CMFAS RES6A Quiz 26

A ‘worst of’ Equity Linked Note (ELN) is designed such that its performance is tied to the poorest performing asset within a basket of underlying securities. This means that even if several underlying assets perform well, the investor’s return will be dictated by the one that performs the worst. This characteristic inherently increases the downside risk for the investor compared to a standard ELN linked to a single asset, as they are exposed to the potential decline of multiple stocks or indices. The higher risk is typically compensated by a higher potential yield or a deeper discount at issuance. The settlement method (cash or physical) is a feature of the ELN’s terms and conditions, not specific to whether it’s a ‘worst of’ structure. ELNs generally do not offer fixed coupon payments; their returns are linked to the performance of the underlying assets.

For an investor who buys a put option, the breakeven point is reached when the underlying asset’s price at expiration falls below the exercise price by an amount equal to the premium paid. In this scenario, the exercise price is $95 and the premium is $7, so the breakeven price for the underlying asset is $95 – $7 = $88. The maximum loss for a put option buyer is limited to the premium paid for the option, as the buyer has the right, but not the obligation, to exercise. If the option expires worthless (i.e., the underlying price is at or above the exercise price), the buyer only loses the initial premium. Therefore, the maximum loss is $7.

A Mandatory Call Event (MCE) causes a Callable Bull/Bear Contract (CBBC) to expire early. The distinction between N-Category and R-Category CBBCs primarily lies in the potential for a residual cash payment upon an MCE. For an N-Category CBBC, the call price is equal to its strike price, meaning the holder will not receive any cash payment once the MCE occurs and the CBBC is called. In contrast, for an R-Category CBBC, the call price is different from the strike price, which allows the holder to potentially receive a small amount of cash payment, known as the ‘Residual Value’, when the CBBC is called. The other options describe incorrect characteristics or distinctions between the CBBC categories. For instance, the MCE can be triggered at any time before expiry for both categories, not just at expiry for N-Category. Gearing is a general characteristic of CBBCs, not a distinguishing factor between N and R categories in the way described. Also, the relationship between call price and strike price for R-Category CBBCs depends on whether it’s a Bull or Bear contract, not a universal ‘lower’ or ‘higher’ rule.

Structured notes with embedded short options involve the investor effectively selling an option. When an investor sells an option, they receive a premium upfront, which contributes to an enhanced yield. However, this strategy inherently caps the potential profit to the premium received (or the enhanced yield derived from it). In contrast, if the underlying asset moves unfavorably, the investor is obligated to fulfill the terms of the option, which can lead to substantial losses that far exceed the initial premium received. This asymmetry in potential outcomes—limited maximum gain versus potentially large maximum loss—is what defines a negatively skewed risk-reward ratio. The distribution of potential returns is ‘skewed’ towards the negative side, meaning there’s a higher probability or magnitude of losses compared to gains. The other options describe scenarios that are either the opposite (unlimited upside, limited downside, positively skewed) or misrepresent the risk profile (balanced, symmetrical, or fully compensated moderate downside), which are not characteristic of embedded short options.

Yield Enhanced Securities, also known as Discount Certificates, have a specific settlement mechanism at expiration. If the underlying asset’s closing price on the expiration date is at or above the exercise price (cap strike), 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 date. In the given scenario, the closing price of Company XYZ shares ($4.70) is below the exercise price ($4.80). Therefore, the investor would receive the value of the underlying, which is $4.70 per warrant.

A Bonus Certificate is designed to offer a minimum return (the ‘Bonus’) as long as the underlying asset’s price stays above a predefined barrier level. However, a critical characteristic of this product is that if the underlying asset’s price falls below this barrier, the investor loses the benefit of the bonus. In such a situation, the investor’s exposure becomes similar to a direct investment in the underlying asset, meaning they face a 1:1 downside exposure to the underlying asset’s performance below the barrier. This implies that for every unit of decline in the underlying asset below the barrier, the investor’s capital will decrease proportionally. The product does not provide principal protection once the barrier is breached, nor does it guarantee the bonus payment in that specific scenario.

