CMFAS RES6A Quiz 28

The 5-year Singapore Government Bond Futures contract explicitly states ‘Daily Price Limit: None’ in its specifications. This means that unlike some other futures contracts which might have circuit breakers or price bands, this particular contract allows for prices to move freely without any upper or lower limits within a trading day. This characteristic facilitates continuous price discovery, enabling the market to reflect real-time supply and demand dynamics and investor sentiment without artificial restrictions or trading halts triggered by price movements. The absence of daily price limits ensures that the market can react immediately and fully to new information, potentially leading to higher volatility but also greater efficiency in price formation.

When an investor’s margin account balance falls below the maintenance margin level due to adverse market movements, a margin call (also known as an additional margin call) is issued. The purpose of this call is to ensure that the investor maintains sufficient collateral to cover potential future losses. According to futures market rules, when a margin call occurs, the investor is required to deposit additional funds to bring the account equity back up to the initial margin level, not just the maintenance margin level. This requirement provides a buffer against further market fluctuations and ensures the integrity of the clearing system. Failing to meet a margin call typically results in the forced liquidation of the investor’s position by the broker.

Basis risk arises when the asset being hedged is not perfectly matched by the underlying asset of the futures contract used for hedging. The provided text explicitly states that basis risk occurs because ‘The underlying asset in the futures contract is not completely identical.’ In the given scenario, the firm is hedging a ‘specialized alloy’ with a ‘broadly traded metal futures contract.’ The difference in specific characteristics between the specialized alloy and the generic metal futures means their prices may not move in perfect correlation, leading to a fluctuating basis and thus residual exposure, which is basis risk. While other factors like uncertainty about the exact transaction date or early liquidation of the futures contract can also contribute to basis risk, the scenario’s focus on the ‘unexpected price fluctuations between the specialized alloy and the generic metal futures’ most directly points to the asset mismatch as the primary cause.

An accumulator is a structured note that obligates an investor to purchase a predetermined quantity of a reference stock at regular intervals, typically at a discounted strike price. In a ‘1X2 gear’ accumulator, the quantity of shares the investor must purchase depends on the daily closing price of the underlying stock relative to the strike price and a knock-out barrier. If the daily closing price is above the strike price but remains below the knock-out barrier, the investor is required to purchase 1X the predefined quantity of shares. If the daily closing price falls below the strike price, the investor must purchase 2X the predefined quantity. The agreement is immediately terminated if the daily closing price is at or above the knock-out barrier. In the given scenario, the closing price of SGD 13.50 is above the strike price of SGD 12.00 but below the knock-out barrier of SGD 15.00, thus triggering the 1X purchase obligation.

The question assesses understanding of the liquidity and early exit characteristics of different equity-linked structured products. An Equity Linked Exchange Traded Fund (ETF) is designed to be traded on an exchange, allowing investors to sell their position on any trading day, thus offering high liquidity and flexibility without being subject to specific structural triggers or significant surrender penalties. Equity Linked Structured Notes and Structured Funds, however, typically allow early redemption only if specific barrier options are part of their structure, meaning the ability to exit is conditional. For an Equity Linked Investment-Linked Policy (ILP), while surrender is possible, the terms often indicate that an earlier surrender is likely to result in a greater potential loss, which acts as a disincentive or penalty for early exit.

The structured product’s yield is determined by the formula: 0.50% + [4.00% x n/N]. In this specific scenario, ‘n’ represents the number of days the HSI fixed within the defined accrual range (between 22,200 and 22,400). The question states that the HSI fixed within this range for 150 days. The total number of trading days, ‘N’, is given as 250. Therefore, we substitute n = 150 and N = 250 into the formula. The calculation proceeds as follows: First, determine the ratio n/N, which is 150/250 = 0.6. Next, calculate the variable component of the yield: 4.00% x 0.6 = 2.40%. Finally, add the fixed component to the variable component: 0.50% + 2.40% = 2.90%. This represents the investor’s simple annualized return. The other options are incorrect because: 4.50% would be the return if the HSI had fixed within the accrual range for all 250 days. 2.10% is the return from a different scenario where the accrual stopped after 100 days due to a knock-out event, which did not occur in this case. 0.50% would imply that no variable coupon was earned, which is incorrect as the HSI was within the range for 150 days.

