CMFAS RES6A Quiz 47

When a customer indicates that margins for Extended Settlement (ES) contracts will be provided after the T+2 period, or if no funds are forthcoming, the regulatory framework imposes restrictions on the types of trading activities permitted. This is a measure to manage the risk exposure of both the customer and the trading member. In such a situation, the customer is only allowed to execute trades that reduce their existing risk exposure. Risk-increasing activities, which would further expose the customer and the member to potential losses, are prohibited. Similarly, risk-neutral activities, which do not alter the overall risk profile, are also generally not permitted under these specific conditions. The intent is to mitigate potential losses when margin requirements are not met promptly.

The scenario describes a problem where positions in futures contracts with distant expiry dates lead to significant losses due to challenges in efficiently closing them under adverse market conditions. This directly relates to the concept of liquidity, which is typically poorer for longer-dated contracts. According to the CMFAS Module 6A syllabus, a Maturity Limit is specifically designed to address this issue by limiting losses from poor liquidity. It restricts trading in further-month contracts, which are generally less liquid and more volatile, making them difficult to unwind in adverse conditions. While other limits like Maximum Loss Limit, Open Contracts Limit, and Stress Test Limit are important for overall market risk management, they do not specifically target the risk arising from the illiquidity of long-dated futures contracts as directly as a Maturity Limit does.

Yield Enhanced Securities, also known as Discount Certificates, are structured warrants with a specific payout mechanism. At maturity, if the underlying asset’s closing price on the expiration or valuation date is at or above the exercise price, 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 on the expiration or valuation date. In the given scenario, the underlying asset’s closing price of $5.10 is below the exercise price of $5.30. Therefore, the investor would receive a cash settlement equal to the underlying’s closing price, which is $5.10.

Constant Proportion Portfolio Insurance (CPPI) is a specific, rule-based, and non-discretionary trading strategy. Its core mechanism involves continuously re-balancing an investment portfolio between performance (risky) assets and safe assets using a predefined mathematical algorithm. This strategy is designed to ensure a fixed minimum return at a future date by dynamically adjusting exposure to risky assets, thereby preserving capital while allowing participation in market upside. Strategic Asset Allocation refers to a long-term investment approach to portfolio construction based on an investor’s risk tolerance and objectives, not a dynamic capital preservation mechanism. An Absolute Return Strategy aims to generate positive returns irrespective of market conditions but does not define a specific rebalancing methodology like CPPI. A Capital Protected Note is a type of structured product that offers capital protection, often achieved through embedded derivatives, but it is the product itself rather than the dynamic portfolio management strategy described.

Equity Linked Exchange Traded Funds (ETFs) are designed to be highly liquid, allowing investors to sell their positions on any trading day, similar to regular stocks. Furthermore, ETFs are known for generally having a low Total Expense Ratio (TER) and minimal upfront brokerage fees, which aligns with an investor’s preference for minimizing initial transaction costs. In contrast, Equity Linked Structured Notes and Structured Funds typically involve higher upfront costs due to their complex nature and the inclusion of derivatives. Their early redemption is often conditional on specific barrier options, rather than being freely tradable daily. Equity Linked Investment-Linked Policies (ILPs) involve both investment and insurance components, incurring insurance charges and potentially significant losses upon early surrender, making them less suitable for an investor focused on low upfront costs and flexible daily liquidation.

The provided text explicitly states that ETF prices are likely to deviate more significantly from their Net Asset Value (NAV) when the ETF is not trading in the same time zone as its underlying assets. This phenomenon occurs because when the underlying market (e.g., an Asian market for an Asian equity ETF) is closed, market-makers trading the ETF in a different time zone (e.g., the US) face increased uncertainty regarding the real-time value of the underlying assets. To compensate for this risk and potential price movements in the underlying market before it reopens, market-makers will incorporate a risk premium or discount into the ETF’s trading price. This leads to a wider divergence between the ETF’s trading price and its last calculated NAV.

The Constant Proportion Portfolio Insurance (CPPI) strategy aims to preserve capital while participating in market upside. A key component of this strategy is the ‘cushion’, which represents the excess value of the fund above the capital preservation target. It is calculated by subtracting the minimum value required for capital preservation from the current portfolio value. In this case, the cushion is SGD 150 million (current portfolio value) – SGD 120 million (minimum capital preservation target) = SGD 30 million. The ‘multiplier’ is then applied to this cushion to determine the maximum amount that can be allocated to performance (risky) assets. Therefore, the maximum allocation to performance assets is SGD 30 million (cushion) 3 (multiplier) = SGD 90 million.

