CMFAS RES6A Quiz 29

The Barrier Capital Preservation Certificate (Straddle) is specifically designed for investors who anticipate the underlying asset to trade within a defined range, without a strong directional bias (neither sharply rising nor falling), while also desiring capital preservation. This product incorporates both an upper and a lower knock-out barrier, allowing for participation in either upward or downward movements until one of the barriers is breached. If no knock-out event occurs, the investor receives a capped return at maturity along with the agreed capital amount. In contrast, a Standard Knock-Out Call is suitable for a rising underlying, a Barrier Reverse Convertible is effectively a bond combined with a short knock-out put, making it more suitable for stable-to-rising underlying scenarios, and a Barrier Capital Preservation Certificate (Shark’s Fin) primarily features an up-and-out call, making it suitable for a rising underlying with a capped upside.

A Mandatory Call Event (MCE) for a Bull Callable Bull/Bear Contract (CBBC) is triggered when the underlying asset’s spot price touches or falls below the specified Call Price. In the given scenario, the spot price of $9.90 falls below the Call Price of $10.00, thereby triggering an MCE. When an MCE occurs, the CBBC expires early, and its trading terminates immediately. For an R-Category CBBC, the Call Price is different from the Strike Price (as seen with $10.00 Call Price and $9.50 Strike Price), and the holder is eligible to receive a small cash payment, known as the Residual Value. This characteristic differentiates it from an N-Category CBBC, where the Call Price equals the Strike Price, and no residual value is paid upon an MCE.

The Barrier Capital Preservation Certificate (Straddle) is designed for investors who do not have a firm directional view on the underlying asset but expect it to trade within a specific range, avoiding large price swings. A key characteristic is the expectation that realised volatility will be higher than current implied volatility, making the strategy attractive relative to its potential payout. It incorporates both an upper and a lower knock-out barrier, providing capital preservation at maturity if neither barrier is breached. In contrast, a Knock-Out Call is suitable for a rising underlying, and a Knock-Out Put for a falling underlying. A Barrier Reverse Convertible involves being short a knock-out put option, typically for investors seeking enhanced yield with a view that the underlying will stay above a certain level, rather than a range-bound view with higher realised volatility expectations relative to implied volatility.

The Product Highlights Sheet (PHS), as mandated by MAS guidelines for products offered to retail investors, is designed to provide a clear, concise, and prominent summary of the product’s essential characteristics. This includes its key features, the associated risks, and all relevant fees and charges. The primary objective is to empower retail investors to quickly understand the core aspects of a potentially complex financial product, thereby enabling them to make an informed investment decision. It does not replace the comprehensive prospectus or offering document, which contains the full legal terms and conditions, but rather complements it. The PHS is a disclosure document, not a legally binding contract itself, nor does it guarantee product suitability for all investors or minimal investment risk; suitability assessment is a separate process conducted by the financial adviser.

The portfolio manager’s objective is to profit from a moderate upward movement in the stock price while limiting potential losses. A bull call spread is specifically designed for a moderately bullish market view, offering limited upside profit potential and, crucially, limited downside risk. It involves buying an in-the-money call option and simultaneously selling a higher strike out-of-the-money call option with the same expiration date. This strategy reduces the net cost of establishing a bullish position compared to a naked long call, and the short call caps the maximum potential loss. A long strangle is suitable for anticipating significant volatility (either up or down) but not a specific directional moderate move. Selling a naked call option carries unlimited risk, which contradicts the goal of capping potential losses. Buying a long put option is a bearish strategy, directly opposing the manager’s bullish outlook.

The question describes a barrier feature where the option is initially inactive and only becomes active if the underlying asset price reaches a specific level. This characteristic precisely defines a knock-in barrier option. Conversely, a knock-out barrier option is active from issuance but terminates if the barrier level is breached. American and Bermudan barrier options relate to the timing of when the barrier event can be observed (any time during the product’s life for American, or on specified dates/intervals for Bermudan), rather than the initial activation status of the option itself.

