CMFAS RES6A Quiz 61

Callable Bull/Bear Contracts (CBBCs) are structured products with a mandatory call feature. For a Bull CBBC, a Mandatory Call Event (MCE) occurs when the price of the underlying asset falls to or below a pre-determined call price. Upon an MCE, the CBBC is mandatorily called, leading to its early termination and immediate cessation of trading. This mechanism is designed to limit the issuer’s risk. Unlike some other leveraged products, CBBCs do not have margin requirements. Additionally, implied volatility is generally considered insignificant to the pricing of CBBCs. There is no feature for a CBBC to automatically convert between a bull and bear contract; these are distinct products chosen based on the investor’s market outlook.

The investor’s objective is to protect a long stock position against moderate declines, achieve a cash-neutral position (no upfront net premium cost), and allow for some limited upside. A zero-cost collar is specifically designed for this purpose. It involves simultaneously buying a protective put (which provides downside protection) and selling an out-of-the-money covered call (which generates premium income to offset the cost of the put and caps upside potential). The strike prices are typically adjusted so that the premium received from selling the call equals the premium paid for buying the put, resulting in a zero net cost. Implementing only a covered call strategy would generate income and slightly mitigate a decline, but it offers very limited downside protection and does not aim for a cash-neutral position in terms of hedging cost. Purchasing only a protective put option provides downside protection but incurs an upfront premium cost, which goes against the objective of a cash-neutral strategy. Executing a long straddle involves buying both a call and a put with the same strike and expiry, which is a volatility play betting on a significant price movement in either direction, and it involves a net premium outlay, not a cash-neutral protection strategy for a long position.

The MAS Guidelines on the Product Highlights Sheet (PHS) are designed to ensure that retail investors receive clear, concise, and balanced information about complex financial products. Its fundamental purpose is to distill essential information, including key features, risks, and fees, into an easily digestible format. This empowers investors to understand the product’s core aspects and make informed decisions without having to navigate lengthy and complex legal documents. It is not intended to be a comprehensive legal contract, which is typically found in the offer document or prospectus. While it provides information, it is distinct from a marketing brochure as it must present a balanced view of both benefits and risks. Furthermore, the PHS supplements, rather than replaces, the full prospectus or offer document, which contains more detailed legal and financial information.

To create a synthetic long stock position, an investor needs to combine a long call option with a short put option, both having the same strike price and expiration date. This combination replicates the unlimited profit potential and downside risk profile of directly owning the underlying share. The long call provides upside participation, while the short put obligates the writer to buy the stock if its price falls below the strike, effectively mimicking the downside exposure of holding the stock. The put-call parity principle demonstrates that such replication is possible. Initiating a short call and a long put would create a synthetic short stock position. Initiating both a long call and a long put would result in a long straddle or strangle, which profits from significant price movement in either direction, not a direct replication of a long stock position. Similarly, initiating both a short call and a short put would result in a short straddle or strangle, which profits from minimal price movement.

The scenario describes a fund manager seeking exposure to a complex underlying asset (a niche global equity index) while avoiding the operational challenges and costs of direct ownership of its constituent securities. An Indirect Investment Policy Fund, also known as a swap-based fund, is specifically designed for this purpose. As per the syllabus, these funds do not invest directly or fully in the underlying asset but instead use derivative transactions to link their performance to the underlying asset. This allows for synthetic exposure without the need to manage individual securities directly. The other options describe different types of funds or features that do not address the core requirement of gaining indirect exposure to a complex index while minimizing direct asset ownership. A fund designed with features to preserve capital focuses on risk management of the invested capital, not the method of gaining underlying exposure. A Capitalized Fund relates to the reinvestment of dividends, not the method of achieving synthetic exposure to an underlying index. A Target Date Fund is structured to adjust its risk profile over time, typically for retirement planning, and is unrelated to the method of indirect asset exposure.