A Knock-Out Event, also referred to as a Mandatory Call Event (MCE), occurs if, on an observation date, any underlying index level falls below 75% of its initial level. To determine if a Knock-Out Event has occurred, one must calculate 75% of the initial level for each index and then compare it to the observed level. If even one index’s observed level is strictly less than its 75% threshold, the event is triggered. In the correct scenario, for Index Gamma, 75% of its initial level (150) is 112.5. The observed level of 110 is less than 112.5, thus triggering the Knock-Out Event. For the other options, no index falls below its respective 75% threshold. It is crucial to note the ‘less than’ condition, meaning an observed level exactly at 75% of the initial level would not trigger the event.

The scenario describes two distinct situations related to Extended Settlement (ES) contracts. Firstly, a mark-to-market loss on Company Alpha’s ES contract directly impacts the Additional Margin. According to the rules, a loss in an ES contract will increase the amount of Additional Margins required. Secondly, the client realizes a profit from offsetting an existing ES contract for Company Beta. The guidelines state that a mark-to-market gain from an ES trade may be used to offset other margin requirements of the same customer. This means the profit generated can be applied to reduce other margin obligations, such as the increased Additional Margin from Company Alpha or margin for a new trade. Therefore, the loss increases Additional Margin, and the profit can be utilized to reduce other margin requirements.

Credit Linked Notes (CLNs) involve the investor effectively selling a Credit Default Swap (CDS) on a specified ‘reference entity’. The investor receives enhanced yield but is exposed to the credit risk of this reference entity. The payout of a CLN is contingent upon whether a credit event occurs for the reference entity. If a credit event happens, the investor may lose principal. Bond Linked Notes (BLNs), on the other hand, embed a short-put option on a bond. This means the investor sells a put option on a bond, and their payout depends on the market price of that bond. If the bond’s price falls below the strike price of the put option, the investor may be obligated to purchase the bond, potentially leading to a loss of principal. The key distinction lies in the underlying derivative and what triggers the primary risk: a CDS on a reference entity for CLNs, and a put option on a bond for BLNs.

Effective gearing is calculated as Delta multiplied by the Gearing ratio. This metric provides a more accurate representation of the actual percentage change in a warrant’s price for a given percentage change in the underlying asset’s price, as it incorporates the warrant’s sensitivity (Delta) to the underlying. While the simple gearing ratio indicates the leverage in terms of capital outlay, it does not account for the warrant’s specific price sensitivity. The conversion ratio is used in the calculation of gearing and delta but is not a standalone metric for this specific sensitivity. Time decay, or theta, refers to the erosion of a warrant’s value over time, irrespective of the underlying asset’s price movement, and therefore does not measure the price sensitivity to changes in the underlying.

Operational risk refers to the risks arising from the failure of internal processes, people, and systems, or from external events. The scenario describes issues stemming from a malfunctioning internal trading software (system failure) and a key staff member failing to execute instructions (human error/process failure). These are direct examples of operational risk. Issuer risk relates to the financial stability of the entity issuing a product. Concentration risk pertains to a lack of diversification in an investment portfolio. Basis risk is specific to futures contracts, representing the difference between the futures price and the cash price of the underlying asset.

Company warrants are typically issued directly by the underlying company itself, often as a ‘sweetener’ attached to a bond or rights issue. Upon exercise, these warrants usually result in the issuance of new shares by the company, which can lead to a dilution of the company’s earnings per share. Structured warrants, on the other hand, are issued by third-party financial institutions and are based on various underlying assets. For structured warrants listed on SGX-ST, settlement is typically conducted via cash, meaning the holder receives a cash payment equivalent to the warrant’s intrinsic value, rather than physical delivery of the underlying shares. This distinction means structured warrants do not affect the share capital of the underlying company.

CDP computes margin requirements for Members on a gross basis. This means that long and short positions, or mark-to-market gains and losses, belonging to different customers do not cancel each other out in the calculation of a Member’s overall margin requirement. While a mark-to-market gain for a customer’s ES trade may reduce that specific customer’s Additional Margin requirement or offset other margin requirements for the same customer, it cannot be used to offset a loss incurred by a different customer when CDP calculates the Member’s total margin obligation. Therefore, the Member must meet the Additional Margin requirement arising from Customer B’s loss, and Customer A’s gain does not reduce this specific liability at the Member’s overall level as determined by CDP. The Member’s total Additional Margin requirement will be the sum of the individual Additional Margin obligations for each customer’s position.

