CMFAS RES6A Quiz 39

The scenario describes an unfunded swap-based ETF. In this structure, the ETF itself uses the proceeds from the sale of its units to purchase a pool of collateral. This collateral is then held by a third-party custodian and pledged in favor of the ETF. The returns generated by this collateral are exchanged with a swap counterparty for the performance of the desired index. This mechanism allows the ETF to maintain direct control over the collateral assets, thereby mitigating counterparty risk. In contrast, a fully funded swap-based ETF involves the ETF transferring its sale proceeds to the swap counterparty, which then purchases and pledges the collateral to the ETF. Synthetic replication ETFs generally use swaps but the specific collateralization method distinguishes unfunded from fully funded. Physical replication ETFs directly hold the underlying securities of the index, which is not the case here as a swap agreement is mentioned.

Global Exports Pte Ltd is hedging a USD receivable, meaning they are concerned about the USD depreciating against the SGD. To hedge this, they would sell USD/SGD futures contracts. By selling futures, they lock in an exchange rate for their future USD receipts. The initial 3-month USD/SGD futures rate is 1.3450. This is the rate at which they effectively ‘sell’ their anticipated USD. When the funds are received three months later, two transactions occur: 1. Cash Market Transaction: Global Exports receives USD 1,500,000 and converts it at the prevailing spot rate of 1.3300. This yields SGD 1,500,000 1.3300 = SGD 1,995,000. 2. Futures Market Transaction: The company closes out its futures position. They initially sold USD/SGD futures at 1.3450. At the time of closing, the futures rate would have converged to the spot rate, which is 1.3300. Since they sold at a higher rate (1.3450) and effectively bought back (or settled) at a lower rate (1.3300), they make a profit on the futures contract. The profit per USD is (1.3450 – 1.3300) = 0.0150 SGD. The total profit from the futures position is 0.0150 USD 1,500,000 = SGD 22,500. The net effective amount received in Singapore Dollars is the sum of the cash market proceeds and the futures profit: SGD 1,995,000 + SGD 22,500 = SGD 2,017,500. This outcome demonstrates that the hedge successfully locked in the initial futures rate of 1.3450 (1,500,000 USD 1.3450 SGD/USD = SGD 2,017,500), protecting the company from the appreciation of the Singapore Dollar.

The adjustment for dividends on structured warrants requires recalculating the exercise price using a specific adjustment factor. The formula for the new exercise price is: New Exercise Price = Old Exercise Price x Adjustment Factor. The Adjustment Factor is calculated as: (P – SD – ND) / (P – ND), where P is the last cum-date closing price of the underlying, SD is the special dividend per share, and ND is the normal dividend per share. Given the values: Old Exercise Price = $22.00 P (Last cum-date closing price) = $20.00 SD (Special dividend) = $0.80 ND (Normal dividend) = $0.20 First, calculate the Adjustment Factor: Adjustment Factor = (20.00 – 0.80 – 0.20) / (20.00 – 0.20) Adjustment Factor = (19.00) / (19.80) Adjustment Factor ≈ 0.959595959 Next, calculate the New Exercise Price: New Exercise Price = $22.00 x 0.959595959 New Exercise Price ≈ $21.111111 Rounding to two decimal places, the new exercise price is $21.11.

Callable Bull/Bear Contracts (CBBCs) are designed to closely track the performance of their underlying asset, with a delta typically close to 1. This means that for every point change in the underlying asset, the CBBC’s price will change by approximately the same amount, adjusted by its conversion ratio. The conversion ratio specifies how many units of the CBBC correspond to one unit of the underlying asset. In this scenario, a conversion ratio of 10:1 means that 10 units of the CBBC track 1 unit of the underlying. If the underlying index increases by 10 points, a Bull CBBC’s value would increase by the underlying change divided by the conversion ratio. Therefore, 10 points / 10 (conversion ratio) equals an approximate 1-point increase in the CBBC’s value. The other options are incorrect because they either misinterpret the impact of the conversion ratio, suggest an incorrect direction of movement for a Bull CBBC, or imply no movement at all.

