CMFAS RES6A Quiz 64

To determine the number of futures contracts required to hedge an equity portfolio, the formula N = (VP / (F T)) β is used, where N is the number of contracts, VP is the current value of the portfolio, F is the current futures quote, T is the value per point (contract multiplier) for the futures contract, and β is the beta of the portfolio. Given: Portfolio Value (VP) = $12,500,000 Portfolio Beta (β) = 1.15 Futures Quote (F) = 3,450 points Contract Multiplier (T) = $50 per index point First, calculate the total value represented by one futures contract: F T = 3,450 $50 = $172,500. Next, apply the formula for the number of contracts: N = ($12,500,000 / $172,500) 1.15 N = 72.463768… 1.15 N = 83.33333… Since futures contracts are typically traded in whole numbers, rounding to the nearest whole contract yields 83 contracts.

The effectiveness of a hedge refers to how well the hedged position mitigates risk compared to an unhedged position. Even when a hedge is initially structured correctly, discrepancies between the expected and actual outcomes can arise. A primary source of such error, as highlighted in futures strategies, is the divergence of the actual basis (the difference between the spot price of the underlying asset and the futures price) at the time the hedge is lifted from its projected value. If the basis behaves differently than anticipated, the hedge will not perfectly offset the risk, leading to a deviation from the expected financial result. Other factors like general economic shifts or counterparty credit risk, while relevant in finance, are not typically cited as the main sources of error specifically in the context of hedge effectiveness and its evaluation after lifting, assuming proper initial structuring.

When an investor sells a put option, they are taking on an obligation. If the buyer of that put option decides to exercise their right, the seller of the put option is then obligated to purchase the underlying asset from the buyer at the agreed-upon strike price. This is a fundamental concept of options trading, where the seller of an option takes on an obligation in exchange for the premium received. The other options describe either the rights of an option buyer (call or put) or the obligation of a call option seller, which are distinct from the put option seller’s obligation.

Futures packs and bundles are specifically designed to allow market participants to purchase or sell a series of futures representing a particular segment along the yield curve in a single transaction. This eliminates the need to enter multiple orders for each contract, thereby reducing the overall cost of trading and, crucially, limiting the possibility that some orders may go unfilled, which is known as legging risk. A standard futures contract would require individual orders for each maturity, increasing legging risk and transaction costs. An OTC swap agreement is a different type of derivative entirely, not a standardized exchange-traded product for this purpose. A mutual offset system transaction facilitates transferring positions between exchanges but does not inherently combine multiple contracts into a single order to mitigate legging risk for yield curve strategies.

When the balance in a futures margin account falls below the maintenance margin level, an additional margin call is triggered. According to the rules, the investor is then required to deposit funds to bring the account balance back up to the initial margin level, not just to the maintenance margin level. In this scenario, the initial margin was $15,000 and the maintenance margin was $12,000. Since the account balance dropped to $11,000 (which is below the maintenance margin), the investor must top up the account to the initial margin level of $15,000. Options suggesting restoration to the maintenance level or no action are incorrect, as is the immediate automatic liquidation, which typically occurs if a margin call is not met.

The daily mark-to-market (MTM) process for Extended Settlement (ES) contracts is a crucial risk management mechanism. Its primary objective, as stated in the syllabus, is to limit the exposure of the Central Depository (CDP) to potential losses arising from price changes in open ES positions. By revaluing these positions daily to their respective valuation prices, the CDP prevents the accumulation of significant, unmanageable losses that could otherwise occur if positions were only valued at maturity. This ensures that any gains or losses are recognized and settled on a daily basis, requiring members to maintain sufficient funds or credit facilities to cover any MTM losses. The other options describe different aspects: final settlement is distinct from daily revaluation, Initial Margins relate to new trades, and arbitrage opportunities are a potential market dynamic, not the objective of the MTM process itself.

