CMFAS RES6A Quiz 08

The premium of a call option is influenced by several factors. An increase in the underlying share price directly increases the call option’s intrinsic value, thus raising its premium. Higher implied volatility suggests a greater likelihood of significant price movements in the underlying asset, which increases the probability of the call option ending in-the-money, thereby increasing its time value and overall premium. A decrease in expected future dividends for the underlying share is also beneficial for call options. Dividends typically lead to a reduction in the underlying share price when it goes ex-dividend, which would negatively impact a call option’s value. Therefore, lower expected dividends mitigate this potential price drop, supporting a higher call option premium. The other options present combinations of factors that would either decrease the call option’s premium or have mixed effects, making them less likely to result in the strongest increase.

To determine the combined change in the value of the option positions, we must calculate the change for each type of option separately and then sum them. For the call options on Company X, the Delta is 0.60. A positive Delta indicates that the option price moves in the same direction as the underlying asset price. With a $1.50 increase in the share price, each call option’s value will increase by 0.60 $1.50 = $0.90. Since there are 500 call options, the total increase in value for the call position is 500 $0.90 = $450. For the put options on Company Y, the Delta is -0.45. A negative Delta indicates that the option price moves in the opposite direction to the underlying asset price. With a $2.00 decrease in the share price, each put option’s value will increase by -0.45 (-$2.00) = $0.90. Since there are 300 put options, the total increase in value for the put position is 300 $0.90 = $270. The combined change in the value of both option positions is the sum of these individual changes: $450 (increase) + $270 (increase) = $720 increase.

A Callable Bull/Bear Contract (CBBC) is a leveraged product with a mandatory call feature. This means that if the price of the underlying asset reaches a specified ‘call price’ at any time before expiry, a Mandatory Call Event (MCE) is triggered. When an MCE occurs, the CBBC expires early, and its trading terminates immediately. For a Bull Contract, an MCE is specifically triggered when the underlying asset’s spot price touches or falls below the call price. CBBCs are categorised into N-CBBC (No residual value) and R-CBBC (Residual value). For an N-CBBC, the call price is equal to its strike price, and the CBBC holder will not receive any cash payment once an MCE occurs. Conversely, for an R-CBBC, the call price is different from the strike price, and the holder may receive a small amount of cash payment (residual value) when the CBBC is called. Therefore, in the described scenario, an N-CBBC Bull Contract experiencing an MCE will terminate with no residual payment.

Tracking error refers to the disparity in performance between an ETF and its underlying index. This can arise from various factors, even after accounting for management fees. One significant contributor, especially for physically replicated ETFs, is the cost and operational challenges associated with adjusting the ETF’s portfolio to accurately reflect changes in the index’s composition. These ‘index replication costs’ or ‘rebalancing costs’ can include transaction fees, bid-ask spreads, and the impact of liquidity constraints when buying or selling underlying securities. While other options like NAV trading at a discount, liquidity risk, or foreign exchange risk are valid risks associated with ETFs, they describe different types of performance discrepancies or operational challenges, rather than the specific issue of the fund’s internal portfolio performance diverging from its benchmark due to replication challenges.

Accumulators are equity-linked structured products where an investor agrees to purchase a pre-determined quantity of a reference stock at regular intervals at a fixed strike price. A significant risk for the investor arises when the market price of the underlying stock falls below this strike price. In such a situation, the investor is still obligated to purchase the shares at the higher, pre-agreed strike price, even though the shares could be bought cheaper in the open market. This exposes the investor to a direct loss on each accumulated share. The knock-out barrier, conversely, is typically triggered when the stock price rises to or above a certain level, leading to the termination of the agreement, not when the price falls. Accumulators do not feature interim coupon payouts; their primary function is share accumulation. Furthermore, accumulators explicitly state that there is no capital preservation feature, meaning the investor’s principal is at risk.

An Up-and-Out call option is a type of barrier option that is initially active (or ‘in-the-money’) but terminates prematurely, becoming worthless, if the underlying asset’s price rises to or exceeds a pre-defined upper barrier level. This is its ‘knock-out’ condition. The investor essentially bets that the price will rise but not beyond a certain point. If the price falls below the strike price, the option would be out-of-the-money, but it would not necessarily terminate unless it also hit a lower barrier (which would be a different type of option, like a double barrier option). If the price remains between the strike and barrier, the option would stay active and could expire in-the-money if the final price is above the strike and below the barrier.