Under the UCITS regulations, which govern European ETFs, there are specific limits on counterparty risk exposure for derivative instruments like swaps. The guidelines stipulate that an 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 marked-to-market value of the swaps with any one counterparty cannot exceed 10% of the fund’s NAV on a daily basis. This regulation is crucial for managing the credit risk associated with synthetic replication strategies common in European ETFs.

An Equity Linked Note (ELN) typically involves an embedded put option. In this scenario, the investor purchased the ELN for SGD 480,000. The nominal investment is SGD 500,000, and the strike price is SGD 25.00. This implies that if the put option is exercised, the investor would receive shares equivalent to the nominal value divided by the strike price, which is SGD 500,000 / SGD 25.00 = 20,000 shares. At maturity, the Company XYZ share price is SGD 22.00, which is below the strike price of SGD 25.00. Therefore, the embedded put option is exercised, and the investor is obligated to receive 20,000 shares of Company XYZ. If the investor immediately sells these shares at the prevailing market price of SGD 22.00 per share, the cash received would be 20,000 shares SGD 22.00/share = SGD 440,000. Comparing this to the initial investment of SGD 480,000, the investor incurs an immediate loss of SGD 480,000 – SGD 440,000 = SGD 40,000. This outcome is financially equivalent to a cash settlement mode where the investor receives the cash value of the shares.

Synthetic replication is a methodology where an Exchange Traded Fund (ETF) uses derivative instruments, such as swaps, to replicate the performance of an underlying index without directly holding the physical assets. This approach is particularly advantageous when the index constituents are illiquid, difficult to acquire, or expensive to hold in a physical portfolio. It allows the ETF to gain exposure to the index’s returns efficiently. Direct replication, whether full replication or representative sampling, involves physically acquiring the underlying securities. While full replication aims to hold all index constituents, and representative sampling holds a subset, both methods become impractical or very costly when the underlying assets are highly illiquid or hard to access. Cash-based replication refers to a specific type of ETF (Cash ETF) that invests in short-term money market instruments, not a general methodology for tracking an illiquid index of other asset classes.

An investor anticipating a future purchase of shares, but concerned about a potential price increase before their funds are available, would employ a long hedge strategy using Extended Settlement (ES) contracts. By purchasing ES contracts, the investor effectively locks in the ‘purchase’ price for the underlying shares. If the share price rises by the time the investor’s funds are liquid, the gain from the long ES position would offset the higher cost of acquiring the shares on the spot market, thereby protecting the investor from the adverse price movement. Selling ES contracts, conversely, constitutes a short hedge, which is typically used to protect against a decline in the price of shares already held or an anticipated sale. An immediate purchase on the spot market is not viable if the investor’s funds are not yet liquid. Acquiring put options would provide protection against a price fall, not against a price increase for an anticipated purchase.

The Constant Proportion Portfolio Insurance (CPPI) strategy aims to ensure a minimum return by dynamically allocating assets between a ‘safe’ component and a ‘performance’ (risky) component. The amount that can be exposed to risk, known as the ‘cushion’, is calculated as the difference between the current fund value (NAV) and the capital preservation level. In this case, the cushion is SGD 1,200,000 (current NAV) – SGD 1,000,000 (preservation level) = SGD 200,000. The maximum amount allocated to performance assets is then determined by multiplying this cushion by the fund’s specified multiplier. Therefore, the maximum allocation to performance assets is SGD 200,000 (cushion) 3 (multiplier) = SGD 600,000. This calculation ensures that even if the performance assets decline, the fund still has sufficient ‘safe’ assets to meet the capital preservation target.