The primary mechanism for correcting an ETF’s market price when it trades at a premium or discount to its Net Asset Value (NAV) is arbitrage, facilitated by Authorized Participants (APs). When an ETF trades at a premium, APs can profit by purchasing the underlying basket of securities that the ETF tracks. They then deliver this basket to the ETF issuer in exchange for new ETF units (creation process). These newly created ETF units are then sold on the secondary market. This action increases the supply of ETF shares in the market, which in turn puts downward pressure on the ETF’s market price, bringing it closer to its NAV. This process ensures that the ETF’s market price generally stays in line with its underlying value. The fund’s portfolio manager’s role is to manage the portfolio to track the underlying index, not to directly correct market price discrepancies through rebalancing. While increased selling pressure from existing ETF holders might contribute to price adjustment, it is the systematic, large-scale activity of APs that constitutes the primary arbitrage mechanism. Exchanges do not automatically adjust ETF trading prices to match NAV; price discovery is market-driven.

A diagonal spread is defined by its construction using options on the same underlying security but with both different strike prices and different expiration dates. This makes it a combination of characteristics found in both vertical and horizontal spreads. A vertical spread involves options with the same underlying, same expiration month, but different strike prices. A horizontal (or calendar) spread uses options on the same underlying, same strike prices, but with different expiration dates. A condor spread is a variation of a butterfly spread, typically involving four options with four distinct strike prices, usually with the same expiration date, designed to profit from limited price movement within a wider range.

When a futures position is initiated, the investor is required to deposit an initial margin. The maintenance margin is the minimum amount of funds that must be maintained in the account at all times. A margin call (request for additional margin) is triggered when the account equity falls below this maintenance margin level. To calculate the maximum loss a trader can incur before receiving a margin call, one must determine the difference between the initial margin and the maintenance margin. First, calculate the initial margin: 8% of $150,000 = $12,000. Next, calculate the maintenance margin: 75% of the initial margin = 0.75 $12,000 = $9,000. The maximum loss before an additional margin call is then the initial margin minus the maintenance margin: $12,000 – $9,000 = $3,000.

For Over-The-Counter (OTC) options, counterparty credit risk is a significant concern because there is no central clearing house to guarantee the obligations. To mitigate this risk, parties typically enter into a legal agreement known as a Credit Support Annex (CSA). The CSA defines the terms under which collateral is posted or transferred between the counterparties. This collateral serves to reduce the potential loss if one party defaults on its contractual obligations, thereby managing the credit exposure arising from the derivative positions. Other options like circuit breakers are for market disruption risk, maturity concentration controls are for market risk, and premium payment limits are a specific type of credit risk control, but the CSA is the primary mechanism for collateralizing counterparty risk in OTC derivatives.

The question requires calculating the early redemption payout for the structured fund. The initial investment is SGD 100,000. The fund’s initial date was 16 March 2014, and the early redemption occurred on 15 September 2015. First, determine the number of observation periods. The fund is call protected for the initial 1-year period. The first early redemption observation date is 15 March 2015 (1 year after inception). Thereafter, observation dates occur every 6 months. The redemption on 15 September 2015 marks the second observation period (15 March 2015 to 15 September 2015). Therefore, the ‘No. of Observations’ is 2. The ‘Periodic Yield’ is stated as 4.25%. The total accrued yield percentage for early redemption is calculated as ‘Periodic Yield x No. of Observations’ = 4.25% x 2 = 8.5%. The product’s investment objective includes ‘Capital preservation – 100% of investment capital payable to investor’ and ‘Attractive yield based on market performance’. This means the investor receives their initial principal back plus the accrued yield. So, the total payout amount is the initial investment plus the accrued yield. Total Payout = Initial Investment + (Initial Investment x Total Accrued Yield Percentage) Total Payout = SGD 100,000 + (SGD 100,000 x 0.085) Total Payout = SGD 100,000 + SGD 8,500 Total Payout = SGD 108,500.