The correct option explains how the upfront discount in a Discount Certificate is structurally generated. According to the CMFAS Module 6A syllabus, a Discount Certificate is constructed such that the premium received from the sale of call options is greater than the cost incurred from the purchase of a zero-strike option. This net premium is then passed on to the investor at the time of investment, resulting in the product being issued at a discount to its face value, meaning the investor’s initial outlay is less. The second option is incorrect because the text explicitly states that a Discount Certificate investor will not receive a full coupon payout at maturity or redemption. The third option is incorrect because a Discount Certificate is composed of a long zero-strike call and a short call, not a short put. A short put is typically a component of a Reverse Convertible. The fourth option is incorrect as the discount is a direct result of the structured option components and their net premium, not an independent subsidy from the issuer.

For Contracts for Differences (CFDs), investors do not own the underlying shares directly. Instead, they enter into a contract with a CFD provider. When a corporate action like a cash dividend occurs, the CFD position is adjusted to reflect this. For an investor holding a short CFD position, meaning they are betting on the price of the underlying asset to fall, they are essentially in a position analogous to having borrowed and sold the shares. Therefore, when a dividend is paid on the underlying shares, the investor with a short CFD position is obligated to pay this dividend amount to the CFD provider, resulting in a debit to their account. Conversely, an investor with a long CFD position would receive a credit for the dividend amount. The other options are incorrect because CFDs are derivatives that track the underlying asset’s corporate actions, so there is a financial impact. Also, since the investor does not own the physical shares, they do not receive direct payments from the company’s share registrar.

When a structured note is issued by a Special Purpose Vehicle (SPV) established by a bank, the SPV is a separate legal entity. This means that the SPV’s assets and liabilities are not reflected on the establishing bank’s balance sheet, making it an ‘off-balance sheet’ transaction from the bank’s perspective. Consequently, in the event of a default, noteholders can only make a claim on the SPV’s assets and have no recourse to the bank that set up the SPV. This is a critical distinction from direct issuance by the bank. Structured notes, whether directly issued or via an SPV, are not covered by the Deposit Insurance Scheme in Singapore. While an SPV issuer may enter into swap transactions, and investors might bear the credit risk of the swap counterparty if passed on, the primary implication of SPV issuance itself regarding recourse to the establishing bank is the limitation of claims to the SPV’s assets.

For SGX to make a full corporate action adjustment to an Extended Settlement (ES) contract, the critical timing condition is that the Book Closure Date of the corporate event on the underlying security must occur before the ES contract’s settlement day. The fundamental objective of these adjustments is to ensure that the contract’s value after the corporate event remains, as far as practicable, equivalent to its value before the event. This maintains fairness and consistency for contract holders. Other options present incorrect timing conditions, misstate the primary objective, or incorrectly attribute the role of the Corporate Actions Adjustment Review Committee (CAARC), which provides guidance for corporate actions not falling into standard categories, rather than being a prerequisite for all adjustments.

An investor who anticipates a significant appreciation of the Singapore Dollar (SGD) against the Japanese Yen (JPY) is essentially bullish on SGD and bearish on JPY. In the context of Foreign Exchange (FX) warrants, this means the investor expects the value of SGD relative to JPY to increase. To profit from this view, the investor would purchase a call warrant on the currency pair where SGD is the base currency and JPY is the counter currency. Therefore, buying SGD/JPY call warrants grants the holder the right to buy SGD with JPY at a specified exchange rate, which becomes more valuable if SGD appreciates against JPY. Buying SGD/JPY put warrants would be appropriate if the investor expected SGD to depreciate against JPY. Buying JPY/SGD call warrants would imply a bullish view on JPY against SGD, which is the opposite of the investor’s stated view. Selling warrants typically implies a bearish or neutral view, aiming to collect premium, and carries unlimited risk for call options if the market moves unfavorably.