An investor holding a long position in a stock who wishes to protect against a decline in price while being willing to limit potential upside gains, and crucially, to do so without incurring an upfront net premium cost, would implement a zero-cost collar. This strategy involves buying a protective put option to hedge against downside risk and simultaneously selling a covered call option. The premiums are structured such that the premium received from selling the call option offsets the premium paid for buying the put option, resulting in a net zero premium outlay. This perfectly matches the scenario described, where the investor seeks to mitigate losses and cap gains with no net upfront cost. Other options describe different strategies with distinct objectives and cost structures. For instance, a long straddle profits from volatility and has a net cost. Selling a naked call is a high-risk income-generating strategy, not a protective one for a long stock. A synthetic long stock replicates owning the stock and is not primarily a protective strategy for an existing long position, nor is it inherently zero-cost.

The structured fund’s design explicitly links its attractive yield objective to the relative performance of the Nikkei 225 and S&P 500 indices. For an early redemption (Mandatory Call Event) to occur, the returns performance of Index 1 (Nikkei 225) must be greater than or equal to the returns performance of Index 2 (S&P 500). Similarly, if the product does not terminate early, the enhanced payout of 125.5% at maturity is contingent on the performance of the Nikkei 225 being greater than or equal to the performance of the S&P 500. This aligns directly with the investment theme that Japan is expected to outperform. The other options describe conditions that are either irrelevant to the specific yield-triggering mechanism of this product (e.g., both indices achieving positive returns, which is not the primary condition for yield), or are contrary to the conditions for achieving the attractive yield (e.g., S&P 500 outperforming Nikkei 225), or relate to capital preservation features that are distinct from the yield generation mechanism.

The investor’s view is characterized by not having a strong directional preference for the underlying asset, anticipating limited price swings, and expecting the asset to remain within a specific price range. They also require capital preservation if either an upper or lower barrier is breached. A Barrier Capital Preservation Certificate (Straddle) is designed precisely for this scenario. It contains both an upper and a lower knock-out barrier, offering capital preservation if either barrier is breached, and allows participation in the underlying’s performance as long as it stays within the defined range. The other options are unsuitable because: A Barrier Capital Preservation Certificate (Shark’s Fin) is primarily for a rising underlying asset with an up-and-out barrier. A standard Knock-Out Call option is for a rising underlying and typically does not include capital preservation upon knock-out. A Barrier Reverse Convertible involves being effectively short a knock-out put option and is generally for investors seeking enhanced yield with a view that the underlying will not fall below a certain level, not for a range-bound scenario with two barriers and capital preservation on both sides.

A calendar spread, also known as a horizontal or time spread, is a futures strategy that involves simultaneously taking a long and a short position in contracts for the same underlying asset but with different delivery months. The direction of the spread depends on the trader’s view of the yield curve. If a trader anticipates the yield curve flattening or inverting, the strategy outlined in the CMFAS Module 6A syllabus is to sell the contract with the nearer delivery month and simultaneously buy the contract with the further delivery month. This aims to profit from the expected relative movement of prices between the two delivery months. Conversely, if a steepening yield curve is expected, the strategy would be to buy the nearer contract and sell the further contract. The other options describe either the incorrect direction for a flattening yield curve calendar spread, an inter-commodity spread, or a basis trade.

A fund manager anticipating a sustained upward trend in market interest rates expects bond prices to fall, as bond prices and interest rates generally move inversely. To protect a portfolio of long-duration bonds from a decline in value, the manager needs a strategy that profits when bond prices decrease. Purchasing bond put options provides the right, but not the obligation, to sell bonds at a specified strike price. If interest rates rise and bond prices fall below the strike price, the put options gain value, thereby offsetting losses in the underlying bond portfolio. Selling bond call options would generate premium income but would expose the manager to potential unlimited losses if bond prices unexpectedly rose, and it does not directly hedge against falling bond prices. Acquiring bond call options would be a strategy for an investor expecting interest rates to fall and bond prices to rise, which is contrary to the scenario presented. While entering a short position in bond futures contracts is a valid hedging strategy against rising interest rates, the question specifically asks for a bond option strategy.