The fund trustee’s primary and immediate responsibility, as outlined in the CMFAS Module 6A syllabus, is to act in a fiduciary capacity for unit holders. When a breach occurs, such as the consistent failure to provide timely reports that impacts the dissemination of audited accounts to unit holders, the trustee is mandated to inform the Monetary Authority of Singapore (MAS) within three business days of becoming aware of the breach. Concurrently, the trustee must ensure that the fund manager takes appropriate corrective action to rectify the operational deficiency and safeguard the interests of the unit holders. While other options might represent valid actions in different contexts (e.g., direct intervention in operations, commissioning an audit, or recommending structural changes), they do not constitute the primary and immediate responsibility of the trustee in response to a known breach that affects unit holder reporting and regulatory compliance.

Arbitrage opportunities between Interest Rate Swaps (IRS) and Eurodollar futures strips arise when there is a discrepancy between the fixed rate offered in the IRS market and the implied fixed rate derived from a series of Eurodollar futures contracts. In this scenario, the market-quoted fixed rate for the IRS is higher than the rate implied by the futures strip. This means the market IRS is ‘overpriced’ for a fixed-rate payer, or conversely, ‘underpriced’ for a fixed-rate receiver. To profit from this, an arbitrageur should ‘sell’ the overpriced instrument and ‘buy’ the underpriced synthetic equivalent. Selling the IRS means entering into it as a fixed-rate receiver, thereby receiving the higher market fixed rate and paying the floating rate. Simultaneously, the arbitrageur needs to create a synthetic position that effectively pays a fixed rate and receives a floating rate, mirroring the IRS, but at the lower rate implied by the futures. This is achieved by buying the Eurodollar futures strip. Buying Eurodollar futures locks in a future lending rate, which effectively means receiving floating and paying fixed. By combining these two positions, the arbitrageur receives the higher fixed rate from the market IRS and pays the lower fixed rate implied by the futures strip, with the floating rate payments netting out, thereby locking in a risk-free profit. The other options either involve taking positions that would lead to a loss, or do not constitute a balanced arbitrage strategy.

When a corporate treasury manager anticipates receiving funds in the future and expects interest rates to decline, the objective is to lock in the current, more favorable implied forward yield for a future deposit. Eurodollar futures contracts are priced inversely to interest rates. If interest rates fall, Eurodollar futures prices rise. Therefore, by selling Eurodollar futures contracts today, the manager establishes a short position. If interest rates do decline as expected, the actual deposit will earn a lower interest rate. However, the short Eurodollar futures position will generate a profit (by being bought back at a higher price, reflecting the lower interest rates), which will offset the reduced interest income from the deposit. This strategy effectively locks in the current implied forward yield. Purchasing Eurodollar futures would be a strategy to benefit from rising interest rates, typically used to hedge against increasing borrowing costs or to speculate on rate increases. Entering into a forward rate agreement (FRA) is another method for hedging interest rate risk, but the question specifically asks about Eurodollar futures. Investing in short-term commercial papers immediately is not feasible if the funds are not yet available.

The question examines the operational procedures when a futures contract, subject to specific daily price fluctuation rules, reaches its established daily limit during a trading session. Based on the provided information, particularly the example of the SiMSCI futures contract, when such a price movement occurs, trading is typically allowed to continue at or within the price limit for a specified cooling-off period. After this cooling-off period, the price limits are generally removed for the remainder of that trading day. This mechanism is designed to manage initial volatility while eventually allowing the market to determine prices without artificial restrictions. Immediate suspension of trading for the entire day is not the described process. While limits may be widened, this is typically mentioned for the next trading session if a contract settles at its limit, not automatically for the current session. Margin calls are a consequence of the daily mark-to-market process and performance bond requirements, triggered by losses or increased positions, rather than an immediate, direct operational response to hitting a price limit during the session itself.