The Zero Coupon Fixed Income Plus Option Strategy is designed to offer capital preservation through a zero-coupon bond while providing potential for upside returns linked to an underlying financial instrument via a call option. The ‘Participation Rate’ is a crucial component that determines how much of the underlying asset’s positive performance, specifically the appreciation above the ‘Strike Price’, will be passed on to the investor. It does not define the maximum potential gain, nor does it guarantee the principal sum (that’s the role of the zero-coupon bond component). The ‘Strike Price’, not the participation rate, determines the threshold at which the underlying asset must perform before any upside return from the option component is generated. Therefore, the participation rate directly specifies the percentage of the underlying asset’s appreciation beyond the strike price that contributes to the structured product’s return.

The Singapore Government Bond futures (SB) contract’s final settlement price methodology is designed to ensure fairness and prevent manipulation from extreme price quotes. As per the contract specifications, when calculating the arithmetic mean of bid and offer prices from the Singapore Government Securities Dealers, the three highest and three lowest bid prices, as well as the three highest and three lowest offer prices, are explicitly discarded. This process helps to remove outliers and potential distortions before the mean is calculated and converted to a yield, contributing to a more robust and representative final settlement price. The final yield is derived from a basket of bonds, with the benchmark bond weighted at 60% and the remaining weight distributed among other bonds, not solely based on the benchmark. Furthermore, the SB contract has no daily price limits, and the final settlement price is derived through a defined calculation based on dealer contributions, not directly set by the Monetary Authority of Singapore based on internal models.

An equal-weighted index (EWI) allocates the same weight to each constituent stock, regardless of its market capitalization. This contrasts with a market-capitalization-weighted index (MWI), where larger companies have a greater influence. Consequently, the EWI inherently has a lower concentration in a few dominant large-cap companies, as it underweights these giants and overweights numerous smaller stocks. Because smaller-cap stocks are generally more volatile than larger companies, and the EWI has a greater tilt towards these smaller firms, the EWI typically exhibits higher overall volatility. Furthermore, to maintain its equal weighting, the EWI requires periodic rebalancing (e.g., quarterly), leading to higher turnover compared to an MWI, which primarily adjusts based on market price movements.

The Semi-annual Accounts and Reports to Unit holders are the primary source for the specific information requested. This document includes the ‘Statement of Investments,’ which provides a detailed listing of the fund’s investment portfolio, and the ‘Statement of Changes in Net Assets,’ which outlines how the fund’s net assets have changed over the past two reporting periods. These two statements collectively address the investor’s need for both detailed portfolio composition and historical net asset fluctuations. The Monthly Performance Report focuses on short-term returns, risk analysis, and principal terms. The Investment Manager Report typically details the performance of underlying assets, Assets Under Management (AUM), and a performance outlook. The Fund Factsheet offers a concise summary of key fund information, including high-level asset allocation and performance figures, but not the detailed breakdown or historical changes in net assets as comprehensively as the semi-annual reports.

Vega is the option Greek that quantifies an option’s sensitivity to changes in the volatility of the underlying asset. When managing an options portfolio, setting limits for Vega is crucial to control potential losses that could arise from unexpected increases or decreases in market volatility. These limits are typically established based on the maximum loss an institution is willing to tolerate given specified movements in volatility. The question specifically asks about addressing potential losses from ‘unexpected shifts in the underlying asset’s price volatility,’ which directly corresponds to the risk measured and managed by Vega. Delta measures sensitivity to the underlying asset’s price changes, and its limits are usually expressed in currency amounts. Theta measures sensitivity to the passage of time (time decay). Gamma measures the rate of change of Delta, indicating how much Delta will change for a given movement in the underlying asset’s price. While all are important for comprehensive risk management, Vega specifically addresses volatility risk as described in the scenario.

The product terms state that the fund is call protected for an initial 1.5-year period, after which the Call Barrier becomes operative. The initial date is 16 December 2014, making the first callable date 15 June 2016. The scenario’s observation date of 15 December 2017 falls after this call protection period, meaning the call barrier is active. The Mandatory Call Event (knock-out trigger) occurs if the closing index level of ANY 4 of the underlying indices on the Early Redemption Observation Date is less than 75% of the initial level. In this scenario, all four indices are at 70% of their initial levels, which satisfies the condition for a Mandatory Call Event. When this event occurs, the product terms specify that the fund will terminate, and the investor receives the latest quarterly coupon and the redemption value. The redemption value is explicitly stated as 100% of the invested capital. Furthermore, no further quarterly coupons will be paid after the knock-out event. Therefore, the investor receives the latest quarterly coupon payment and 100% of their invested capital, and the fund ceases to exist. Option 2 is incorrect because the product terms clearly state that the latest quarterly coupon is received upon a mandatory call event. Option 3 is incorrect because the fund terminates, it does not continue to maturity. Option 4 is incorrect because the redemption value is 100% of invested capital, not a percentage reflecting the index performance.