An Indirect Investment Policy Fund, also known as a swap-based fund, is specifically designed to provide investors with a return linked to an underlying asset without directly investing in that asset. Instead, it gains exposure through derivative transactions, such as total return swaps, or by investing in hedging assets and exchanging their performance for that of the underlying asset via derivatives. This method allows the fund to bypass restrictions on direct investment in certain assets or markets. The other options describe different fund structures or investment strategies: investing in domestic stocks to replicate sentiment is a correlation strategy, not the specific mechanism of an Indirect Investment Policy Fund; establishing a pre-defined, rule-based formula for payouts is characteristic of a Formula Fund; and allocating capital for preservation while directly investing in foreign bonds involves direct investment, which is contrary to the indirect exposure mechanism of this fund type for the specified underlying asset.

Gamma is defined as the sensitivity of delta to changes in the underlying asset price. It quantifies how fast delta changes when the underlying asset moves. Therefore, if an options trader is concerned about the rate at which their portfolio’s delta exposure will change due to significant movements in the underlying asset price, Gamma is the most relevant ‘Greek’ to assess this risk. Delta measures the sensitivity of the option price to the underlying asset price, not the rate of change of delta itself. Theta measures the rate of time decay, or the loss of an option’s value over time. Vega measures the sensitivity of an option’s value to changes in implied volatility.

The scenario describes an Exchange Traded Fund (ETF) aiming to track an index in a market with significant foreign investment restrictions, while also minimizing direct holdings of potentially illiquid foreign securities and adhering to strict counterparty exposure limits. Synthetic replication methods, such as derivative-embedded or swap-based approaches, are specifically designed to gain exposure to markets that cannot be easily accessed through direct investment due to foreign investment or tax limitations. These methods involve a counterparty providing the index performance. Under Singapore’s regulatory framework, such as the Code on CIS or UCITS, synthetic ETFs must comply with a maximum of 10% net counterparty exposure. To achieve this, the derivative issuer or swap counterparty typically deposits collateral for the balance (e.g., 90%) with a third-party custodian, with the collateral owned by the ETF’s trustee. This approach effectively addresses market access, minimizes direct holdings, and manages counterparty risk within regulatory boundaries. Direct replication, whether full or representative sampling, would involve direct investment in the underlying securities, which is impractical or impossible given the stated foreign investment restrictions. Lastly, a synthetic replication method without collateralization would fail to meet the regulatory requirement for limiting net counterparty exposure.

To determine the number of futures contracts needed to hedge an equity portfolio, the following formula is applied: Number of Contracts (N) = (Value of Portfolio (VP) / Value of one futures contract) Beta of Portfolio (β). First, calculate the value of one futures contract by multiplying the current futures quote by the value per point (multiplier). In this case, the value of one futures contract is 3,000 points $50/point = $150,000. Next, substitute the values into the formula: N = ($10,000,000 / $150,000) 1.2. This calculation yields N = 66.666… 1.2 = 80 contracts. Since the portfolio has a positive beta (1.2), indicating it is more sensitive to market movements than the overall market, the fund manager needs to take an opposite position in the futures market to hedge against market risk. Therefore, to achieve a delta-neutral position, the fund manager should sell 80 futures contracts.

Company warrants are typically issued by the underlying company itself, often as a ‘sweetener’ to a bond or rights issue. Upon exercise, these warrants usually lead to the issuance of new shares by the company, which is a form of physical settlement. In contrast, structured warrants are issued by third-party financial institutions, not the underlying company. For structured warrants listed on the SGX-ST, the common settlement mechanism is cash settlement, where the holder receives a cash amount based on the difference between the underlying asset’s price and the exercise price, rather than physical shares. The other options incorrectly attribute the issuer or settlement method to the wrong type of warrant or incorrectly state that both types share the same issuer or settlement method.