The Interest Rate Parity (IRP) theory posits that the difference in interest rates between two countries should be equal to the forward premium or discount between their currencies in the foreign exchange market. This relationship holds to prevent risk-free arbitrage opportunities. If Country Alpha has higher domestic interest rates than Country Beta, investors would theoretically be incentivized to invest in Country Alpha’s assets to earn the higher return. To counteract this, and to ensure no arbitrage profit can be made, Country Alpha’s currency must trade at a forward premium against Country Beta’s currency. This means that the forward exchange rate would reflect an appreciation of Country Alpha’s currency relative to its spot rate against Country Beta’s currency. Conversely, Country Beta’s currency would trade at a forward discount against Country Alpha’s currency. This forward premium or discount effectively offsets the interest rate differential, making the return on an investment in either currency, when hedged against exchange rate risk, approximately equal.

The question describes an investor’s preference for an equity-linked product with high liquidity (daily exchange trading) and a generally lower overall cost structure. An Equity Linked Exchange Traded Fund (ETF) is designed to be traded on an exchange throughout the day, offering significant liquidity. Furthermore, ETFs are known for their generally low total expense ratios (TERs) and transparent fee structures, which typically include low brokerage fees and recurring management and administration fees. In contrast, Equity Linked Structured Notes often have higher product costs due to their complexity and use of derivatives, and their early redemption is typically tied to specific barrier options rather than daily exchange trading. Equity Linked Structured Funds also tend to have higher upfront, recurring, and back-end fees compared to ETFs, and their liquidity is similarly tied to barrier options. Equity Linked Investment-Linked Policies (ILPs) involve a more complex fee structure encompassing insurance charges and various investment charges, and their liquidity is primarily through policy surrender, which can incur significant losses if done early.

To determine the net profit or loss, we must calculate the gross profit from the price difference and then subtract all associated expenses, including commissions, GST on commissions, and financing interest. 1. Calculate Total Purchase Value (Buy): 8,000 units $2.50/unit = $20,000.00 2. Calculate Buy Transaction Costs: Commission (Buy): $20,000 0.35% = $70.00 GST on Commission (Buy): $70.00 8% = $5.60 Total Transaction Cost (Buy): $70.00 + $5.60 = $75.60 3. Calculate Total Sales Value (Sell): 8,000 units $2.75/unit = $22,000.00 4. Calculate Sell Transaction Costs: Commission (Sell): $22,000 0.35% = $77.00 GST on Commission (Sell): $77.00 8% = $6.16 Total Transaction Cost (Sell): $77.00 + $6.16 = $83.16 5. Calculate Financing Interest: Annual Interest: $20,000 (initial purchase value) 5.5% = $1,100.00 Daily Interest: $1,100.00 / 360 days = $3.0555… Interest for 7 days: $3.0555… 7 = $21.3888… (rounded to $21.39) 6. Calculate Total Expenses Incurred: $75.60 (Buy Costs) + $83.16 (Sell Costs) + $21.39 (Financing) = $180.15 7. Calculate Net Profit/Loss: Gross Profit: $22,000.00 (Sales Value) – $20,000.00 (Purchase Value) = $2,000.00 Net Profit: $2,000.00 – $180.15 (Total Expenses) = $1,819.85

The question describes an investor’s specific requirements for a CFD order: immediate execution at the current market price, coupled with a mechanism for any unfulfilled portion of the order to remain active at the price where the initial part was executed. This precise combination of features is characteristic of a Market-to-Limit Order. A Market-to-Limit Order aims to execute at the prevailing market price, and if it is only partially filled, the remaining quantity stays in the market at the price at which the executed portion was filled. In contrast, a Limit Order prioritizes price over immediate execution, and any unfilled part remains at the specified limit price. A Market Order seeks immediate execution at the best available price but does not explicitly detail the behavior of partially filled orders remaining open at the executed price in the same way. A Stop Entry Order is a contingent order designed to enter the market when a specific price threshold is crossed, not for immediate execution at the current market price with these specific partial fill rules.