When a company declares dividends, the price of its shares typically falls by the dividend amount on the ex-dividend date. For call warrants, this reduction in the underlying share’s value would disadvantage warrant holders if no adjustment were made. To compensate warrant holders for this dilution, the exercise price of the call warrant is typically reduced. The adjustment factor formula for dividends, (P – SD – ND) / (P – ND), shows that both Special Dividends (SD) and Normal Dividends (ND) contribute to lowering the numerator more than the denominator (if SD > 0), resulting in an adjustment factor less than 1. When this factor is multiplied by the old exercise price, it results in a new, lower exercise price. This ensures that the warrant holder is not unfairly penalized by the company’s dividend distribution.

A structured note is a hybrid financial instrument that combines a traditional debt instrument (like a bond) with one or more derivative components. Its return characteristics, such as coupon payments or the final principal amount, are directly tied to the performance of an underlying asset or index, which could be equities, interest rates, commodities, or a basket of these. A crucial aspect is that the note holder typically does not have direct ownership or claim over these underlying instruments. Furthermore, while some structured notes may offer principal protection, it is often not guaranteed, and investors are exposed to the credit risk of the issuer, as well as the market risk of the underlying assets. The derivative component allows for customized risk-return profiles but also introduces complexity and potential for capital loss. Option 1 accurately captures these core characteristics: it is a debt instrument, its returns are linked to underlying assets via embedded derivatives, and principal repayment is often not guaranteed. This aligns with the fundamental definition and features of structured notes as outlined in the CMFAS Module 6A syllabus. Option 2 is incorrect because structured notes do not grant direct ownership claims over underlying assets. Additionally, their coupon payments are generally not fixed and are instead contingent on the performance of the underlying, making them subject to market fluctuations. Option 3 is incorrect because a structured note is not solely a pure derivative contract; it is a debt instrument with embedded derivatives. More importantly, principal protection is not an inherent guarantee for all structured notes; it depends on the specific structure, and many carry the risk of principal loss. Option 4 is incorrect as structured notes deviate significantly from traditional debentures. Traditional debentures typically offer fixed interest rates and their market value is primarily influenced by prevailing interest rates and the issuer’s creditworthiness. Structured notes, however, have variable returns linked to underlying asset performance, making them distinct from conventional fixed-income instruments.

The premium percentage for a call warrant is calculated using the formula: Premium (%) = [((Conversion Ratio × Warrant Price) + Exercise Price – Share Price) / Share Price] × 100. In this scenario, the share price (S) is $12.50, the exercise price (X) is $12.00, the warrant price (WP) is $0.60, and the conversion ratio (n) is 4. First, calculate the total cost of acquiring the underlying share through the warrant: (n × WP) + X = (4 × $0.60) + $12.00 = $2.40 + $12.00 = $14.40. Next, determine the difference between this total cost and the current market share price: $14.40 – $12.50 = $1.90. Finally, divide this difference by the current share price and multiply by 100 to express it as a percentage: ($1.90 / $12.50) × 100 = 0.152 × 100 = 15.20%. This value represents the percentage by which the effective cost of obtaining the underlying share via the warrant exceeds its current market price.

Company warrants are typically issued by the underlying listed company, often as a ‘sweetener’ with bond or rights issues. When exercised, the company issues new shares, implying physical settlement. They are generally long-dated, with maturities of 3-5 years. In contrast, structured warrants are issued by third-party financial institutions and are based on various underlying instruments. Structured warrants listed on the SGX-ST are typically cash-settled, meaning the holder receives a cash payment equal to the intrinsic value at expiry, rather than physical delivery of the underlying asset. They usually have a shorter maturity, often less than one year. Therefore, the distinction in issuer and settlement method is a key characteristic.

The question pertains to the ‘Anticipated View on Market Scenarios’ component of a structured fund, as outlined in the CMFAS Module 6A syllabus, Chapter 8.1.5. An investor’s outlook on market scenarios (bullish, bearish, or market-neutral) directly dictates the investment strategy and the specific financial instruments, particularly underlying assets and derivatives, that will be selected and combined to achieve returns aligned with that view. For instance, a bullish view might lead to the use of call options or equity-linked derivatives, while a bearish view might involve put options or inverse strategies. The other options represent distinct components of a structured fund: the payout schedule (fixed/variable coupons, participative returns), the choice of maturity (short, medium, long-term, or open-ended), and aspects related to principal preservation (fixed income portion’s credit rating), which, while important, are not the primary way an anticipated market view influences the fund’s core return-generating design.