The trading name of a structured warrant provides key information about its features. According to the CMFAS Module 6A syllabus, the ‘e’ prefix in a warrant’s trading name, such as ‘MNO PQR eCW260715’, specifically denotes that it is a European-style warrant. A European-style warrant can only be exercised on its expiration date, not at any time before maturity. In contrast, an American-style warrant, which allows for early exercise, would typically have no prefix for its exercise style. The ‘MNO’ part of the name would refer to the underlying instrument, and ‘PQR’ would refer to the issuer, not the ‘e’ prefix.

The S&P 500 Equal Weight Index (EWI) is structured to assign the same weight to each constituent stock, contrasting with a market-weighted index where a company’s influence is proportional to its market capitalization. This methodology means the EWI inherently allocates a larger proportion of its weight to smaller market capitalization stocks. Smaller companies are generally perceived to be more volatile than their larger counterparts due to factors such as less diversified revenue streams, greater sensitivity to economic shifts, and lower liquidity. Consequently, an index with a significant tilt towards these inherently more volatile smaller cap stocks will typically exhibit higher overall volatility. While the EWI does have a regular rebalancing schedule, reduced concentration risk, and specific performance characteristics, these do not directly explain its higher volatility in the context of sensitivity to market fluctuations driven by smaller firms.

An accumulator agreement obligates the investor to purchase a predefined number of shares at the strike price on specified observation days. If the underlying share price consistently trades below the strike price, the investor is still required to buy the shares at the higher strike price, incurring significant marked-to-market losses. This highlights the lack of capital preservation in such products. Concurrently, the knock-out barrier serves to limit the investor’s potential gains; if the share price reaches or exceeds this barrier, the agreement terminates, preventing the investor from accumulating more shares at a discount to the market price. Therefore, the investor faces substantial downside risk while their upside potential is capped. The other options are incorrect because: the investor is obligated to buy even if the price is below the strike, the knock-out limits gain, it does not protect against losses, nor does it guarantee profit; investors are generally not entitled to dividends before share delivery; and early termination is typically not unilateral and often involves substantial ‘break’ costs.

An accumulator agreement, particularly one without capital preservation features, obligates the investor to purchase the underlying shares at the pre-defined strike price for the tenor of the agreement, regardless of whether the market price falls significantly below that strike price. The agreement’s termination is typically triggered only if the underlying share price reaches or exceeds the specified knock-out barrier, or if the investor requests early termination, which usually incurs substantial ‘break’ costs and requires the bank’s consent. The financial institution does not automatically adjust the strike price downwards to reflect unfavorable market movements; the investor bears the risk of market price depreciation.

Structured funds are characterized by their use of financial engineering, often incorporating derivatives, to achieve specific risk/return profiles or cost/savings objectives. A key distinction from traditional mutual funds lies in their management approach. Traditional mutual funds rely heavily on the fund manager’s expertise and active, discretionary decisions regarding asset allocation and security selection. In contrast, structured funds typically employ static or rule-based allocation decisions. Their aim is often to replicate the performance of an underlying asset or provide a synthetic return linked to it, rather than actively managing a portfolio based on ongoing market views. While structured funds can offer features like capital preservation, this is a potential outcome of their design, not the sole defining characteristic of their management. Similarly, not all structured funds are exchange-traded (that describes ETFs, a type of structured product), and their investment universe is not limited solely to derivatives, as some can invest directly in underlying assets.

UCITS regulations, which govern many European-domiciled funds including synthetic ETFs, impose specific limits on counterparty risk. These regulations stipulate that an ETF is not permitted to have more than 10% of its prevailing Net Asset Value (NAV) exposed to derivative instruments, such as swaps, issued by a single counterparty. This limit is applied to the marked-to-market value of the swaps on a daily basis to manage potential counterparty default risk. While funds may voluntarily adopt stricter limits, the regulatory maximum under UCITS is 10%.