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 is at or above the exercise price, the holder will receive a cash settlement equal to the exercise price. Conversely, if the closing price is below the exercise price, the holder will receive a cash settlement equal to the value of the underlying on that date. In the scenario presented, the underlying asset’s closing price is above the exercise price, therefore the settlement amount is the exercise price.

When a mandatory call event is triggered for a Bull Knock-Out Certificate, it means the underlying asset’s price has fallen to or below the specified Call Price (knock-out level). At this point, the certificate is terminated prematurely. However, it does not necessarily result in a total loss. Instead, the investor receives a ‘residual value’ if the spot price at the time of the mandatory call is still above the Strike Price. This residual value is calculated as the difference between the settlement price (which is the spot price at the mandatory call) and the Strike Price, divided by the Conversion Ratio. Therefore, the investor receives a payment based on this calculation, rather than the certificate remaining active, being converted, or becoming completely worthless if a positive residual value exists. The other options describe incorrect outcomes for a mandatory call event on a Bull Knock-Out Certificate.

To create a synthetic long stock position, an investor would combine a long call option with a short put option, both having the same strike price and expiration date. This combination replicates the risk and payoff profile of directly owning the underlying share, offering unlimited profit potential if the underlying price rises and significant downside risk if it falls. A short call and long put would create a synthetic short stock position. A long call and long put (straddle) is a volatility strategy, while a short call and short put (short strangle) is a strategy betting on low volatility.

An accumulator agreement, particularly one with a knock-out barrier, is designed to terminate immediately if the underlying reference stock’s daily closing price reaches or exceeds the specified knock-out price. In this scenario, the knock-out price is SGD 17.00, and the closing price of Reference Stock RST is SGD 17.05, which is above the knock-out barrier. Therefore, the agreement is triggered for termination. Upon termination, the investor is obligated to pay for and take delivery of any shares accumulated up to that point. The options related to purchasing 200 or 400 shares at the strike price would only apply if the knock-out barrier had not been reached. The investor does not have an option to continue the agreement once the knock-out condition is met.

When an investor’s account equity for a futures contract falls below the maintenance margin level due to adverse market movements, an additional margin call is triggered. The purpose of this call, as per standard futures market procedures, is to require the investor to deposit additional funds to restore the account balance not just to the maintenance margin level, but back up to the original initial margin level. Therefore, if the initial margin was $20,000 and the maintenance margin was $15,000, and the account equity dropped to $14,000, the investor would need to deposit funds to bring the balance back to $20,000. Simply bringing it back to the maintenance margin level would not be sufficient. No immediate action is incorrect because the account is below the required minimum. Automatic liquidation typically occurs if the margin call is not met by the stipulated time, not immediately upon the account falling below the maintenance level.

To calculate the net profit for a CFD long position, all associated costs must be deducted from the gross profit. First, determine the gross profit from the price difference. Then, calculate the transaction costs for both the opening (buy) and closing (sell) positions, including commission and Goods and Services Tax (GST) on the commission. Finally, calculate the financing interest incurred for the holding period. 1. Gross Profit: Sale Value: 5,000 units $2.70 = $13,500 Purchase Value: 5,000 units $2.50 = $12,500 Gross Profit = $13,500 – $12,500 = $1,000 2. Transaction Costs (Buy): Commission (Buy): $12,500 0.35% = $43.75 GST on Commission (Buy): $43.75 8% = $3.50 Total Transaction Cost (Buy) = $43.75 + $3.50 = $47.25 3. Transaction Costs (Sell): Commission (Sell): $13,500 0.35% = $47.25 GST on Commission (Sell): $47.25 8% = $3.78 Total Transaction Cost (Sell) = $47.25 + $3.78 = $51.03 4. Financing Interest: The financing interest is typically calculated on the initial contract value. Daily Interest = ($12,500 5.5%) / 360 = $1.90972 per day (using 360 days as per common market practice for interest calculations in some contexts, consistent with the provided examples) Total Financing Interest (7 days) = $1.90972 7 = $13.36804 ≈ $13.37 5. Total Expenses: Total Expenses = $47.25 (Buy) + $51.03 (Sell) + $13.37 (Financing) = $111.65 6. Net Profit: Net Profit = Gross Profit – Total Expenses = $1,000 – $111.65 = $888.35