The question describes a scenario where an Exchange Traded Fund (ETF) consistently trades at a discount to its Net Asset Value (NAV). According to the CMFAS Module 6A syllabus, discrepancies between an ETF’s trading price and its NAV can arise due to several factors. These include supply and demand imbalances, periods of high market volatility, direct investment restrictions in the underlying markets (e.g., for specific sectors or countries like emerging markets), or when the underlying assets are domiciled in different time zones from where the ETF is traded. Given the scenario mentions an ETF tracking ’emerging market equities’ and ‘consistently trading at a notable discount’ despite ‘generally stable market conditions’, the most probable reason points to structural issues like investment restrictions or time zone differences affecting arbitrage efficiency. Other options describe different risks or general characteristics of ETFs that do not directly explain a persistent NAV discount in this specific context. For instance, high management fees are generally not characteristic of passive ETFs, and synthetic replication typically aims for lower tracking error. While market-maker issues can affect liquidity, a consistent discount suggests a more fundamental structural reason related to the underlying market access.

A Total Return Swap (TRS) is a derivative contract where one party (the fund) pays a fixed or floating rate (like SIBOR plus a spread) to a counterparty, and in return, receives the total return of an underlying asset or index, including both capital appreciation and any income generated. This allows the fund to gain synthetic exposure to the index’s performance without having to directly purchase and manage the underlying securities or actively roll over futures contracts. The other options describe different structured fund strategies: investing in zero-coupon bonds and call options is characteristic of a zero-plus option strategy, dynamically adjusting asset allocation based on a cushion and multiplier is part of Constant Proportion Portfolio Insurance (CPPI), and directly acquiring constituent securities is a method of direct index replication, not synthetic exposure via derivatives.

A Callable Bull/Bear Contract (CBBC) is a structured product 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. When an MCE is triggered, the CBBC terminates immediately, regardless of its original maturity date. This early termination can lead to the investor losing their entire initial investment, especially in the case of an N-CBBC (No residual value), or receiving only a small residual amount for an R-CBBC (Residual value). Therefore, when the underlying asset price is nearing the call price, the most critical and immediate concern for the investor is the high probability of an MCE and the associated capital loss. The other options are incorrect because implied volatility is generally insignificant to CBBC pricing, CBBCs terminate rather than convert into shares upon an MCE, and while CBBCs do have financial costs deducted daily, the primary and most immediate risk when the underlying is close to the call price is the mandatory call event itself, not primarily time decay as seen in standard warrants.

Structured products designed to offer a minimum return of principal at maturity typically achieve this by investing a substantial portion of the capital into a zero-coupon bond. This bond is structured to mature at the product’s expiry, returning the initial principal. To provide potential upside participation, the remaining capital is then used to purchase a long-call option on an underlying asset. This combination allows for principal protection while still offering exposure to market gains. Employing short options strategies, conversely, is generally associated with structured products that do not offer a minimum return of principal, as they generate premium income but expose the investor to potential losses beyond the premium received. Physical settlement in an underlying asset is a form of maturity pay-out, not a strategy for guaranteeing principal. Investing the entire principal component in high-yield corporate bonds is a strategy for the return component, aiming for higher fixed returns, but it does not guarantee the principal and carries credit risk.

Futures contracts are marked-to-market daily. This means that at the end of each trading day, the exchange sets a settlement price, and each trading account is credited or debited based on the day’s profits or losses. Even if a contract hits its daily price limit, the loss up to that limit is still recorded. If this loss causes the investor’s account to no longer meet the minimum performance bond requirements, a margin call (or performance bond call) will be issued. The investor would then need to add funds or reduce positions to satisfy these requirements. The daily price limit regulates price swings but does not prevent the recording of losses up to that limit, nor does it automatically halt trading indefinitely or liquidate positions without a prior margin call.

According to the CMFAS Module 6A syllabus, specifically section 13.7.8 ‘Acceptance of Orders during Margin Calls’, if a customer fails to meet a margin call by the close of the market on T+2, the Member and Trading Representative are generally prohibited from accepting orders for new trades. However, a crucial exception exists: orders that would result in the customer’s Required Margins being reduced may still be accepted. A ‘risk reducing trade’ is defined as the closure of a position in an ES contract which reduces a customer’s Maintenance Margins requirements, such as the liquidation of a naked open position. This type of trade directly reduces the overall margin requirement, making it permissible. Conversely, ‘risk increasing trades’ (which increase Maintenance Margins) and ‘risk neutral trades’ (which do not impact Maintenance Margins) are not allowed under these circumstances, nor are orders to establish entirely new positions unless they specifically reduce required margins, which is not typically the case for establishing new positions.

