CMFAS RES6A Quiz 80

An increase in expected dividends for an underlying share typically leads to a reduction in the share’s price when it goes ex-dividend. For call options, a decrease in the underlying share price negatively impacts their value, causing their premiums to decline. Conversely, for put options, a decrease in the underlying share price is beneficial, leading to an increase in their premiums. Therefore, higher expected dividends generally result in lower call option premiums and higher put option premiums, assuming all other factors remain unchanged.

Extended Settlement (ES) Contracts are designed as marginable futures contracts, requiring only a small portion of the contract value as margin collateral. This allows investors to gain significant exposure to a larger amount of securities with a relatively smaller amount of capital, offering leverage typically ranging from 5x to 20x. This makes them highly capital-efficient for taking a view on the market for up to 35 days. Direct cash purchases in the ready market require the full capital outlay, offering no leverage. Contra trading, while potentially offering ‘infinite leverage’ for very short periods, typically incurs financing costs or requires cash tie-up if positions are held beyond a few days, making it less ideal for a 35-day view without significant cost. Standard margin financing facilities usually offer lower leverage (e.g., 2x for shares, 3x for cash) compared to ES contracts, thus providing less capital efficiency for substantial exposure.

When a futures trader’s margin account balance falls below the maintenance margin level, the exchange’s mark-to-market procedures trigger a margin call. The requirement is not merely to bring the account back to the maintenance margin level, but specifically to deposit additional funds to restore the account balance to the initial margin level. This ensures sufficient collateral is held against the open position. Liquidating contracts might reduce the margin requirement, but it is not the direct and immediate action mandated by a margin call. There is typically no extended grace period; the funds must be deposited immediately or by a stipulated time set by the broker/exchange.

The question pertains to the specific criteria for bonds included in the basket used to determine the final settlement price for the 5-year Singapore Government Bond Futures, as outlined in the CMFAS Module 6A syllabus. The contract specifications clearly state that the final settlement price is calculated from prices of all bonds in a selected basket of Singapore Government Bonds, each with a minimum issuance size of SGD 1 billion and a term-to-maturity ranging from 3 to 6 years on the first calendar day of the contract month. Therefore, the first option accurately reflects these essential characteristics. The second option is incorrect because the 3% coupon is for the notional bond of the futures contract itself, not a requirement for bonds in the basket, and there’s no mention of a ‘within the last 12 months’ issuance criterion. The third option describes the role and weighting of a benchmark bond within the basket, not the general criteria for a bond’s initial inclusion in the basket. The fourth option is incorrect as the term-to-maturity range is 3 to 6 years, not precisely 5 years, and the assessment date is the first calendar day of the contract month, not the last trading day.

Arbitrage opportunities arise when there is a temporary discrepancy between the prices of equivalent financial instruments. In this scenario, the fixed rate on the Interest Rate Swap (IRS) is higher than the implied fixed rate from the Eurodollar futures strip. This indicates that the IRS is relatively overpriced, and the futures strip is relatively underpriced. To profit from this, an arbitrageur would sell the overpriced instrument and buy the underpriced instrument. Therefore, the arbitrageur would sell the IRS (receiving the higher fixed rate and paying floating) and simultaneously buy the strip of Eurodollar futures contracts (locking in the lower implied fixed rate). This strategy ensures a risk-free profit by exploiting the pricing inefficiency.

For Eurodollar futures contracts, the minimum price fluctuation depends on whether it is the spot month or another contract month. For contract months other than the spot month, the minimum price fluctuation is 0.0050 points, which corresponds to USD 12.50. If the price of such a contract increases by 0.0100 points, this represents two times the minimum price fluctuation (0.0100 / 0.0050 = 2). Therefore, the resulting gain for holding one contract would be 2 multiplied by USD 12.50, which equals USD 25.00.

A reverse cash-and-carry arbitrage is a strategy employed when the futures price is undervalued relative to the spot price and the net cost of carrying the asset. The core idea is to profit from this mispricing by simultaneously selling the underlying asset short in the spot market, lending the proceeds from this short sale, and buying a futures contract for the same asset. Upon the futures contract’s expiry, the arbitrageur accepts delivery of the asset through the futures contract and uses this delivered asset to cover the initial short position in the spot market. This sequence of transactions locks in a risk-free profit from the initial mispricing. The first option accurately describes these steps. The second option describes a cash-and-carry arbitrage, which is the opposite strategy, executed when the futures price is overvalued. The third and fourth options do not represent valid arbitrage strategies as described in the context of cash-and-carry or reverse cash-and-carry.