The scenario describes an Exchange Traded Fund (ETF) that tracks a commodity index by investing in futures contracts. When such an ETF needs to replace expiring futures contracts with new ones, and the price of the new contract is consistently higher than the expiring one, this situation is known as contango. The process of selling expiring contracts and buying new ones is called rolling over. In a contango market, rolling over futures contracts results in a loss for the ETF, as it is effectively selling low and buying high. These losses directly reduce the ETF’s performance relative to its underlying index, thereby increasing its tracking error. Tracking error is a measure of how much the ETF’s performance deviates from the performance of the index it aims to track. Therefore, the contango effect during futures rollover is a significant source of tracking error for commodity-linked ETFs. Backwardation is the opposite scenario, where the price of the next contract is lower than the expiring one, which could lead to gains during rollover. Cash drag refers to the impact of uninvested cash holdings, such as dividends, on an ETF’s performance, which is a different source of tracking error. Bid-ask spread refers to the difference between the buying and selling price of a security or ETF unit, and while it can contribute to tracking error, the specific phenomenon of rolling futures at a higher price is distinctively the contango effect.

For a put option buyer, the option is exercised if the underlying asset price at expiration (ST) is below the exercise price (X). The payoff at expiration is calculated as X – ST. In this scenario, the exercise price is $85 and the underlying asset price at expiration is $78. Therefore, the payoff from exercising the option is $85 – $78 = $7. The investor initially paid a premium of $6 for the option. To determine the net profit or loss, the premium paid must be subtracted from the payoff. So, the net profit is $7 (payoff) – $6 (premium) = $1. The maximum loss for a put option buyer is the premium paid, which is $6, but this only occurs if the option expires worthless (i.e., the underlying price is at or above the exercise price).

When a Constant Proportion Portfolio Insurance (CPPI) strategy product’s portfolio value drops to its pre-defined floor, the strategy dictates a mandatory reallocation. The manager is compelled to move the entire fund into risk-free assets to preserve the capital floor. A critical consequence of this action is that the investor will no longer participate in any subsequent appreciation of the underlying asset, as the portfolio is fully invested in non-risky instruments. This is a key risk highlighted in the CPPI strategy. The other options describe actions contrary to the CPPI mechanism at the floor, such as increasing allocation to risky assets, requiring additional capital, or converting to a pure equity fund, none of which are characteristic responses of a CPPI strategy reaching its floor.

An investor anticipating a moderate upward movement in the underlying asset’s price has a moderately bullish market view. To generate an immediate positive cash flow, the investor should employ a credit spread strategy. The Bull Put Spread is designed for a moderately bullish outlook and involves receiving a net credit upfront. It is constructed by selling an in-the-money (ITM) put option and simultaneously buying an out-of-the-money (OTM) put option with the same expiration date. This combination results in a net credit received by the investor. The Bear Call Spread, while also a credit spread, is suitable for a moderately bearish market view, not a bullish one. The Bull Call Spread is typically a debit spread, meaning it requires an initial cash outlay (net debit), which contradicts the desire for an ‘immediate positive cash flow’. A Bear Put Spread is also a debit spread and is used for a bearish market outlook.

The question describes a scenario where a CFD provider in Singapore offers pricing that is directly determined by the real-time market price of the underlying asset. This aligns precisely with the Direct Market Access (DMA) business model. In the DMA model, the investor’s order goes through the CFD provider’s platform, but the investor effectively gains direct access to the market where the underlying asset is traded, and the market price of that underlying asset dictates the price of the CFD contract. This is explicitly stated as the predominant approach for CFD providers in Singapore. The Market-Maker model, in contrast, involves the CFD provider quoting its own bid-ask prices, which are based on the underlying asset but not necessarily a direct pass-through of the underlying market’s real-time price. Exchange-Traded CFDs are traded on an exchange like listed equities, which is a different mechanism and noted as uncommon, primarily in Australia. A Proprietary Trading Desk model describes how a firm might manage its risk or generate profit by trading against client orders, but it doesn’t specifically define the pricing mechanism as being directly tied to the underlying market’s live price in the way DMA does.