The effectiveness of a hedge is not static and can be influenced by evolving market conditions. Changes in volatilities of the underlying assets or shifts in yield spread relationships directly impact the risk profile that the hedge is designed to mitigate. To maintain the desired level of risk reduction and ensure the hedge remains effective, a portfolio manager would need to re-evaluate and potentially adjust the hedge ratio in response to such dynamic market developments. The initial calculation of futures contracts is part of the hedge’s setup, not an ongoing market development prompting adjustment. The projected value of the basis at the lift date is primarily a factor for evaluating the hedge’s performance after it has been closed out, identifying sources of error, rather than a trigger for mid-hedge adjustments. Lastly, if the original beta of the equity portfolio remains constant, it implies that the systematic risk exposure of the portfolio has not changed in that regard, and thus, this specific factor would not necessitate an adjustment to the hedge ratio.

Delta measures the sensitivity of an option’s price to a change in the underlying asset’s price. Specifically, it indicates how much the option’s premium is expected to change for every $1 movement in the underlying share price. For a call option, Delta is a positive value between 0 and 1. If the underlying share price increases, the call option’s premium is expected to increase. To calculate the anticipated change in the option’s premium, one multiplies the option’s Delta by the change in the underlying share price. In this scenario, a Delta of 0.72 multiplied by a $2.50 increase in the underlying share price yields an expected increase of $1.80 in the call option’s premium.

When an investor short-sells a stock and simultaneously buys a call option to hedge, the strategy aims to limit potential losses if the stock price rises. The maximum loss for this hedged short position occurs when the stock price at expiration (ST) is above the call option’s strike price (X). In such a situation, the call option will be exercised, offsetting some of the loss from the short stock position. The formula for profit in this scenario is: Profit = (Short Sale Price – ST) + (ST – Strike Price – Call Premium). This simplifies to Profit = Short Sale Price – Strike Price – Call Premium. The maximum loss is the negative of this profit. Given: Short Sale Price (S0) = $50.00 Strike Price (X) = $52.00 Call Premium (c0) = $3.00 Maximum Loss = -(S0 – X – c0) = -($50.00 – $52.00 – $3.00) = -(-$2.00 – $3.00) = -(-$5.00) = $5.00. Therefore, the maximum potential loss the investor faces is $5.00. An unlimited loss would be the case for an unhedged short position. The premium of $3.00 is only part of the cost, and $2.00 represents the difference between the short sale price and the strike price, not the total maximum loss.

A Bull Equity-Linked Note (ELN) incorporates an embedded short put option. The investor, by purchasing the ELN, is effectively selling a put option. This means the investor receives a premium (or a discount on the note’s issue price, leading to an enhanced yield) but takes on the obligation to buy the underlying shares at the strike price if the put option is exercised. The put option is typically exercised by the counterparty if the underlying share price falls below the strike price at maturity. In this scenario, the put strike price is $9.00, and the underlying share price at maturity (ST) is $8.50. Since ST ($8.50) is less than the strike price ($9.00), the embedded put option is ‘in-the-money’. According to the ELN’s structure, when the share price falls below the strike price, the noteholder receives shares of the underlying stock instead of cash. The number of shares received is calculated as the face value of the note divided by the strike price ($10,000 / $9.00 = 1,111.11 shares, typically rounded to 1,111 shares). The value of these 1,111 shares at maturity, when the share price is $8.50, would be 1,111 shares $8.50/share = $9,443.50. Since the investor’s initial issue price for the ELN was $9,900, receiving shares worth $9,443.50 represents a loss on their investment. This outcome highlights the equity market risk associated with ELNs when the underlying stock performs poorly. Option 2 is incorrect because receiving the full face value in cash only occurs if the share price is at or above the strike price at maturity. Option 3 is incorrect as ELNs with embedded puts do not offer full capital protection when the underlying stock falls below the strike price; they expose the investor to potential losses. Option 4 is incorrect because the put option is in-the-money and would effectively be exercised, leading to share delivery, not the put expiring unexercised or the investor receiving the face value.