The investor’s primary concerns are mitigating counterparty risk and ensuring the ability to easily exit the position before maturity. Futures contracts are traded on regulated exchanges, which provides a central clearing mechanism that effectively eliminates counterparty risk. The daily mark-to-market procedures further ensure that positions are settled regularly, reducing accumulated risk. Additionally, being exchange-traded and standardised, futures contracts benefit from an active secondary market, allowing investors to easily offset their positions before expiry. In contrast, forward contracts are private, over-the-counter agreements negotiated directly between two parties. They are not centrally cleared, exposing investors to counterparty risk. Furthermore, forward contracts are non-standardised and lack an active secondary market, making it difficult to exit a position before its maturity.

A Zero Coupon Fixed Income Plus Option Strategy, often referred to as a ‘Zero Plus’ option, is designed to offer capital preservation along with potential for upside returns. The capital preservation aspect typically comes from the zero-coupon fixed income instrument, which is expected to return the principal sum at maturity, assuming no credit event from the issuer. The upside potential, however, is derived from the embedded call option. The return beyond the initial principal is directly linked to the performance of the underlying financial instrument (e.g., an equity index, commodity, or currency pair). Specifically, this upside is realized if the underlying asset’s price at the fixing date exceeds a predetermined strike price. The extent of the investor’s participation in this positive performance is then determined by the ‘participation rate’. Therefore, the combination of the underlying instrument’s performance above the strike price and the participation rate dictates the additional returns. The other options are incorrect because zero-coupon notes do not provide fixed coupon payments; their return is from the difference between the purchase price and the face value at maturity. The credit rating of the issuing bank is crucial for assessing the risk of principal loss (credit risk) but does not determine the upside investment returns. Lastly, while an option premium is involved in the structure, it is typically embedded and does not directly dictate the maximum possible gain; rather, the participation rate and the underlying asset’s performance are the key drivers of potential upside.

A standard stop-loss order is designed to become a market order once the specified stop price is reached. In highly volatile market conditions, especially when there are significant price gaps where no transactions occur at the stop price, the triggered market order will be executed at the next available price. This often results in an execution price that is worse than the intended stop-loss price, a phenomenon known as slippage. The CFD provider cannot guarantee execution at the exact stop price under such conditions unless a premium service like a ‘guaranteed stop-loss’ is utilized. The order would not be automatically cancelled, nor would it convert into a limit order, as its primary function is to close the position once the stop price is breached.

Structured funds, under Singapore’s regulatory framework, are governed by the Code on Collective Investment Schemes (CIS) under the Securities & Futures Act (SFA). A key requirement for these funds is the regular provision of Net Asset Values (NAVs) to ensure transparency and proper valuation. In contrast, structured notes and structured deposits are generally not subject to this specific requirement for regular NAV reporting. This distinction highlights a significant difference in the ongoing operational and disclosure obligations between these product types. Regarding fees, structured funds typically have separate fund management and administration fees, whereas structured deposits and notes often embed their fees within the product’s pricing, such as through a lower yield or participation rate. Furthermore, structured funds must be managed by an asset management company holding a Capital Markets Services (CMS) license.

The question describes a situation where a regulatory body wants to moderate the pace of transactions during high market volatility without completely stopping trading. This specific function aligns with the definition of ‘Shock Absorbers’ as outlined in the CMFAS Module 6A syllabus. Shock absorbers are systems in the trading infrastructure that slow down trading when markets experience significant volatility, but they do not halt trading completely. In contrast, ‘Circuit Breakers’ trigger trading halts, completely pausing market activity. ‘Limits’ impose session or daily price restrictions to curb volatility without necessarily slowing or halting trading activity. The option referring to a comprehensive assessment framework for a nation’s environment describes ‘Country Risk’ (specifically the PESTLE framework), which is a type of investment risk but not a tool for mitigating market disruption in the manner described.