A structured note is a debt instrument whose return characteristics are linked to the performance of other underlying instruments. The derivative component, often referred to as the ‘Return Component,’ is designed to provide exposure to a chosen asset class. This exposure can be achieved through various derivative strategies, such as selling an option in exchange for a fixed premium or taking a long position in an option. Therefore, the derivative component’s primary contribution is to link the note’s performance to the underlying asset, influencing the potential returns. The note holder typically does not have a direct claim over the underlying instruments, which are merely a reference. Structured notes do not guarantee a fixed, predictable coupon payment; instead, their returns fluctuate based on the underlying instrument’s performance. While credit risk is a consideration for structured notes, the derivative component’s fundamental role in generating returns is not solely to act as a credit default swap for issuer protection, but rather to provide market exposure.

For a call option, it is considered ‘in-the-money’ when the current market price of the underlying asset is higher than the option’s strike price. The intrinsic value of a call option is calculated as the positive difference between the current market price and the strike price. In this case, the current market price of Stock X is $55, and the call option’s strike price is $50. Since $55 is greater than $50, the option is in-the-money. The intrinsic value is calculated as $55 (Current Market Price) – $50 (Strike Price) = $5. The premium paid for the option is a separate cost and does not affect the intrinsic value calculation.

To construct a synthetic short put, an investor combines a long position in the underlying asset with a short call option. This combination replicates the payoff profile of a short put, where the investor profits if the underlying asset’s price rises or stays above the strike price, and faces potential losses if the price falls significantly. The other options represent different synthetic positions: a short underlying combined with a long call creates a synthetic long put; a long underlying combined with a long put creates a synthetic long call; and a short underlying combined with a short put creates a synthetic short call.

The provided text clearly distinguishes between principal preservation and principal guarantee. Principal preservation involves structuring the product such that a portion of the investment is placed in fixed income securities (like zero-coupon bonds) that mature at the same time as the structured product, aiming to return the principal. However, this does not guarantee the principal, as the underlying fixed income security may default. Therefore, principal preservation still carries default risk. In contrast, principal guarantee means the investor’s initial investment is explicitly guaranteed by certain collaterals, acting as a form of investment insurance. This guarantee feature is priced into the structured product, making it more expensive than a product with only principal preservation for the same principal amount. Option 1 accurately captures these distinctions, highlighting the collateral-backed assurance and higher cost of a guarantee versus the reliance on underlying securities and default risk of preservation. Option 2 incorrectly states that principal preservation offers complete assurance and misrepresents the mechanism of principal guarantee. Option 3 is incorrect because the two features provide different levels of capital protection. Option 4 is also incorrect as a principal guarantee is a priced feature, not a free add-on, and principal preservation does not involve purchasing separate insurance.

To determine the total expenses incurred for the CFD trade, we need to calculate the commission for both the buy and sell transactions, the Goods and Services Tax (GST) on these commissions, and the financing interest for the duration the position was held. 1. Calculate Buy Transaction Costs: Initial Value = Quantity × Opening Price = 5,000 units × $1.50 = $7,500 Commission (Buy) = Initial Value × Commission Rate = $7,500 × 0.35% = $26.25 GST on Commission (Buy) = Commission (Buy) × GST Rate = $26.25 × 8% = $2.10 Total Buy Transaction Cost = Commission (Buy) + GST on Commission (Buy) = $26.25 + $2.10 = $28.35 2. Calculate Sell Transaction Costs: Closing Value = Quantity × Closing Price = 5,000 units × $1.65 = $8,250 Commission (Sell) = Closing Value × Commission Rate = $8,250 × 0.35% = $28.875 (rounded to $28.88) GST on Commission (Sell) = Commission (Sell) × GST Rate = $28.88 × 8% = $2.3104 (rounded to $2.31) Total Sell Transaction Cost = Commission (Sell) + GST on Commission (Sell) = $28.88 + $2.31 = $31.19 3. Calculate Financing Interest: Daily Financing Rate = (Initial Value × Annual Financing Rate) / 360 days = ($7,500 × 5.5%) / 360 = $412.50 / 360 = $1.145833… per day Total Financing Interest = Daily Financing Rate × Number of Days = $1.145833… × 15 days = $17.1875 (rounded to $17.19) 4. Calculate Total Expenses Incurred: Total Expenses = Total Buy Transaction Cost + Total Sell Transaction Cost + Total Financing Interest Total Expenses = $28.35 + $31.19 + $17.19 = $76.73