Constant Proportion Portfolio Insurance (CPPI) is a sophisticated, rule-based trading strategy employed within structured funds to achieve a fixed minimum return, most commonly capital preservation, by a specified future date. The core of this strategy involves a continuous, systematic re-balancing of the investment portfolio. Assets are dynamically shifted between ‘performance assets’ (which are typically riskier and offer growth potential) and ‘safe assets’ (which are more stable and preserve capital). This re-balancing is governed by a predefined mathematical algorithm, ensuring that the fund’s exposure to risky assets is adjusted to maintain a ‘cushion’ – a portion of assets that can absorb losses without jeopardizing the principal preservation target. This mechanism allows investors to participate in market upside while providing a defined level of downside protection. It is crucial to note that CPPI is non-discretionary, meaning it operates strictly according to its rules rather than relying on a fund manager’s subjective market timing or forecasts. Other options describe static allocations, reliance on discretionary management, or external guarantees, which do not accurately represent the internal, dynamic, and rule-based nature of the CPPI strategy itself.

Operational risk encompasses all risks stemming from the failure of internal processes, people, and systems, or from external events. The scenario where the firm’s automated trading system experiences a critical software malfunction, leading to processing delays and data discrepancies, directly aligns with this definition as it represents a breakdown in internal systems and procedures that disrupts business operations. This is a classic example of operational failure. Other options describe different types of risks: a client’s portfolio being heavily invested in one sector and suffering losses due to a downturn in that sector illustrates concentration risk. A structured product facing potential default because its issuer is in financial distress exemplifies issuer risk, which is a form of counterparty risk. Finally, a futures hedge failing to perfectly offset losses due to a mismatch in timing or contract specifications describes basis risk.

Indirect Investment Policy Funds, often referred to as Swap-based Funds, are structured to provide investors with a return linked to the performance of an underlying asset without directly investing in or fully holding that asset. Instead, these funds achieve their exposure by allocating a portion or all of their net proceeds into derivative transactions. These derivatives are specifically designed to replicate the performance of the underlying asset, allowing the fund to meet its investment objectives indirectly. Options suggesting direct ownership of all underlying components, exclusive investment in cash equivalents, or reliance on a fixed-income portfolio with fixed coupons do not accurately describe how such a fund gains primary exposure to the underlying asset’s performance.

A vertical spread is characterized by using options of the same underlying security, same class, and same expiration month, but with different strike prices. In contrast, a diagonal spread is a more complex strategy that combines elements of both vertical and horizontal (calendar) spreads. It involves options on the same underlying security but with different strike prices AND different expiration dates. Therefore, the key differentiator between a diagonal spread and a vertical spread lies in the expiration dates of the options involved; vertical spreads use options with the same expiration, while diagonal spreads use options with different expiration dates.

Extended Settlement (ES) contracts are leveraged instruments, meaning a small initial margin controls a much larger underlying asset value. When an investor holds a long position and the underlying security’s price declines significantly, the value of their position decreases. This reduction in value can cause the investor’s equity in the account to fall below the required maintenance margin level. To restore the account to the required margin level and maintain the open position, the investor will receive a margin call, demanding additional funds. Failure to meet this margin call within the stipulated timeframe can lead to the broker liquidating the position. Physical delivery typically occurs at the contract’s expiration if the position has not been offset, not as an immediate consequence of an adverse price movement. While a broker may liquidate a position if a margin call is not met, it is not an automatic, immediate closure by the exchange irrespective of the investor’s ability to meet margin requirements. A decline in contract value due to unfavorable price movement increases the risk and the potential need for margin, it does not lead to a decrease in the margin requirement.

The scenario describes an investor’s desire to buy CFDs, prioritizing immediate execution at the best available price, but with a strict upper price limit. Crucially, if the order is only partially filled, the investor wants the remaining portion to stay active in the market at the price where the initial part was executed. This specific behavior is characteristic of a Market-to-Limit Order. A Market-to-Limit Order attempts to execute at the current market price up to a specified limit. If it cannot be fully filled at or below that limit immediately, any unfilled portion remains open at the price of the last partial fill. A Limit Order, conversely, would only execute at the specified limit price or better, and if partially filled, the remaining portion would typically stay at the original limit price, not the price of the partial fill. A Market Order would execute immediately at the best available price without any upper price constraint, which contradicts the investor’s requirement for a maximum threshold. A Stop Entry Order is a contingent order used to enter the market once a specific price level is crossed, not for immediate best-price execution with a partial fill strategy.