The trustee in a structured fund holds a critical role in investor protection. Its fundamental responsibility, as outlined in the trust deed, is to act as an independent custodian of the fund’s assets. This ensures that the assets are held separately and securely. Furthermore, the trustee is tasked with overseeing the fund manager to ensure that all operations, investment decisions, and administrative actions are conducted strictly in accordance with the terms and conditions stipulated in the trust deed. This oversight minimizes the risk of mismanagement and safeguards the interests of the unit holders. The other options describe responsibilities typically associated with the fund manager (formulating strategy, executing transactions), distributors (managing distribution, handling queries, processing subscriptions/redemptions), or financial advisors (offering personalized advice), not the trustee.

To determine the number of Treasury bond futures contracts to sell, two main steps are required. First, calculate the hedge ratio, which measures the relative price sensitivity of the bond to be hedged compared to the cheapest-to-deliver (CTD) bond underlying the futures contract. The formula for the hedge ratio is: Hedge ratio = (PVBP of hedge security) / (PVBP of most deliverable bond × Conversion factor for most deliverable bond). Given: PVBP of bond to be hedged = 0.5800 PVBP of cheapest-to-deliver issue = 0.6750 Conversion factor for cheapest-to-deliver issue = 0.93 Hedge ratio = 0.5800 / (0.6750 × 0.93) Hedge ratio = 0.5800 / 0.62775 Hedge ratio ≈ 0.9238596 Second, calculate the number of futures contracts using the hedge ratio, the total value of the bond position to be hedged, and the par value of one futures contract. The formula is: Number of contracts = – Hedge ratio × (Total value to be hedged / Par value of futures contract). Given: Total value to be hedged = USD 35,000,000 Par value of futures contract = USD 100,000 Number of contracts = – 0.9238596 × (USD 35,000,000 / USD 100,000) Number of contracts = – 0.9238596 × 350 Number of contracts ≈ – 323.35 Since contracts must be in whole numbers, Sarah should sell 323 contracts. The negative sign indicates a short position (selling futures) is required to hedge a long bond position.

The scenario describes issues arising from a poorly implemented internal system update and insufficient staff training, leading to delayed or incorrect processing of client instructions. This directly aligns with the definition of operational risk, which refers to risks due to the operations of the issuer and the risk of business operations failing as a result of human errors or breakdown of internal procedures and systems. Issuer risk relates to the counterparty’s ability to fulfill obligations. Concentration risk pertains to an uneven allocation of funds across a limited number of instruments. Liquidity risk concerns the ability to buy or sell financial instruments without significant price impact or delay. Therefore, the situation presented is a clear illustration of operational risk.

UCITS regulations, which govern many ETFs in Europe, impose specific limits on counterparty risk exposure for funds that use derivative instruments like swaps. The regulations stipulate that a UCITS-compliant ETF is not permitted 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 maximum amount that a single swap counterparty can owe to the fund is capped at 10% of the fund’s NAV. This limit is crucial for managing the credit risk associated with synthetic replication strategies. While fund managers may voluntarily set lower limits, the regulatory maximum remains 10%. Options such as 5%, 15%, or 25% are incorrect as they do not align with the specific UCITS regulatory requirement for single counterparty exposure.

A synthetic short put position is constructed by holding a long position in the underlying asset and simultaneously selling a call option on that same asset with the same expiration date and strike price. In this scenario, the investor already holds the shares (long underlying). To replicate the payoff profile of a short put option, the investor needs to sell a call option. This strategy allows the investor to collect premium income and benefits if the stock price remains stable or declines slightly, similar to a short put position. Purchasing a put option would either be a speculative long put position or a protective put if combined with the underlying shares, which aims to limit downside risk, not replicate a short put. Simultaneously buying a call and selling a put (with the same strike and expiration) is a synthetic long stock position. Short selling the underlying and buying a call option creates a synthetic long put position.

Credit Linked Notes (CLNs) and Bond Linked Notes (BLNs) are both structured products designed to offer yield enhancement, but they achieve this through different embedded derivatives and, consequently, expose investors to distinct primary risks that trigger their payouts. A CLN’s payout is fundamentally tied to the creditworthiness of a specified ‘reference entity’. The investor in a CLN effectively sells credit protection (similar to a Credit Default Swap) on this reference entity. Therefore, a potential loss of principal or reduced return in a CLN is triggered by a credit event, such as a default, by the reference entity. In contrast, a BLN embeds a short-put option on a particular bond. The payout of a BLN, and the potential for the investor to receive the underlying bond instead of their principal, is determined by the price performance of that specific bond. Bond prices can be affected by a wider range of factors than just a credit default, including credit downgrades, widening credit spreads, and changes in interest rates. Thus, the core difference lies in the primary event that dictates the product’s performance and potential impact on principal: a credit event for a CLN versus the price movement of an underlying bond for a BLN.