The fund trustee’s main role is to look after the interests of the unit holders and ensure that the fund manager manages the Collective Investment Scheme (CIS) in accordance with the investment objective and restrictions as laid out in the trust deed and prospectus. This oversight function is central to their fiduciary duty. While the trustee is responsible for informing the Monetary Authority of Singapore (MAS) of any breaches within three business days, and ensuring proper accounting records are kept and audited, their primary responsibility when a fund manager deviates from the investment mandate is to ensure compliance with the fund’s governing documents. The trustee does not directly manage the fund’s assets or intervene in portfolio rebalancing; that remains the fund manager’s role. Similarly, while unit holders receive reports, the immediate action for a breach of mandate is not to seek collective instruction from them or to prepare the accounts, which is the fund manager’s task.

The Auto-Redeemable Structured Fund XYZ’s features state that the product becomes auto-redeemable from 1 year after the inception date and every 6 months thereafter. This occurs if the performance of the Nikkei 225 index at the valuation time on the relevant early redemption observation date is greater than or equal to the performance of the S&P 500 index. When this condition is met, the product is redeemed at a pre-determined price specific to that observation date. For an auto-redemption occurring after 2.0 years, the pre-determined redemption price is 117.00% of the initial principal. Therefore, the fund would be automatically redeemed, and the investor would receive 117.00% of their initial investment. The other options misinterpret the auto-redemption conditions, the automatic nature of the redemption, or the specific payout structure at early redemption.

Knock-out options are a specific type of barrier option where the option’s validity is conditional on the underlying asset’s price not reaching or crossing a predetermined barrier level. In this scenario, the investor holds a knock-out call option with a knock-out barrier set at $12.00. When the share price of Company X briefly touches $12.05, it crosses this specified barrier. According to the features of knock-out products, the occurrence of this ‘barrier event’ immediately extinguishes the option. This means the option ceases to exist and becomes invalid, irrespective of its intrinsic value at that moment or any subsequent price movements. The terms of the option agreement would then dictate any final settlement, which could be zero or a predetermined amount, but the option itself is no longer active.

The question describes the characteristics of an unfunded swap arrangement within an Exchange Traded Fund (ETF). In this structure, the ETF itself takes the initiative to purchase a pool of collateral using the proceeds from the sale of its units. This collateral is then held by a third-party custodian. The ETF subsequently exchanges the returns generated by this collateral with a swap counterparty for the performance of the target index. This method aims to limit the ETF’s exposure to the swap counterparty, requiring daily rebalancing to ensure the collateral’s value is at least 90% of the ETF’s Net Asset Value (NAV). In contrast, a fully funded swap arrangement involves the ETF transferring its sale proceeds to the swap counterparty, who then purchases and pledges the collateral in favour of the ETF.

The question tests understanding of the independent oversight functions for structured products, as outlined in the CMFAS Module 6A syllabus. An independent trustee is appointed to hold the assets and underlying financial instruments, providing assurance that the product’s assets are managed with due care. Concurrently, financial auditors are engaged to verify that the structured product’s financial statements are true and fair, and to ensure fair valuation of the product and its underlying instruments. These two roles are distinct and independent, directly addressing the concerns of asset management and financial reporting accuracy for investor protection. Other options describe internal functions, regulatory bodies, or market participants, which, while important, do not fulfill the specific independent roles of holding assets and auditing financial statements for the structured product itself.