A reverse convertible is constructed from a low-risk component (a long zero-coupon bond) and a high-risk component (a short put option). The attractive yield comes from the interest accretion of the zero-coupon bond and the premium received from selling the put option. The upside performance is capped. The downside risk, however, is significant. The short put option obligates the investor to purchase the underlying asset at the strike price if its market value falls below that level. This means that if the underlying asset’s price declines substantially, the investor faces losses to the full extent of that fall, potentially losing the entire investment amount beyond just the coupon. Therefore, the short put option is the primary component responsible for the investor’s exposure to the full downside risk of the underlying asset’s price decline. The long zero-coupon bond provides the low-risk yield component, and while it has interest rate risk, it is not the source of the direct exposure to the underlying asset’s price fall. The capped upside limits potential gains but does not cause the downside exposure. The product’s structure does not involve general leverage that magnifies both gains and losses in the way implied by the fourth option; its specific risk profile is due to the short put.

A long butterfly spread and a long condor spread are both market-neutral strategies involving four options, designed for situations where the investor expects limited movement in the underlying asset’s price. However, their primary structural difference lies in the number of distinct strike prices utilized. A long butterfly spread is constructed using four options across three different strike prices (e.g., one long, two short, one long at ascending strikes). In contrast, a long condor spread uses four options across four distinct strike prices, creating a wider range between the inner short options. Both strategies aim for limited profit and limited risk, typically resulting in a debit position, which represents the maximum possible loss. The type of options (calls or puts) can be used for either strategy, and the underlying asset’s volatility expectation for both is generally neutral.

The investor’s primary objective is a ‘consistent stream of returns’ and ‘predictable distributions’. This directly relates to how the fund distributes its earnings to investors. The ‘Degree of Payout Schedule’ component of a structured fund explicitly addresses this by defining whether the fund provides fixed or variable coupons at regular intervals, or participative returns based on the underlying asset’s outcome, or a combination of both. While the selection of underlying assets generates the returns, the anticipated market view influences the fund’s overall strategy, and the chosen maturity period dictates the investment horizon, it is the payout schedule that specifically governs the regularity and type of income distribution to the investor.

The scenario describes issues arising from a newly implemented, intricate trading platform, inadequate staff training, and high personnel turnover, leading to delayed or erroneous processing of client instructions. These are all examples of failures in internal processes, people, and systems. Operational risk specifically encompasses risks due to the operations of a business failing as a result of human errors or breakdown of internal procedures and systems. Issuer risk, on the other hand, relates to the risk that the issuer of a financial product cannot fulfill its obligations. Basis risk is specific to futures contracts, concerning the difference between cash and futures prices. Leverage risk pertains to the magnified gains or losses in leveraged products like futures due to small price movements. Therefore, the situation described most accurately falls under operational risk.

The scenario highlights a specific problem where futures contracts with distant expiry dates result in magnified losses due to reduced liquidity during volatile market conditions. The Maturity Limit is a direct control measure designed to address this. It restricts exposure to longer-dated contracts, which are typically less liquid and more volatile, making them challenging to exit in adverse markets. While an Open Contracts Limit manages overall exposure, a Maximum Loss Limit controls general trading losses, and Stress Tests assess risk, none of these specifically target the illiquidity risk associated with extended maturity contracts as effectively as a Maturity Limit.

An Equity-Linked Structured Note (ELSN) is specifically designed to meet the dual objectives of capital preservation and potential participation in equity market upside. This is achieved through its unique construction, which involves two primary components: a zero-coupon bond and an equity call option. The zero-coupon bond is purchased at a discount and is intended to mature at its face value, thereby providing the mechanism for capital preservation. The ‘discount sum’ (the difference between the bond’s face value and its present value) is then utilized to purchase an equity call option. This call option offers the investor exposure to potential gains from the underlying equity asset. If the equity performs well, the option’s value increases, contributing to the overall return. If the equity performs poorly, the call option simply expires worthless, meaning the investor does not lose more than the premium paid for the option (which came from the bond’s discount), and the principal from the bond component remains preserved. The other options describe alternative investment strategies that do not align with the specific structure and inherent characteristics of an Equity-Linked Structured Note as outlined in the syllabus.

