gearing is 0.70 7.5 = 5.25. This value indicates the percentage change expected in the warrant’s price for every 1% change in the underlying asset’s price. Therefore, an effective gearing of 5.25 means the warrant’s price is expected to change by 5.25% for every 1% movement in the underlying index. The other options either present incorrect calculations for effective gearing or misinterpret what effective gearing represents. Effective gearing does not directly measure sensitivity to interest rates, total premium over intrinsic value, or the proportion of underlying volatility captured.

Extended Settlement (ES) contracts are subject to adjustments when corporate actions occur on their underlying securities. According to SGX’s prescribed methods, when a corporate event, such as a bonus issue, results in an increase or decrease in the number of shares, the primary adjustment made to the ES contract is an alteration to its contract multiplier. A bonus issue directly increases the number of shares held by shareholders. Therefore, to reflect this change and maintain the contract’s value equivalence before and after the event, the contract multiplier is increased. While a bonus issue also affects the share price (typically diluting it), the adjustment to the settlement price is generally applied when the corporate event primarily impacts the share value or price directly, rather than the number of shares. Bringing forward the Last Trading Day (LTD) is a measure typically reserved for corporate actions that do not fall into the standard categories or require specific guidance from the Corporate Actions Adjustment Review Committee (CAARC). The cancellation and re-issuance of contracts is not a standard adjustment procedure for a bonus issue.

The question describes a market outlook where a trader anticipates significant price volatility but lacks a directional view, aiming to profit from large movements while limiting risk. This perfectly aligns with neutral options strategies designed for high volatility. A long straddle involves simultaneously buying an at-the-money (ATM) call and an ATM put with the same strike price and expiration date. This strategy provides unlimited profit potential if the underlying asset moves significantly in either direction (up or down) and has a limited maximum loss, which is the total premium paid for both options. The other options describe strategies that either have an opposite market view (short strangle for low volatility), are directional (bullish call spread), or incorrectly state characteristics of a similar strategy (long strangle’s maximum loss is typically lower than a straddle’s due to OTM strikes, not higher).

When an investor holds a short position in a Contract for Differences (CFD) and the underlying company declares a cash dividend, the investor’s account is typically debited with the dividend amount. This is because a short CFD position economically mirrors selling the underlying asset. If an investor were to physically short-sell shares, they would be obligated to pay any dividends declared during the period they held the short position to the lender of the shares. Similarly, in a CFD, the CFD provider effectively ‘lends’ the economic exposure, and thus, the short CFD holder must compensate for the dividend that would have been paid to a long holder. Conversely, investors with long CFD positions would receive a credit for the dividend amount.

A Stop Sell order is typically placed below the current market price by a trader holding a long position. Its primary purpose is to limit potential losses by triggering a sell order if the market price falls to or below the specified stop price. Conversely, a Market-if-Touched (MIT) Sell order is generally placed above the current market price. This order type is used to initiate a short position if the market rallies and touches the specified trigger price, indicating a potential reversal or breakout. Therefore, to protect an existing long position against a decline and simultaneously prepare to enter a new short position on an upward rally, the trader would use a Stop Sell order below the market and an MIT Sell order above the market, respectively.

The question assesses the candidate’s understanding of the distinct structural compositions of a Discount Certificate and a Reverse Convertible, as detailed in Chapter 10 of the CMFAS Module 6A syllabus. While these two structured products can achieve similar risk-return profiles, their underlying components differ. A Discount Certificate is typically constructed by combining a long zero-strike call option with a short call option. The net premium from these options allows the product to be issued at a discount to its face value. Conversely, a Reverse Convertible is fundamentally composed of a bond (or note) and a short put option. Both structures lead to a capped upside and full downside exposure to the underlying asset due to the embedded short option position. The other options incorrectly describe the constituent derivatives or fixed-income components of these structured products.