The provided CMFAS Module 6A syllabus material on ‘Daily Price Limits’ explicitly states that ‘When a futures contract settles at its limit bid or offer, the limit may be widened to facilitate transactions for the next trading session. This may help futures prices return to a level reflective of the current market environment.’ This directly supports the idea that the exchange might adjust the daily price limit to be wider. The other options describe actions that are either incorrect or not directly related to the exchange’s response to a contract settling at its daily price limit. Liquidation of all open positions or an indefinite trading halt are extreme measures not typically triggered solely by hitting a daily price limit. While margin calls are part of futures trading, they are a response to an investor’s account performance, not the exchange’s direct action on the price limit itself.

The core distinction between American and European options, particularly from the perspective of an option writer, lies in their exercise provisions. American options grant the holder the right to exercise at any time before or on the expiration date. This means an option writer of an American-style contract faces the uncertainty of when their obligation to deliver (for a call) or purchase (for a put) the underlying asset might be triggered. They have no control over this timing, which can lead to unexpected liabilities. In contrast, European options can only be exercised at expiration, providing the writer with certainty regarding the timing of potential exercise. The other options describe general risks associated with options trading or writing that are not specific to the American-style exercise feature. Unlimited loss for a naked call writer is a risk regardless of the option style. Time decay affects both types of options. Liquidity risk of the underlying asset is a market risk not directly tied to the option’s exercise style.

This question assesses the understanding of a hedging strategy involving a short stock position combined with a long call option. The investor short sells a stock and simultaneously buys a call option to limit potential losses if the stock price rises. The maximum potential loss for this combined strategy occurs when the stock price at expiration (ST) rises above the call option’s strike price (X). In this scenario, the loss from the short stock position is partially offset by the profit from the long call option. The maximum loss is calculated as the difference between the strike price and the short sale price, plus the premium paid for the call option. Given: Short Sale Price (S0) = $75.00 Call Strike Price (X) = $78.00 Call Premium (c0) = $4.00 The maximum loss for this hedged position is calculated as: X – S0 + c0 Maximum Loss = $78.00 – $75.00 + $4.00 = $3.00 + $4.00 = $7.00. This means that regardless of how high the stock price climbs above the strike price, the investor’s loss per share for this combined strategy will not exceed $7.00. The other options represent either the premium paid, the difference between the strike and short price, or the maximum potential gain for the strategy.

The question addresses the management of risk arising from changes in implied market volatility for options portfolios. Vega is the specific option Greek that quantifies the sensitivity of an option’s price to a 1% change in the underlying asset’s implied volatility. Therefore, when a portfolio manager is concerned about shifts in market volatility, Vega is the primary Greek to monitor. According to the CMFAS Module 6A syllabus, limits for Vega are typically set by determining the maximum tolerable loss that would be accepted given specified movements in volatility, whether upwards or downwards. Delta measures the sensitivity to the underlying asset’s price, Gamma measures the rate of change of Delta, and Theta measures the impact of time decay on the option’s value. While these other Greeks are crucial for overall risk management, Vega is uniquely focused on volatility risk.