Structured products designed for capital preservation often employ specific strategies to ensure the return of the initial principal at maturity. One common method involves investing the principal component in a zero-coupon bond, which matures at par, combined with a long-call option strategy to capture potential upside. Another strategy for principal protection is Constant Proportion Portfolio Insurance (CPPI), which dynamically allocates capital between a risky asset and a risk-free asset to maintain a minimum capital floor. However, if a structured product includes a conversion feature, allowing the repayment at maturity to be in an underlying asset (like a stock or bond) or an alternate currency, it is inherently not principal protected. This is because the value of the underlying asset or the alternate currency can fluctuate, meaning the investor may receive less than their initial principal amount in their original currency or asset terms. The structure of the return component, such as a conditional coupon based on market index performance, relates to how returns are generated and distributed, but it does not directly determine whether the initial principal itself is guaranteed.

The trading name of a structured warrant provides key information about its features. Breaking down ‘GLOBEX FIN eCW280615’: – ‘GLOBEX’ represents the Underlying Instrument. The first part of the trading name typically indicates the underlying asset. – ‘FIN’ represents the Issuer. The second part identifies the financial institution that issued the warrant. – ‘e’ indicates the Exercise Style, specifically European style. If there were no prefix, it would denote an American-style warrant. – ‘CW’ signifies the Type of Warrant, which in this case is a Call Warrant. ‘PW’ would denote a Put Warrant. – ‘280615’ represents the Expiration Date in YYMMDD format. Therefore, ‘280615’ translates to June 15, 2028. Based on this breakdown, the warrant is a European-style call warrant, with GLOBEX as the underlying asset, issued by FIN, and it expires on June 15, 2028.

The question pertains to the final settlement price determination for the 3-month Singapore Dollar Interest Rate Futures contract, as outlined in the CMFAS Module 6A syllabus, Appendix C. According to the specifications, the final settlement price for this contract is based on the Association of Banks in Singapore’s USD/SGD Swap Offered Rates, which are determined at 11.00 am, Singapore time, on the last trading day. The other options refer to the final settlement price mechanisms for different futures contracts also detailed in Appendix C: the British Bankers’ Association’s rates are for Eurodollar Futures, the Tokyo Financial Exchange’s final settlement price for its Euroyen TIBOR contract, and the Official Opening Price of TSE’s 10-year JGB futures contract for the Full-sized 10-year Japanese Government Bond Futures.

The strategy described, which involves continuously re-balancing an investment portfolio between performance assets and safe assets using a set formula or mathematical algorithm to ensure a fixed minimum return and principal preservation, is precisely what Constant Proportion Portfolio Insurance (CPPI) entails. The text explicitly states that CPPI is ‘totally rule-based and non-discretionary’ and that ‘The principal is preserved by adjusting the exposure to the performance assets so that the underlying portfolio… can absorb a defined decrease in value before its value falls below the level required to achieve principal preservation.’ Dynamic Asset Allocation is a broader investment approach that involves adjusting asset weights over time, but it does not specifically define the rule-based, non-discretionary principal preservation mechanism characteristic of CPPI. A Guaranteed Investment Scheme typically refers to a financial product that offers a guaranteed return, often provided by an external entity, rather than an internal portfolio rebalancing strategy. Strategic Portfolio Rebalancing involves adjusting asset allocations to maintain a target mix or respond to long-term market outlooks, but it does not inherently include the specific principal protection and non-discretionary, formulaic rebalancing of CPPI.

The product’s payout mechanism, if not terminated early, involves several steps. First, the final performance is calculated based on the arithmetic weighted average performance of the basket components. This performance is then calibrated against a threshold of 110%, meaning the calculation considers the excess return over 10%. In this scenario, the average performance is 105%. When calibrated against the 110% threshold, the effective performance is 105% – 110% = -5%. The product terms explicitly state that if the final performance (after calibration against the threshold) is negative, the final payout is zero, and 100% of the initial investment is returned. Since the calculated performance of -5% is negative, the capital preservation feature is activated, ensuring the investor receives their full initial investment of SGD 100,000.