The Constant Proportion Portfolio Insurance (CPPI) strategy involves dynamically allocating assets between a risky component and a risk-free component. The allocation to the risky asset is determined by the cushion value and a multiplier. First, calculate the cushion value, which is the difference between the total portfolio value and the floor value. In this scenario, the cushion value is $1,200,000 (total portfolio) – $1,000,000 (floor value) = $200,000. Next, calculate the multiplier, which is 1 divided by the anticipated crash size. With a crash size of 25% (or 0.25), the multiplier is 1 / 0.25 = 4. Finally, the allocation to the risky asset is found by multiplying the cushion value by the multiplier. So, $200,000 (cushion) 4 (multiplier) = $800,000. This amount represents the portion of the portfolio that should be invested in the risky asset to maintain the desired principal protection.

The interest calculation for a Range Accrual Note (RAN) is based on the proportion of days the reference index remains within the agreed range, applied to the annual coupon rate. The formula for the total interest earned over an observation period, given a daily accrual for days within range, is: Nominal Value × Annual Coupon Rate × (Number of Days in Range / Day Count Basis). In this scenario, the nominal value is SGD 200,000, the annual coupon rate is 3.5% (0.035), the number of days the index closed within the specified range is 240, and the day count basis is 360. Therefore, the total interest earned is SGD 200,000 × 0.035 × (240 / 360) = SGD 7,000 × (2/3) = SGD 4,666.67.

To determine the adjusted exercise price for a call warrant following a dividend announcement, the adjustment factor formula is applied. The formula for the adjustment factor is (P – SD – ND) / (P – ND), where P is the last cum-date closing price of the underlying share, 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: Old Exercise Price (OEP) = S$12.00 Last cum-date closing price (P) = S$150.00 Special Dividend per Share (SD) = S$3.00 Normal Dividend per Share (ND) = S$1.50 First, calculate the numerator of the adjustment factor: P – SD – ND = S$150.00 – S$3.00 – S$1.50 = S$145.50 Next, calculate the denominator of the adjustment factor: P – ND = S$150.00 – S$1.50 = S$148.50 Now, calculate the Adjustment Factor: Adjustment Factor = S$145.50 / S$148.50 ≈ 0.9797979797… Finally, calculate the New Exercise Price: New Exercise Price = OEP × Adjustment Factor New Exercise Price = S$12.00 × (145.50 / 148.50) New Exercise Price = S$12.00 × 0.9797979797… New Exercise Price ≈ S$11.757575… Rounding to two decimal places, the adjusted exercise price is S$11.76.

Under the Singapore regulatory guidelines for Extended Settlement (ES) contracts, when a Member or Trading Representative receives an indication from a customer that margins are forthcoming after the T+2 period, or that no funds are forthcoming, the allowable trading activity for that customer’s account becomes restricted. In such situations, and also beyond the T+2 period, only risk-reducing activities are permitted. This measure is in place to mitigate potential risks associated with delayed or absent margin payments. Activities that are risk-increasing or risk-neutral are explicitly disallowed under these circumstances. The option stating that only activities reducing overall risk exposure are allowed correctly reflects this regulatory requirement. Other options are incorrect because they either permit activities (risk-increasing or risk-neutral) that are specifically prohibited when margins are delayed, or they impose an overly restrictive ban on all trading, which is not the case as risk-reducing trades are still allowed.

An investor anticipating a moderate upward movement in an underlying asset’s price is looking for a moderately bullish strategy. The requirement for an upfront cash inflow indicates a credit spread. Among the vertical spread strategies, the Bull Put Spread is designed for a moderately bullish market view and generates a net credit upon initiation. It is constructed by selling a higher strike put option (which is typically in-the-money) and simultaneously buying a lower strike put option (which is typically out-of-the-money) on the same underlying asset with the same expiration date. This combination results in a net credit received by the investor. The maximum profit for this strategy is the net credit received, achieved if the underlying asset’s price closes above the higher strike price at expiration, causing both options to expire worthless. The other options describe strategies for different market views, different cash flows, or incorrect constructions.

The scenario describes an options strategy where an investor uses two options on the same underlying security, but with distinct strike prices and different expiration dates. According to the definitions of option spreads, a diagonal spread is precisely characterized by options on the same underlying asset having both different strike prices and different expiration dates. In contrast, a vertical spread involves options with the same expiration date but different strike prices, while a horizontal (or calendar) spread uses options with the same strike price but different expiration dates. A ratio spread is defined by the quantity of options bought versus sold, rather than solely by the combination of different strikes and expirations.