Constant Proportion Portfolio Insurance (CPPI) is a systematic, rule-based strategy designed to ensure a minimum return or capital preservation at a future date. Its core mechanism involves continuously re-balancing the investment portfolio between ‘performance assets’ (risky assets like equities) and ‘safe assets’ (like cash or bonds). When the value of the performance assets declines, the strategy dictates a reduction in the exposure to these assets. This ‘de-risking’ action involves selling performance assets and increasing the allocation to safe assets, thereby protecting the principal from further market downturns. Conversely, if performance assets perform well, the strategy allows for increased exposure to capture upside. Increasing exposure to performance assets during a decline would contradict the capital preservation objective. Halting trading is not part of the continuous, algorithmic nature of CPPI. Redistributing the entire portfolio into alternative investments is a broader asset allocation decision, not the specific rebalancing action mandated by CPPI.

The question describes a derivative product that is issued by a third-party financial institution, traded on the SGX-ST, grants the holder the right to buy an underlying asset at a set price, and is typically settled in cash upon exercise. These characteristics are the defining features of a Structured Warrant, as outlined in the CMFAS Module 6A syllabus. Structured warrants are distinct from Company Warrants, which are typically issued by the underlying company itself (not a third party) and often result in the physical delivery of new shares upon exercise. Convertible bonds are debt instruments with an embedded option to convert into shares, making them fundamentally different from warrants. While an equity option shares some similarities, the specific details of third-party issuance and cash settlement on SGX-ST in this context point directly to a structured warrant.

An accumulator is a structured product where an investor agrees to buy a predefined quantity of an underlying asset at a specified strike price on a regular basis over a tenor. A key feature of many accumulators is a knock-out barrier. As described in the CMFAS Module 6A syllabus, if the closing price of the underlying asset reaches or exceeds this knock-out barrier on any trading day during the tenor, the accumulator agreement will terminate immediately. This means the investor will no longer be able to purchase additional shares at the strike price, thereby limiting their potential gains from accumulating shares at a discount to the market price. This scenario is distinct from situations where the price falls below the strike price, which would obligate the investor to continue buying at the strike price, potentially incurring significant losses, or trigger margin calls in the case of unfunded accumulators. Corporate actions or significant market disruptions might lead to adjustments of terms, but simply hitting the knock-out barrier directly leads to termination.

In a Dual Currency Investment (DCI), the investor’s payout depends on the spot exchange rate at maturity relative to the strike price and the breakeven level. In this scenario, the USD/SGD strike price is 1.2250, and the breakeven level is 1.2136. At maturity, the USD/SGD spot rate is 1.2200. Since the spot rate of 1.2200 is below the strike price of 1.2250, the embedded put option is exercised. This means the investor’s principal of SGD 100,000 is converted into the alternate currency, USD, at the terms specified by the DCI. According to the DCI structure provided, the investor would receive USD 82,400. Next, we compare the maturity spot rate to the breakeven level. The spot rate of 1.2200 is above the breakeven level of 1.2136. When the USD 82,400 is converted back to SGD at the prevailing spot rate of 1.2200 (82,400 1.2200 = SGD 100,528), the investor receives an amount greater than their initial principal of SGD 100,000. This indicates a positive return, aligning with the moderate case scenario for a DCI.

The question describes an option strategy constructed with options on the same underlying security, but with different strike prices and different expiration dates. This combination of characteristics precisely defines a diagonal spread. 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 different expiration dates. A ratio spread, while also an option strategy, is defined by buying and selling option contracts in specified ratios, rather than by the specific combination of differing strike prices and expiration dates as the primary defining characteristic.

The Eurodollar futures contract specifications indicate that the minimum price fluctuation for contract months other than the spot month is 0.0050 point. This 0.0050 point translates to a monetary value of USD 12.50. It is important to distinguish this from the spot month’s minimum fluctuation of 0.0025 point, which is equivalent to USD 6.25.