The question describes an Accrual Barrier Knock-out (ABKO) note. The yield calculation depends on the number of days (‘n’) the HSI spot price fixes within the accrual range (between 22,200 and 22,400). The knock-out barrier at 22,400 means that if the HSI trades above this level, the coupon stops accumulating. In the given scenario, the HSI fixes within the accrual range for the first 150 trading days. On the 151st day, it closes above the knock-out barrier and stays there. This means ‘n’ is 150 days, as accrual ceases once the knock-out barrier is breached. The total number of trading days (‘N’) is 250. First, calculate the accrual coupon rate: 0.50% + [4.00% x n/N] = 0.50% + [4.00% x 150/250] = 0.50% + [4.00% x 0.6] = 0.50% + 2.40% = 2.90% The investment principal is SGD 1 million. The accrual coupon amount is: SGD 1,000,000 x 2.90% = SGD 29,000 The total redemption proceeds at maturity will be the principal plus the accumulated accrual coupon: SGD 1,000,000 (Principal) + SGD 29,000 (Accrual Coupon) = SGD 1,029,000. Option SGD 1,045,000 would be correct if the HSI had remained within the accrual range for the entire 250 days without breaching the knock-out barrier (0.50% + 4.00% x 250/250 = 4.50% yield). Option SGD 1,021,000 incorrectly uses 100 days for ‘n’, which was an example value from a different scenario. Option SGD 1,005,000 would imply only the base 0.50% yield, suggesting the HSI never fixed within the accrual range or always below the accrual barrier.

The effectiveness of a hedge is evaluated by comparing its actual performance against its anticipated outcome. When deviations occur, the primary reasons are typically related to how well certain market variables were estimated. Specifically, the accuracy of the projected basis at the point the hedge is closed out (the lift date) is crucial. Basis risk, which is the risk that the relationship between the spot price of the underlying asset and the futures price changes unexpectedly, is a significant factor. Additionally, when a cross-hedge is used (hedging an asset with a futures contract on a different but related asset), the parameters used to establish the correlation and sensitivity between the two assets must be precise. Errors in these estimations can lead to the hedge not perfectly offsetting the risk it was designed to cover. Other factors like general market volatility or liquidity are broader market conditions that influence the market, but are not identified as the main sources of error in the hedge’s effectiveness itself. Similarly, initial margin and transaction costs are operational expenses, not direct sources of error in the hedge’s ability to mitigate risk. The underlying asset’s fundamental value shifts are what the hedge aims to protect against, not a source of error in the hedge’s mechanism.

Pairs trading, as described in the CMFAS Module 6A syllabus, is fundamentally designed to be ‘market-neutral’. This means that the strategy aims to remove or significantly reduce the impact of the overall market’s direction on the investment’s outcome. By taking both a long and a short position, typically in highly correlated assets, the investor seeks to profit from the relative performance of the two assets rather than their absolute movements driven by broader market trends. The intention is that the long and short positions will neutralize each other against general market risk, allowing the investor’s gain to be based primarily on stock selection and the convergence of perceived deviations from historical norms. Therefore, mitigating the impact of overall market direction is a core objective.

The question describes an early redemption scenario for a 3-year Auto-Redeemable Structured Fund. The initial investment is SGD 100,000. The fund has an initial 1-year call protection period, after which early redemption observation dates occur every 6 months. The first observation date is after 1 year, and the second observation date would be 6 months after the first. Therefore, the mandatory call event occurs on the second observation date, meaning ‘No. of Observations’ is 2. The product terms state that for an early redemption, the Payout Price = Periodic Yield x No. of Observations. The Periodic Yield is given as 4.25%. So, Payout Price = 4.25% x 2 = 8.50%. The Terminal Value (Payout) = Redemption Value x Payout Price. Since the Redemption Value is 100% of the initial investment, the total payout to the investor will be the initial investment plus the accumulated yield. Thus, the payout is SGD 100,000 x (1 + 0.0850) = SGD 100,000 x 1.0850 = SGD 108,500. Option 2 (SGD 104,250) would be correct if the early redemption occurred on the first observation date (4.25% yield for 1 observation). Option 3 (SGD 125,500) represents the payout if the product reaches maturity and the Nikkei 225 outperforms the S&P 500, which is a different scenario than early redemption. Option 4 (SGD 100,000) would be the payout if the product reaches maturity and the Nikkei 225 does not outperform the S&P 500, or if only the principal is returned without any yield, which is incorrect for an early redemption with a periodic yield.