An accumulator agreement obligates the investor to purchase a predetermined quantity of a reference stock at a fixed strike price over a specified period. A key risk highlighted in the product description is that this condition applies even if the market price of the shares drops below the strike price. Therefore, if the daily closing price consistently falls significantly below the strike price, the investor is still contractually bound to buy the shares at the higher, agreed-upon strike price, leading to potential losses. The agreement’s termination feature (knock-out barrier) is typically triggered when the price is at or above the barrier, not when it falls below the strike price. While some accumulators have a ‘1X2 gear’ scheme where the investor buys 2X the quantity if the price is below the strike, this is still at the fixed strike price, not the lower market price, and it exacerbates the investor’s burden rather than enhancing their position. There is no provision for renegotiating the strike price or automatically exiting the position without obligation under such circumstances; the fixed strike price is a core term of the agreement.

The Interest Rate Parity Theory establishes a relationship between spot exchange rates, forward exchange rates, and the interest rates of two currencies. The formula for the forward rate (F) is given by: F = S x (1 + Rc(n/360)) / (1 + Rb(n/360)), where S is the spot rate, Rc is the interest rate of the counter currency, Rb is the interest rate of the base currency, and n is the number of days. In this scenario: Spot rate (S) = 1.3500 SGD/USD Interest rate for the counter currency (SGD, Rc) = 1.00% or 0.01 Interest rate for the base currency (USD, Rb) = 2.00% or 0.02 Number of days (n) = 90 Substitute these values into the formula: F = 1.3500 x (1 + 0.01 (90/360)) / (1 + 0.02 (90/360)) F = 1.3500 x (1 + 0.01 0.25) / (1 + 0.02 0.25) F = 1.3500 x (1 + 0.0025) / (1 + 0.0050) F = 1.3500 x (1.0025) / (1.0050) F = 1.3500 x 0.9975124378 F = 1.34664179 Rounding to four decimal places, the implied 90-day forward rate is 1.3466 SGD/USD. Since the interest rate for SGD (counter currency) is lower than that for USD (base currency), the SGD is expected to appreciate against the USD in the forward market, resulting in a lower forward rate compared to the spot rate.

The Semi-annual Accounts and Reports to Unitholders are comprehensive documents that include the Statement of Investments, which lists out the details of the investment portfolio, and the Statement of Changes in Net Assets, which shows how the net assets of the fund have changed over the past two reporting periods. These two statements directly address the investor’s need for specific asset holdings and the detailed reconciliation of net asset changes. The Monthly Performance Report focuses on returns and risk analysis, the Investment Manager Report details performance and outlook, and the Fund Factsheet provides a concise overview, none of which offer the granular detail on portfolio holdings and net asset changes over two periods as found in the semi-annual reports.

When a company issues dividends, the terms of existing equity warrants (like call warrants) often need to be adjusted to reflect the change in the underlying share’s value. The adjustment factor for the exercise price, in the case of dividends, is calculated using the formula: (P – SD – ND) / (P – ND). Here, ‘P’ represents the last cum-date closing price of the underlying share, ‘SD’ is the Special Dividend per Share, and ‘ND’ is the Normal Dividend per Share. The numerator subtracts both special and normal dividends from the cum-date price, while the denominator only subtracts the normal dividend, reflecting that normal dividends are typically anticipated and priced into the share, whereas special dividends are not. Therefore, the correct calculation involves subtracting both dividends from the cum-date price in the numerator and only the normal dividend in the denominator.

Callable Bull/Bear Contracts (CBBCs) are structured products whose terms may need adjustment in response to certain corporate actions by the underlying asset’s issuer. According to the guidelines, corporate actions such as bonus issues, rights issues, share splits, and reverse share splits fundamentally alter the capital structure or share value and thus necessitate an adjustment to the CBBC’s terms to maintain fairness and the original economic intent. Conversely, regular cash dividends are typically accounted for by the issuer as part of the funding cost when the CBBC is priced and therefore do not require a separate adjustment. Events like normal quarterly earnings announcements or changes in management, while potentially influencing the underlying share price, are not considered corporate actions that trigger a direct adjustment to the CBBC’s contractual terms.