A knock-out option is a type of barrier option designed to terminate or expire if the price of the underlying asset touches or crosses a specific barrier level during the option’s life. For a knock-out call option, if the underlying asset’s price reaches or exceeds the specified knock-out barrier, the option is extinguished. This means the option ceases to exist, and the investor loses the potential for further gains from price movements beyond that barrier. The payoff upon termination could be zero or a small predetermined termination value, depending on the specific terms of the product. This feature is a core characteristic of knock-out products, differentiating them from standard options.

The scenario describes a problem where futures positions with extended expiry dates suffer from reduced liquidity during market stress, leading to difficulty in unwinding and unexpected losses. The Maturity Limit, as discussed in the CMFAS Module 6A syllabus, is specifically designed to address this. It limits exposure to further-month contracts because their liquidity is typically lower and they become more volatile and difficult to unwind in adverse market conditions. By setting a maturity limit, firms reduce the risks associated with poor liquidity in longer-dated contracts. While other limits like the Maximum Loss Limit, Open Contracts Limit, and Stress Test Limit are crucial for overall risk management, they do not specifically target the liquidity risk inherent in distant-month contracts in the same direct manner as a Maturity Limit.

A bear put spread is a strategy implemented by buying a higher striking in-the-money put option and selling a lower striking out-of-the-money put option of the same underlying security with the same expiration date. This strategy results in a net debit, meaning the investor pays a premium upfront. The maximum profit for a bear put spread is achieved when the underlying asset’s price falls below the strike price of the short put option at expiration. The formula for maximum profit is the difference between the strike prices minus the net debit paid. In this scenario, the difference in strike prices is $50 – $45 = $5.00. The net debit paid is $2.00. Therefore, the maximum potential profit is $5.00 – $2.00 = $3.00. The option of $5.00 represents the difference in strike prices without accounting for the initial debit. The option of $2.00 represents the maximum loss, which is equal to the net debit paid. The option of $7.00 would be an incorrect calculation, possibly from adding the debit instead of subtracting it.

For a put option, it is considered ‘in-the-money’ (ITM) when the strike price is higher than the current market price of the underlying asset. The intrinsic value of an in-the-money put option is calculated as the difference between the strike price and the current market price. In this scenario, the put option has a strike price of $50 and the current market price of Company X shares is $48. Since $50 (strike price) is greater than $48 (current market price), the put option is in-the-money. The intrinsic value is calculated as $50 – $48 = $2. Out-of-the-money (OTM) for a put option occurs when the strike price is lower than the current market price, and its intrinsic value would be $0. At-the-money (ATM) for a put option occurs when the strike price is equal to the current market price, and its intrinsic value would also be $0.

The question describes a scenario where a 3-year Auto-Redeemable Structured Fund triggers an early redemption. The initial investment is SGD 100,000. The fund is call-protected for the initial 1-year period. Thereafter, early redemption observation dates occur every 6 months. The scenario states that the early redemption occurs on the ‘second early redemption observation date’. The first observation date is after 1 year, and the second is after 1 year + 6 months, totaling 1.5 years from inception. Therefore, there have been 2 observation periods (1 year and 1.5 years). The ‘Periodic Yield’ is given as 4.25%. The ‘Payout Price’ for early redemption is calculated as ‘Periodic Yield x No. of Observations’. In this case, Payout Price = 4.25% x 2 = 8.5%. The ‘Investment Objective’ states ‘Capital preservation – 100% of investment capital payable to investor’ and ‘Attractive yield based on market performance’. This means the investor receives their initial capital back plus the calculated yield. The ‘Redemption Value’ is 100% of the initial investment (SGD 100,000). The ‘Payout amount to the investor’ is the ‘Terminal Value’, which is defined as ‘Redemption Value x Payout Price’. However, given the capital preservation objective, this ‘Payout Price’ represents the additional yield percentage on top of the principal. Therefore, the total payout is the initial investment plus the yield earned. Total Payout = Initial Investment + (Initial Investment x Payout Price) = SGD 100,000 + (SGD 100,000 x 8.5%) = SGD 100,000 + SGD 8,500 = SGD 108,500. The other options are incorrect because they either miscalculate the number of observation periods, ignore the principal preservation, or confuse early redemption payouts with final maturity payouts.