The total redemption proceeds are calculated by adding the principal investment to the accrued coupon. The accrued coupon rate is determined by the formula 0.50% + [4.00% x n/N]. In this scenario, ‘n’ is 180 days (the number of days the index fixed within the specified range) and ‘N’ is 250 days (the total trading days). Therefore, the variable portion of the yield is 4.00% multiplied by (180/250), which equals 4.00% multiplied by 0.72, resulting in 2.88%. Adding the fixed component of 0.50% gives a total accrual coupon rate of 3.38%. For an investment of SGD 1 million, the accrual coupon amount is SGD 1,000,000 x 3.38% = SGD 33,800. Consequently, the total redemption proceeds at maturity will be SGD 1,000,000 (principal) + SGD 33,800 (accrual coupon) = SGD 1,033,800.

Gamma measures the rate at which an option’s delta changes in response to movements in the underlying asset’s price. A high gamma indicates that the delta will change significantly for even small fluctuations in the underlying. For an option buyer (long position), positive gamma means that if the underlying price moves favorably, the delta increases, amplifying gains. Conversely, if the underlying price moves unfavorably, the delta decreases, amplifying losses. Therefore, a high gamma implies greater sensitivity and potential for both increased profit and increased loss, making the position riskier due to the rapid change in delta.

When a customer fails to meet a margin call for an Extended Settlement (ES) contract by the stipulated deadline (T+2), the Member and Trading Representative are restricted in the types of orders they can accept. According to the CMFAS Module 6A syllabus, they ‘shall not accept orders for new trades for the customer.’ However, there is a specific exception: ‘orders which would result in the customer’s Required Margins being reduced may be accepted.’ This means that only trades designed to decrease the customer’s margin requirements are permissible. Accepting any new trade, even with a commitment for future deposit, is not allowed once the deadline is missed. Declining all new trade orders is too broad, as risk-reducing trades are explicitly permitted. Risk-neutral trades, which do not impact maintenance margins, are not explicitly allowed as they do not reduce the Required Margins and thus fall under the general prohibition of ‘new trades’ when a margin call is unmet.

An equity-linked structured note consists of a zero-coupon bond and an equity call option. The discount sum, which is the difference between the bond’s face value and its present value, is typically used to purchase the equity call option. If this discount sum is less than the premium required for the call option, the product issuer will purchase fewer option contracts. This directly results in the investor having a participation rate that is less than 100% in the upside performance of the underlying equity asset. The note’s design does not automatically ensure a 100% participation rate if the discount sum is insufficient, nor does it compel the issuer to acquire more contracts at a loss. While principal preservation is a key objective, the scenario described specifically impacts the return component (the option’s performance), not the bond’s face value at maturity, which is separate from the option’s cost.

Tracking error refers to the disparity in performance between an Exchange Traded Fund (ETF) and its underlying index. The provided text explicitly lists ‘cash drag’ as one of the factors that can cause tracking errors. Cash drag occurs when a portion of the fund’s assets is held in cash, rather than being fully invested in the underlying index constituents, which can lead to underperformance relative to the benchmark. While foreign exchange risk, market-maker issues (liquidity risk), and NAV trading at a discount or premium are indeed risks or characteristics associated with ETFs, the syllabus material categorizes them separately from the direct causes of tracking error. Foreign exchange risk affects the value of underlying assets not denominated in the home currency, liquidity risk pertains to the ability to trade the ETF, and NAV discrepancies relate to the secondary market pricing versus the intrinsic value, rather than the fund’s internal replication performance against its index.