The Trust Deed is explicitly described as the legal document that establishes the terms and conditions governing the relationship between investors, the fund manager, and the trustee. It defines the fund’s investment objectives and details the obligations and responsibilities of both the fund manager and the trustee. The trustee, being independent, ensures that the fund is managed in accordance with this deed, thereby minimizing mismanagement risks. The Fund Prospectus, while comprehensive, serves primarily as a disclosure document providing detailed information about the fund. The Product Highlights Sheet is a summary of key features and risks, designed for ease of understanding. A Fund Management Agreement would detail the specific contractual terms between the fund and its manager, but the Trust Deed is the overarching legal instrument that governs the entire scheme, including the critical relationship with investors and the trustee.

When an investor takes a short Extended Settlement (ES) position, they are obligated to physically deliver the underlying stock for settlement. If they fail to have the required shares by the due date (the 3rd market day following the expiration date), the Central Depository Pte Ltd (CDP) is mandated to initiate a buying-in process. This involves CDP acquiring the necessary shares from the market to satisfy the delivery obligation. The buying-in process commences the day after the due date (Last Trading Day + 4), and the starting price for the buy-in is set at two minimum bids above the highest of the previous day’s closing price, the current last done price, or the current bid. The other options describe incorrect mechanisms or consequences not aligned with the specified rules for non-delivery in ES contracts.

Global Connect Pte Ltd is expecting to receive USD in the future and is concerned about the US Dollar depreciating against the Singapore Dollar. This means they face the risk that the SGD equivalent of their USD receivable will be lower than anticipated. To hedge against this specific risk using futures contracts, the company needs to lock in an exchange rate at which they can convert their future USD receipts into SGD. Selling USD/SGD futures contracts allows them to commit to selling a specific amount of USD at a predetermined exchange rate on a future date. This action effectively hedges the foreign currency receivable by mitigating the risk of adverse movements in the USD/SGD exchange rate. Buying USD/SGD futures would expose them to further losses if the USD depreciates. Entering into a Forward Rate Agreement (FRA) is a tool for hedging interest rate risk, not currency risk. Purchasing equity index futures is a strategy to hedge equity market risk, which is unrelated to the currency exposure described.

An accumulator agreement obligates the investor to purchase a predefined quantity of underlying shares at a specified strike price on a regular basis for the tenor of the agreement, provided the share price remains below the knock-out barrier. A fundamental risk is that if the market price of the underlying shares falls significantly below the strike price, the investor is still compelled to buy at the higher strike price, leading to substantial losses. The investor’s potential gain is limited by the knock-out barrier, as the agreement terminates if the share price reaches or exceeds this barrier. Furthermore, investors are typically not entitled to dividends or other corporate action benefits until the shares are actually delivered.

Effective gearing is a crucial metric for understanding the leverage offered by a warrant, calculated as Delta multiplied by Gearing. For the call warrant on Stock A, the effective gearing is 0.55 (Delta) 12 (Gearing) = 6.6 times. This means for every 1% increase in Stock A’s price, the call warrant’s price is expected to increase by approximately 6.6%. For the put warrant on Stock B, the effective gearing is |-0.65| (absolute Delta) 10 (Gearing) = 6.5 times. This means for every 1% decrease in Stock B’s price, the put warrant’s price is expected to increase by approximately 6.5%. Comparing these, the call warrant on Stock A has a slightly higher effective gearing (6.6x) than the put warrant on Stock B (6.5x). Therefore, under the specified conditions, the call warrant on Stock A would experience a marginally larger percentage gain.

The premium for a call warrant is determined by the formula: Premium = (Conversion Ratio x Warrant Price) + Strike Price – Share Price. This formula accounts for the cost of the warrant relative to its intrinsic value and the underlying share price, adjusted for the conversion ratio. In this specific scenario, the conversion ratio (n) is 5, the warrant price (WP) is $0.50, the strike price (X) is $9.50, and the underlying share price (S) is $10.00. Substituting these values into the formula yields: Premium = (5 x $0.50) + $9.50 – $10.00. This simplifies to $2.50 + $9.50 – $10.00, resulting in a premium of $2.00. Other options represent different calculations, such as the intrinsic value of the warrant, the time value of the warrant, or the premium calculation for a put warrant, which would lead to incorrect results for a call warrant’s premium.