The question describes a strategy that is neutral, aims to profit from limited price volatility, and crucially involves four distinct, equally distributed delivery months without a common middle expiry. This precisely defines a Condor spread. A Butterfly spread is also a neutral strategy with four legs, but it is characterized by having a common middle month (selling the middle month twice). An Inter-commodity spread involves futures contracts on different but related underlying assets, and while it is a type of spread, it doesn’t specifically fit the description of a neutral strategy with four distinct, equally distributed delivery months for market stability. A Basis trade is an arbitrage strategy focused on the convergence of values between two securities, not a neutral spread strategy designed for limited price volatility across multiple delivery months.

The question requires the application of the formula for hedging equity risks using futures contracts, as outlined in the CMFAS Module 6A syllabus, Appendix D. The formula provided is N = VP / F x T x β. In this context, ‘F’ (current futures quote) multiplied by ‘T’ (value per tick) represents the total value of one futures contract. Therefore, the formula should be interpreted as N = (VP / (F T)) β. Given values: VP (Current value of portfolio) = $10,500,000 β (Beta of portfolio) = 1.2 F (Current futures quote) = 3,500 points T (Value per tick/point) = $50 Step 1: Calculate the value of one futures contract. Contract Value = F T = 3,500 points $50/point = $175,000 Step 2: Apply the hedging formula to find the number of contracts (N). N = (VP / Contract Value) β N = ($10,500,000 / $175,000) 1.2 N = 60 1.2 N = 72 Therefore, the manager should sell 72 futures contracts to fully hedge the portfolio’s market risk.

The question pertains to the management of option risks, specifically focusing on the ‘Greeks’. Gamma measures the rate of change of an option’s delta, indicating how sensitive the delta itself is to movements in the underlying asset’s price. Managing Gamma is crucial because a high Gamma means delta can change rapidly, leading to significant and unexpected shifts in the portfolio’s exposure. The provided syllabus text outlines two primary methods for restricting Gamma: limiting the absolute change in delta, which directly controls how much the delta can fluctuate, and applying risk tolerance amounts expressed as a maximum potential loss, which sets a monetary cap on the risk associated with Gamma movements. Other options incorrectly associate the rate of change of delta with different Greeks or misattribute their management techniques. Delta measures the option’s direct sensitivity to the underlying asset price, Vega measures sensitivity to volatility, and Theta measures sensitivity to time decay. Rho measures sensitivity to interest rate changes.

The Central Depository Pte Ltd (CDP) initiates the buying-in process when an investor with a short Extended Settlement (ES) position fails to deliver the required shares by the settlement due date. According to the CMFAS Module 6A syllabus, buying-in starts the day after the due date, which is the fourth market day following the Last Trading Day (LTD + 4). The initial price for buying-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. Option 1 accurately reflects both the timing and the pricing mechanism for the initiation of the buying-in process. Option 2 incorrectly states the commencement day and simplifies the pricing. Option 3 incorrectly suggests immediate initiation on the settlement day and a different price reference. Option 4 misrepresents both the timing and the pricing methodology.

An accumulator agreement obligates the investor to purchase a pre-determined quantity of shares at a fixed strike price throughout the tenor of the agreement, as long as the knock-out barrier is not triggered. The strike price is set at the outset and does not adjust based on subsequent market price movements. Therefore, if the market price of the underlying shares falls below the agreed strike price, the investor is still required to accumulate shares at the higher, fixed strike price, leading to an immediate unrealized loss on each accumulated share. The knock-out barrier only terminates the agreement if the daily closing price is at or above the barrier, not when it falls below the strike price. Accumulators do not typically feature capital preservation or automatic strike price adjustments to protect the investor from market downturns; in fact, they expose the investor to significant price risk.