The MAS Guidelines on the Product Highlights Sheet (PHS) mandate that it serves as a concise, standalone document designed to help retail investors understand the key features, risks, and costs of an investment product. Its primary purpose is to provide essential information in an easily digestible format, enabling investors to make informed decisions. Therefore, a mandatory element is a clear and concise summary of the product’s key features, associated risks, and all applicable fees and charges. The PHS is not intended to replace the full offering document (like a prospectus) but to complement it by highlighting critical information. Including the complete legal terms and conditions verbatim would defeat the purpose of conciseness. An exhaustive list of all past financial market events is too broad and not specific to the product’s inherent risks as required for the PHS. A detailed biography of the fund manager and investment team, while potentially found in other offering documents, is not a mandatory core component of the PHS itself, which focuses on the product’s characteristics.

For Contracts for Differences (CFDs), corporate actions like cash dividends directly impact the investor’s account. If an investor holds a long CFD position, they are typically credited with the dividend amount, mirroring the benefit of owning the underlying shares. Conversely, if an investor holds a short CFD position, they are obligated to pay the dividend amount, which is reflected as a debit from their account. This mechanism ensures that the CFD replicates the economic effect of holding or shorting the actual underlying asset. Therefore, for a short CFD position, a declared cash dividend results in a debit to the investor’s account. The other options are incorrect because a credit applies to long positions, CFDs are designed to reflect such impacts, and a dividend declaration does not automatically close a position or only adjust the price without a direct cash impact.

Extended Settlement (ES) contracts are considered a more direct and immediate hedging tool compared to warrants primarily because they offer a near 100% hedge, meaning their delta is approximately 1.0. This implies a one-to-one relationship with the underlying asset’s price movement, providing a very effective and immediate offset to a long position. Furthermore, ES contracts do not require the selection of a specific strike price, simplifying their use for hedging purposes. In contrast, warrants have a delta that is typically less than 1.0 (e.g., 0.5 for at-the-money warrants) and their effectiveness as a hedge depends significantly on the chosen strike price and time to expiry. While warrants may involve a lower initial premium, this characteristic does not make them a more direct or immediate hedging instrument for a long position. The statement that ES contracts allow for greater flexibility in adjusting the hedge ratio dynamically is less accurate than the delta and strike price points, as ES contracts inherently aim for a 1:1 hedge. Warrants’ breakeven points are indeed dependent on the strike price and premium, making the fourth option incorrect.

The investor’s objective is to automatically close a long position if the price declines to a specific level ($81.00) to protect profits, while acknowledging potential market volatility and price gaps. This functionality is precisely what a contingent order, specifically a Stop-Loss order, is designed for. A Stop-Loss order is set to trigger a sell instruction when the underlying asset’s price reaches a pre-determined level, helping to limit potential losses or protect existing gains. A standard market order executes immediately at the best available price at the time it is placed, not at a future trigger price. Therefore, it would not fulfill the investor’s need to wait for a price decline. A limit order to sell at $81.00 or higher, given the current price of $82.50, would likely execute immediately at the prevailing market price of $82.50 (or better), as the limit price is below the current market price. This would not achieve the goal of waiting for the price to fall to $81.00 before closing the position. A market-to-limit order is also designed for immediate execution at the market price when placed, with any unfilled portion remaining open at that price. It is not a contingent order that waits for a specific price trigger in the future before activating.

Auto-callable structured products are designed such that the issuer has the discretion to call the product early. This means the investor does not control when the product might be redeemed. This lack of control over the investment’s duration is known as call risk. If the product is called early, the investor receives their capital and any accrued returns, but then faces the challenge of finding a new investment for those funds, potentially at less favorable rates, which is known as reinvestment risk. The other options describe features or risks that are either inaccurate for auto-callable products or misrepresent their core mechanics. For instance, investors sell their right to early redemption to the issuer, not retain it. While some products may have downside protection, it’s not a universal guarantee of 100% capital return upon early redemption, and returns are influenced by underlying asset performance and option premiums, not solely a fixed yield without exposure.