FX warrants are leveraged instruments that allow investors to speculate on or hedge against currency movements. The price of an FX warrant is driven by changes in the exchange rate between two underlying currencies. When considering a currency pair like SGD/JPY, the first currency (SGD) is the base currency, and the second (JPY) is the quote currency. An investor who anticipates the Singapore Dollar (SGD) to appreciate against the Japanese Yen (JPY) is bullish on SGD and bearish on JPY. This means they expect the SGD/JPY exchange rate (the amount of JPY one SGD can buy) to increase. To profit from an increase in the underlying exchange rate, the investor would buy a call warrant on that currency pair. Therefore, buying an SGD/JPY call warrant is the appropriate strategy. Conversely, an SGD/JPY put warrant would profit if the SGD depreciated against the JPY, causing the SGD/JPY exchange rate to fall. A JPY/SGD call warrant would imply a belief that JPY will appreciate against SGD, which is the opposite of the investor’s view.

In a First-to-Default Credit Linked Note (CLN), the yield required by the note holder is influenced by several factors, including the correlation among the underlying reference entities in the basket. The syllabus material indicates that correlation between the companies is inversely proportional to the number of risk factors of the note. When correlation is lower, there are more independent risk factors, leading to a higher probability of a first default across the basket and thus a higher required yield. Conversely, if the correlation among the entities increases, the effective number of independent risk factors within the basket is reduced. This means the default events of the companies are more likely to occur together, making the first-to-default risk of the entire basket behave more similarly to the risk of a single entity rather than the cumulative risk of multiple independent entities. For example, in a perfectly correlated scenario, the note holder effectively assumes the risk of only one company. This reduction in the effective number of independent risk factors lowers the overall probability of a first default occurring within the basket, and consequently, the yield required by the note holder to compensate for this risk would decrease.

Effective gearing is the most appropriate metric to consider when an investor wants to understand the true sensitivity of a warrant’s price to changes in the underlying asset’s price, relative to the investment outlay. While the gearing ratio indicates how many more warrants can be bought for a certain amount of capital compared to buying the underlying share, it does not account for the warrant’s delta. Delta measures the rate at which the warrant price changes with respect to changes in the underlying asset’s price. By multiplying delta by the gearing ratio, effective gearing provides a more refined measure of the warrant’s leverage, showing the actual percentage change in the warrant’s value for a given percentage change in the underlying asset, taking into account the warrant’s specific sensitivity. The absolute value of delta alone only indicates the change in warrant price per unit change in the underlying, not the amplified effect relative to the investment. Time decay is a crucial factor affecting warrant prices over time, but it does not directly quantify the leverage or sensitivity to underlying price movements in the same way gearing and delta do.

To calculate the total expenses incurred for a CFD transaction, all applicable costs must be summed up. These typically include commission on both the buy and sell transactions, Goods and Services Tax (GST) on these commissions, and financing interest for the period the position is held. 1. Calculate Commission and GST on Purchase: Purchase Value = 5,000 shares × $4.50/share = $22,500 Commission on Purchase = $22,500 × 0.35% = $78.75 GST on Purchase Commission = $78.75 × 8% = $6.30 Total Transaction Cost (Buy) = $78.75 + $6.30 = $85.05 2. Calculate Commission and GST on Sale: Sale Value = 5,000 shares × $4.80/share = $24,000 Commission on Sale = $24,000 × 0.35% = $84.00 GST on Sale Commission = $84.00 × 8% = $6.72 Total Transaction Cost (Sell) = $84.00 + $6.72 = $90.72 3. Calculate Financing Interest: Financing interest is typically calculated on the initial purchase value (or the full notional value of the position) for the duration the position is open. Annual Financing Rate = 5.5% Number of days = 15 Interest = Purchase Value × (Annual Rate / 360 days) × Number of days Interest = $22,500 × (0.055 / 360) × 15 = $51.5625 (rounded to $51.56) 4. Calculate Total Expenses: Total Expenses = Total Transaction Cost (Buy) + Total Transaction Cost (Sell) + Financing Interest Total Expenses = $85.05 + $90.72 + $51.56 = $227.33 Therefore, the total expenses incurred by Mr. Tan for this CFD transaction are $227.33.