The scenario describes a structured fund objective to preserve 100% of initial capital at maturity while participating in market gains. This is the core principle of the Zero Plus Option strategy. In this strategy, a substantial portion of the initial investment is allocated to fixed-income assets, such as zero-coupon bonds, which are expected to mature at the initial capital amount, thereby providing the capital guarantee. The remaining portion of the capital is then used to purchase call options on the target equity index, allowing the fund to benefit from any appreciation in the index. This combination effectively achieves both capital preservation and upside participation. A Total Return Swap (TRS) is primarily used for synthetic index tracking, exchanging a fixed payment for the total return of an underlying asset, and does not inherently provide a capital guarantee in this specific structure. A Constant Proportion Portfolio Insurance (CPPI) strategy is a dynamic asset allocation method that adjusts exposure between risky and risk-free assets based on a floor and multiplier to manage risk and participate in upside, but it operates differently from the fixed allocation of the Zero Plus Option strategy. Directly holding underlying securities provides direct market exposure but does not offer a capital guarantee.

The question describes a long hedge strategy using Extended Settlement (ES) contracts. A long hedge is employed when an investor anticipates purchasing shares in the future but wants to protect against a potential price increase. By buying ES contracts, the investor locks in a ‘purchase’ price for the underlying shares. The unrealised gain or loss on a long ES contract is calculated as the difference between the settlement price and the initial ES contract price, multiplied by the quantity of shares. In this scenario, the initial ES contract price was S$15.30, and the settlement price after three weeks was S$16.00. The quantity of shares is 20,000. Therefore, the unrealised gain is (S$16.00 – S$15.30) 20,000 = S$0.70 20,000 = S$14,000. It is important to note that this calculation, as per the CMFAS Module 6A syllabus, does not take into account brokerage commissions or CDP clearing fees.

In a First-to-Default Credit Linked Note (CLN), the note holder is exposed to the risk of the first entity in a basket to default. When there is lower correlation between the entities in the basket, their default probabilities are considered more independent. This independence means there are more distinct ‘paths’ or scenarios through which a first default can occur, effectively increasing the overall probability that at least one of the entities will default first. To compensate for this higher aggregate probability of a first default, investors (note holders) will demand a higher yield. Conversely, if the entities were perfectly correlated, the risk would be akin to that of a single entity, as they would likely default together or not at all, leading to a lower required yield compared to a low-correlation scenario.

The question describes a scenario for a structured product with early redemption features. The observation date is 15 September 2015. According to the product terms provided in the case study, this date corresponds to the second early redemption observation, occurring at Year 1.5 from the initial date. First, calculate the returns for both underlying indices from their initial values to the observation date. For Nikkei 225 (R1), the return is ((16,500 – 15,000) / 15,000) 100% = 10%. For S&P 500 (R2), the return is ((1,900 – 1,800) / 1,800) 100% ≈ 5.56%. Next, compare the returns to determine if the early redemption condition is met: R1 (10%) is greater than or equal to R2 (5.56%). Since R1 ≥ R2, the early redemption condition (Knock Out/Mandatory Call) is met. As the condition is met at the Year 1.5 observation, the product is called, and the investor receives the payout price specified for that specific observation date. Based on the payout schedule for early redemption (as per the illustration on page 305), the payout for Year 1.5 is 112.80% of the initial investment. The other options represent payouts for different observation periods, maturity payouts, or scenarios where the early redemption condition is not met.

For a call option, it is considered ‘in-the-money’ (ITM) when the current market price of the underlying asset is higher than the option’s strike price. The intrinsic value of a call option is calculated as the difference between the current market price and the strike price, but only if this difference is positive. If the option is out-of-the-money or at-the-money, its intrinsic value is zero. In this scenario, the underlying asset is trading at $53 and the call option’s strike price is $50. Since $53 is greater than $50, the call option is in-the-money. The intrinsic value is calculated as $53 (current market price) – $50 (strike price) = $3. Therefore, the option is in-the-money with an intrinsic value of $3.