Company warrants are typically issued directly by the underlying company. When these warrants are exercised, the company issues new shares to the warrant holders in exchange for the warrants. This process increases the total number of outstanding shares, which can lead to a dilution of the company’s earnings per share. In contrast, structured warrants are issued by third-party financial institutions and are generally cash-settled, meaning their exercise does not involve the issuance of new shares by the underlying company and thus does not cause share dilution. Warrants linked to a basket of securities or warrants with a zero strike price are types or features of structured warrants, and their exercise does not directly impact the underlying company’s share capital in the same way as company-issued warrants.

The first objective is to automatically liquidate an existing long position if the market price declines to a specified threshold, thereby limiting potential losses. This action requires a ‘sell’ order that triggers when the price falls to or below a certain level. A Stop Sell order is designed for this purpose; it is placed below the current market price and converts to a market or limit order once the stop price is touched or breached, helping to protect against further losses on a long position. The second objective is to establish a new short position if the market price unexpectedly rallies significantly above the current level, anticipating a subsequent downward reversal. This requires a ‘sell’ order that triggers when the price rises to or above a certain level above the current market. A Market-if-Touched (MIT) Sell order is appropriate here, as it is placed above the current market price and is triggered to become a market order when that price is touched, allowing a trader to enter a short position on an upward price movement. Therefore, a Stop Sell order is used for the first objective (selling below the market to limit losses), and a Market-if-Touched (MIT) Sell order is used for the second objective (selling above the market to initiate a new short position).

The question pertains to the ‘Structure Risk’ associated with structured products, specifically when an investor shorts a pay-fixed interest rate swaption. As outlined in the CMFAS Module 6A syllabus, Figure 9.4.7(b) illustrates that for a swaption seller (investor) who has shorted a pay-fixed interest rate swaption, the losses are unlimited. This is because the swaption buyer will exercise the option when the market floating rate is higher than the strike rate, and the seller is liable to pay out this floating rate. The higher the floating rate goes, the greater the loss for the seller, with no inherent cap. This contrasts with shorting a receive-fixed interest rate swaption, where losses are typically limited to a pre-determined fixed rate. Therefore, the investor’s potential loss is directly dependent on how high the floating rate rises.

Structured warrants listed on the SGX-ST are typically settled in cash. This means that upon exercise, the holder receives a cash payment equivalent to the intrinsic value of the warrant, rather than receiving the physical underlying shares. This contrasts with company warrants, which often involve physical delivery, where new shares of the underlying company are issued upon exercise. The settlement style for any warrant is determined and made known at the time the warrant is issued, not at the discretion of the holder at expiry. Furthermore, structured warrants are issued by third-party financial institutions, not the underlying company, which means the underlying company does not issue new shares for structured warrant exercises.

The contract specifications for equity index futures, as outlined in the CMFAS Module 6A syllabus, state that the minimum price fluctuation is 1 index point, which has a monetary value of SGD 10. To determine the monetary value of a 0.5 index point movement, one must multiply the observed index point change by the value per index point. Therefore, 0.5 index points multiplied by SGD 10 per index point equals SGD 5.00.

Structured products are designed to meet specific investor needs. For capital preservation, the product typically incorporates a ‘principal component,’ which is often a fixed income instrument like a zero-coupon bond. This bond is structured so that its maturity value equals the initial investment, thereby protecting the principal. The remaining portion of the investment is then used for the ‘return component,’ which might involve options or other derivatives linked to an underlying asset, allowing for potential growth. The other options describe aspects that might be part of a structured product or general investment strategy, but they do not primarily explain the mechanism for capital preservation as described by the principal component in the provided context.

Futures contracts are distinguished from forward contracts primarily by their trading venue and standardization. Futures are standardized agreements traded on regulated exchanges, and their clearing is typically handled by a central clearing house. This structure ensures uniform contract specifications, enhances market transparency, and significantly mitigates counterparty risk because the clearing house effectively becomes the counterparty to both the buyer and seller. In contrast, forward contracts are private, over-the-counter agreements negotiated directly between two parties, leading to customized terms and exposure to the counterparty risk of the other party. While leverage and settlement methods are aspects of futures, they are not the defining characteristics that address the specific objectives of market transparency, standardization, and reduced counterparty risk in the way that exchange trading and central clearing do. The ability to negotiate bespoke terms is a feature of forward contracts, not futures.