Structured products are designed to cater to specific investor needs that cannot be met by traditional financial instruments. One common need is capital preservation combined with participation in market upside. The principal component of a structured product is typically constructed using a low-risk fixed income instrument, such as a zero-coupon bond. This bond is purchased at a discount and structured to mature at a value equal to the investor’s initial capital, thereby ensuring the return of the principal amount at maturity. The remaining portion of the investment is then allocated to the return component, often through derivatives like options, to provide exposure to the underlying asset’s potential gains. The other options describe alternative investment strategies or misrepresent the typical mechanism for principal preservation within a structured product.

Eurodollar futures contracts have specific minimum price fluctuations depending on the contract month. For the spot month, the minimum price fluctuation is 0.0025 point, which equates to USD 6.25. However, for all other contract months (i.e., not the spot month), the minimum price fluctuation is 0.0050 point. Given that the contract size for Eurodollar futures is USD 1,000,000, a 0.0050 point movement translates to a monetary value of USD 12.50 (calculated as 0.0050% of USD 1,000,000, or simply referring to the provided specification). Therefore, for a contract that is not in its spot month, the smallest possible change in value is USD 12.50.

The provided syllabus material states that when a futures contract settles at its limit bid or offer, the limit may be widened for the next trading session. This action is taken by the exchange to facilitate transactions and help futures prices return to a level reflective of the current market environment. Therefore, expanding the daily price limit for the subsequent session is a typical response. Automatic liquidation of all open positions is not a standard procedure when a limit is hit; rather, margin calls are issued if an investor’s account falls below minimum margin requirements due to losses. Indefinite suspension of trading is also not the standard response; adjustments to limits are preferred to allow trading to continue. A mandatory margin call is not issued to all participants irrespective of their account equity; margin calls are triggered when an individual investor’s account no longer meets performance requirements, typically due to losses or increased positions, not simply because a price limit was reached.

The scenario describes a trader aiming for long-term interest rate exposure across multiple consecutive quarterly Eurodollar futures contracts, with a critical need to avoid legging risk (individual orders failing or being partially filled). A futures bundle is specifically designed for this purpose. It allows investors to buy or sell a predefined number of futures contracts in each consecutive quarterly delivery month for two or more years, executing them in a single transaction at a single price. This eliminates the need for multiple orders, reduces overall trading costs, and crucially limits the possibility of some orders going unfilled, directly addressing the legging risk mentioned. A futures pack, while similar, is limited to four consecutive delivery months, which may not be sufficient for ‘long-term interest rate exposure’ across a broader range of quarterly contracts. Trading individual futures contracts would expose the trader to the very legging risk the question seeks to mitigate. The mutual offset system facilitates the transfer of positions between different exchanges (like SGX-DC and CME) and is not primarily designed to manage the execution risk of multi-leg strategies within a single product on one exchange.

The question describes a fund manager’s decision regarding how returns will be distributed to investors – either through consistent income streams (like fixed or variable coupons) or through returns that fluctuate based on market movements (participative returns linked to an underlying asset). This directly corresponds to the ‘Degree of Payout Schedule’ component of a structured fund, which defines whether the fund offers fixed/variable coupons, participative returns, or a combination of both. The choice of the underlying asset refers to the specific assets or indices the fund invests in (e.g., equities, bonds, commodities). The anticipated view on market scenarios relates to the fund’s strategy based on the market outlook (bullish, bearish, or market-neutral). The choice of maturity refers to the fund’s duration (short-term, medium-term, long-term, or open-ended). Therefore, the consideration of prioritizing consistent income versus amplified gains from market movements falls under the payout schedule.