The question describes a fund where the final payout is determined by a pre-defined, rule-based formula, and its strategy involves dynamically adjusting futures contract rolling to optimize returns based on market conditions (backwardation or contango). This aligns precisely with the definition of a Formula Fund, which relies on a pre-determined, rule-based formula for its payout and often employs specific methodologies to achieve its objectives, such as generating ‘alpha’ through efficient rolling mechanisms as seen in the example of a commodity index fund. An Indirect Investment Policy Fund primarily focuses on gaining exposure to underlying assets through derivatives without direct investment, though it may use derivatives, its defining characteristic isn’t the formulaic payout. Capitalized Funds are characterized by the automatic re-investment of dividends, while Funds with Features that Aim to Preserve Capital prioritize conserving a portion of the invested capital.

A Hang Seng Index (HSI) Daily Range Accrual Note (RAN) is designed such that a knock-out event stops the accumulation of future coupons. As per the product features, if the HSI trades at or above the knock-out barrier, a knock-out event occurs. When this happens, the accrual of new coupons ceases. However, any coupons that have already been accrued up to the point of the knock-out event will still be paid on their scheduled periodic interest payment dates. Crucially, RANs are typically structured with principal preservation, meaning the initial principal investment is returned to the note holder at maturity, irrespective of the knock-out event. Therefore, the note does not terminate immediately with principal loss, nor does the accrual continue at a reduced rate, nor does it convert into a direct index investment.

Futures contracts are marked-to-market daily. This means that at the end of each trading day, the exchange determines a settlement price based on the day’s closing price range. Each trading account is then credited or debited based on the day’s profits or losses. If a trader’s account sustains a loss, as would be the case for a long position when prices decline, and this loss causes the account equity to fall below the required maintenance margin, the trader will receive a margin call. This requires them to deposit additional funds or reduce their positions to meet the minimum performance bond requirements. The scenario describes a price decline hitting a daily limit, which, after a cooling-off period, allows trading to continue. Therefore, the day’s actual settlement price, reflecting the market’s movement, will be used for mark-to-market calculations, potentially triggering a margin call. Other options are incorrect because daily price limits often include mechanisms like cooling-off periods or widening, rather than an immediate halt to all trading for the day. Forced liquidation is a consequence of failing to meet a margin call, not an automatic action upon hitting a price limit. The settlement price is derived from the current day’s trading activity, not a reversion to the previous day’s price.

A Credit Linked Note (CLN) is a structured product where the investor effectively sells credit insurance, typically in the form of a Credit Default Swap (CDS), on a specific ‘reference entity’. The investor receives higher-than-market rates for taking on this risk. The payout of a CLN is directly contingent on whether a credit event (such as default or failure to pay) occurs for the reference entity. In contrast, a Bond Linked Note (BLN) embeds the sale of a put option on a specific bond. While also a yield enhancement product, the payout of a BLN is primarily determined by the market price of that underlying bond, which can be affected by various factors including credit downgrades, widening spreads, and interest rate movements, not just a credit default. Therefore, the fundamental distinction lies in the type of embedded derivative (CDS on a reference entity for CLN vs. put option on a bond for BLN) and what specifically triggers their respective payouts (credit event for CLN vs. bond price for BLN).

To adjust the beta of an equity portfolio using futures contracts, the number of contracts required is calculated by considering the change in beta desired, the current portfolio value, and the value of one futures contract. The formula used is: Number of Contracts = (Target Beta – Current Beta) (Portfolio Value / Futures Contract Value). First, determine the value of one futures contract: Futures Contract Value = Futures Quote × Value per Tick = 5,000 × $10 = $50,000. Next, identify the current and target betas: Current Beta = 1.2, Target Beta = 0.8. Now, calculate the number of contracts: Number of Contracts = (0.8 – 1.2) ($10,000,000 / $50,000) = (-0.4) 200 = -80 contracts. A negative number of contracts indicates that futures contracts should be sold to achieve the desired reduction in the portfolio’s beta. Selling futures contracts reduces the portfolio’s overall market exposure.