For an option writer, American-style options present a distinct risk compared to European-style options. The holder of an American option has the flexibility to exercise the option at any time before its expiration date. This means that an option writer, particularly of a call option, could be compelled to deliver the underlying asset at an unfavorable price at any moment, rather than only at expiration. This lack of control over the timing of exercise introduces significant uncertainty and can lead to unexpected obligations. While unlimited losses are a general risk for writers of naked call options (both American and European) if the underlying price rises significantly, the ability of the holder to trigger this obligation at any point is unique to the American style. The illiquidity of some American options in the secondary market is a practical concern, but the fundamental structural risk lies in the early exercise feature. Lastly, time decay generally benefits an option writer, as it reduces the value of the option, making it less costly for the writer to buy it back or less likely to be exercised.

Structured funds are distinct from traditional mutual funds primarily because they incorporate derivatives to replicate an underlying asset’s performance or to provide a synthetic return linked to it. This approach enables them to achieve various anticipated market views, such as long, short, or market neutral positions, and to implement features like capital preservation through systematic adjustments. In contrast, traditional mutual funds typically rely on the manager’s expertise for active allocation of investments directly into underlying assets without using derivatives. Structured funds also generally carry a wider variety of risks, including a greater presence of counterparty risk, unlike the implication that they avoid such risks or are inherently safer. While structured funds do involve adjustments, their allocation is typically static or rule-based, rather than being ‘always actively managed’ in the same discretionary sense as some other investment vehicles.

A Bull Equity-Linked Note (ELN) with an embedded short put option is designed to offer an enhanced yield compared to a plain vanilla fixed-rate note. This enhanced yield is compensation for the investor taking on the risk of being a put option writer. If, at maturity, the underlying equity’s market price falls below the put option’s strike price, the put option will be ‘in-the-money’. As the investor is the writer (seller) of this put option, they are obligated to fulfill the terms of the option. This means they must purchase (take delivery of) the underlying shares at the agreed-upon strike price. If the market price of these shares is significantly lower than the strike price at the time of delivery, the investor will incur a capital loss on the shares received, as their market value is less than what they paid for them. This is the primary downside risk associated with such an ELN.

The trustee of a Collective Investment Scheme (CIS) has a fiduciary duty to unit holders and is responsible for ensuring the fund manager operates within the investment objectives and restrictions outlined in the trust deed and prospectus. A critical responsibility of the trustee, as per regulatory requirements in Singapore, is to inform the Monetary Authority of Singapore (MAS) within three business days after becoming aware of any breaches. While the trustee would also instruct the fund manager to rectify the situation and might eventually report to unit holders, the immediate and primary regulatory obligation upon discovering a breach is to notify MAS. Initiating legal proceedings is a more severe and potentially later step, not the first regulatory reporting requirement.

The strategy of short-selling a stock and simultaneously purchasing a call option on the same stock is a common hedging technique. When an investor shorts a stock, their potential loss is theoretically unlimited if the stock price increases. By buying a call option, the investor acquires the right to purchase the underlying stock at a specified strike price. If the stock price rises above this strike price, the call option will become in-the-money, generating a profit that offsets the increasing losses from the short stock position. This effectively caps the maximum potential loss for the investor, providing protection against significant adverse price movements in the underlying asset. While this strategy limits potential losses, it also reduces the maximum potential profit from the short position by the amount of the premium paid for the call option.

For net short option positions, the gamma is negative. The provided text states that ‘All net buying (long) strategies will have positive gamma and net selling (short) strategies will have negative gamma.’ It also highlights that gamma is highest when the option is at-the-money and close to expiry. When gamma is high, delta changes rapidly. For a net short position with high negative gamma, this rapid change in delta means that if the market moves unfavourably, the investor can suffer significant, magnified losses. Therefore, the primary risk implication is high negative gamma leading to rapid delta changes and potential for magnified losses. The other options are incorrect because: a high positive gamma is associated with long option positions; gamma is highest at-the-money and near expiry, not near zero; and gamma is high, not low, in this specific scenario.