To calculate the total expenses incurred for a CFD transaction, all relevant costs must be summed up. These typically include commission on both the buy and sell sides, Goods and Services Tax (GST) applied to the commission, and financing interest for the duration the position is held. First, calculate the commission and GST for the purchase: – Total Value of Purchase = Quantity × Opening Price = 5,000 × $1.50 = $7,500 – Commission (Buy) = Total Value of Purchase × Commission Rate = $7,500 × 0.35% = $26.25 – GST on Commission (Buy) = Commission (Buy) × GST Rate = $26.25 × 8% = $2.10 – Total Transaction Cost (Buy) = $26.25 + $2.10 = $28.35 Next, calculate the commission and GST for the sale: – Total Value of Sale = Quantity × Closing Price = 5,000 × $1.65 = $8,250 – Commission (Sell) = Total Value of Sale × Commission Rate = $8,250 × 0.35% = $28.875 – GST on Commission (Sell) = Commission (Sell) × GST Rate = $28.875 × 8% = $2.31 – Total Transaction Cost (Sell) = $28.875 + $2.31 = $31.185 Then, calculate the financing interest: – Daily Financing Interest = Total Value of Purchase × Annual Financing Rate ÷ 360 days = $7,500 × 5.5% ÷ 360 = $1.14583 per day – Total Financing Interest = Daily Financing Interest × Number of Days = $1.14583 × 15 = $17.1875 Finally, sum up all expenses: – Total Expenses Incurred = Total Transaction Cost (Buy) + Total Transaction Cost (Sell) + Total Financing Interest – Total Expenses Incurred = $28.35 + $31.185 + $17.1875 = $76.7225 Rounding to two decimal places, the total expenses incurred are $76.72.

Under the UCITS regulations, specifically UCITS III guidelines, a synthetic Exchange Traded Fund (ETF) is subject to strict counterparty risk limits. The marked-to-market value of derivative instruments, such as swaps, with a single counterparty cannot exceed 10% of the fund’s Net Asset Value (NAV) on a daily basis. If this limit is breached, the fund manager is obligated to take immediate action to reduce the exposure to bring it back into compliance. This is a fundamental aspect of risk management and investor protection within the UCITS framework. There is no provision for a grace period or internal exemption for such a breach; immediate corrective measures are required.

The investor’s objective is to maintain their market exposure to the equity index beyond the current contract’s expiry date. This specific action is known as ‘rolling a position’. To achieve this, the investor would simultaneously sell their expiring long June contract and purchase an equivalent number of contracts for a future month, such as September. This effectively transfers their long position from the expiring contract to the new contract month, ensuring continuous market exposure. Allowing the contract to expire would result in cash settlement, thereby closing the position. Offsetting the contract by selling and then waiting would liquidate the current position and break the continuous market exposure. Placing a stop-limit order is a risk management strategy for exiting a position under certain conditions, not for extending market exposure into a new contract period.

This question tests the understanding of the early redemption mechanism and its associated payout structure as detailed in the product terms. The initial date of the product is 16 March 2014. The early redemption observation dates occur every 6 months starting from 15 March 2015. The second early redemption observation date would be 15 September 2015, which is 1.5 years from the initial date. According to the ‘Illustration: Payout Scenarios Upon Mandatory Call Event and At Maturity’ table, if a mandatory call event (knock-out) occurs at Year 1.5, the payout is 112.80% of the initial investment. This percentage includes the original capital plus the accrued yield. The other options represent payouts for different observation periods or the maturity payout scenarios.

Exchange Traded Funds (ETFs) can employ different replication methods to track an underlying index. Direct replication, also known as physical replication, involves the ETF directly holding the securities that constitute the index. In contrast, synthetic replication, such as a swap-based method, achieves index exposure by entering into a swap agreement with a third-party counterparty. Under this agreement, the ETF typically pays a fee or the performance of collateral to the counterparty in exchange for the performance of the underlying index. This structure introduces a unique risk: counterparty credit risk. This is the risk that the third-party counterparty to the swap agreement may default on its obligations, potentially leading to losses for the ETF and its investors. While both types of ETFs face market volatility risk, and direct replication can have operational costs or tracking error (especially with sampling), counterparty credit risk is a distinct and critical risk factor inherent to synthetic replication methods like swap-based ETFs.

The question pertains to the treatment of non-cash corporate actions, such as bonus issues, for investors holding Contracts for Differences (CFDs). According to the CMFAS Module 6A syllabus, specifically Chapter 12.6.8, for non-cash dividends, bonus issues, and rights issues, CFD investors may not be entitled to receive these entitlements. In such cases, the CFD provider may even require the investor to close all open positions before the ex-date. This differs from cash dividends, which CFD investors are typically entitled to receive (or pay, if short), and also from share splits or reverse splits, where the quantity and price in the investor’s account are adjusted to reflect the market equivalent. Therefore, the statement that CFD investors may not be entitled to receive bonus issues and might be required to close positions accurately reflects the common practice.