This question tests the understanding of Mandatory Call Events (MCEs) and the characteristics of R-Category Callable Bull/Bear Contracts (CBBCs) as outlined in the CMFAS Module 6A syllabus, specifically sections 11.5.2 and 11.5.5. For an R-Category Bull Contract, a Mandatory Call Event (MCE) is triggered when the underlying asset price falls and touches or falls below the specified call price. Upon an MCE, the CBBC’s trading terminates immediately. A key feature of R-Category CBBCs (R = Residual value) is that the holder may receive a small cash payment, known as the ‘Residual Value’, when the CBBC is called. Therefore, when the spot price touches the call price for an R-Category Bull CBBC, an MCE occurs, trading stops, and the investor is entitled to a residual cash payment. The other options describe incorrect outcomes: trading does not continue, CBBCs are not converted into underlying assets upon MCE, and the call event is mandatory, not discretionary for the issuer.

The question describes a scenario requiring a highly customized hedging solution for a niche currency and non-standard delivery schedule. Forward contracts are private agreements negotiated directly between two parties, allowing for bespoke terms regarding the underlying asset, quantity, delivery date, and settlement procedures. This flexibility makes them ideal for unique, non-standardized requirements that may not be available on regulated exchanges. Futures contracts, on the other hand, are standardized in terms of quality, quantity, delivery time, and place, and are traded on exchanges. While they offer advantages like liquidity and reduced counterparty risk due to the clearing house, their standardized nature makes them unsuitable for highly specific, tailored needs. Exchange-traded options provide flexibility but are not primarily designed for locking in specific, customized future delivery terms in the same way a forward contract is. A spot currency transaction involves immediate delivery and settlement, making it inappropriate for a payment due 18 months in the future.

To determine the net profit or loss, first calculate the gross profit from the ES contract, then subtract all applicable fees and taxes. 1. Calculate Gross Profit: The investor bought 2,000 units at S$15.00 and the shares closed at S$15.80. Gross profit = (Closing Price – Purchase Price) × Quantity = (S$15.80 – S$15.00) × 2,000 = S$0.80 × 2,000 = S$1,600.00. 2. Calculate Contract Value for Clearing Fee: The clearing fee is based on the value of the contract. Contract Value = Purchase Price × Quantity = S$15.00 × 2,000 = S$30,000.00. 3. Calculate Clearing Fee: The clearing fee is 0.04% of the contract value, subject to a maximum of S$600. Clearing Fee = 0.04% × S$30,000 = 0.0004 × S$30,000 = S$12.00. This amount is below the S$600 cap, so S$12.00 applies. 4. Calculate Total Fees before GST: Total Fees = Brokerage Fee + Clearing Fee = S$20.00 + S$12.00 = S$32.00. 5. Calculate GST: The prevailing Goods and Services Tax (GST) is 8% on both brokerage and clearing fees. GST = 8% × S$32.00 = 0.08 × S$32.00 = S$2.56. 6. Calculate Total Costs (Fees + GST): Total Costs = Total Fees + GST = S$32.00 + S$2.56 = S$34.56. 7. Calculate Net Profit/Loss: Net Profit = Gross Profit – Total Costs = S$1,600.00 – S$34.56 = S$1,565.44.

The question describes a scenario where a futures contract’s price moves beyond the 15% daily price limit from the previous day’s settlement price, and it is not the last trading day. According to the specifications, when the price moves by 15% in either direction, trading at or within a price limit of 15% is allowed for a 10-minute cooling-off period. After this 10-minute period, there are no price limits for the remainder of the trading day. Therefore, the correct protocol involves an initial limited trading period followed by the removal of all price limits.

Market disruption risk involves rapid and large changes in market prices leading to disorderly conditions. To mitigate this, regulators and exchanges implement several measures. Circuit breakers are designed to trigger outright trading halts. Daily price limits are imposed to restrict price volatility without necessarily slowing or halting trading. Shock absorbers, however, are specifically designed systems within the trading infrastructure that slow down trading activity during periods of significant volatility without bringing trading to a complete stop. Capital controls are government measures related to the flow of capital, typically associated with country risk, not a direct mechanism for managing real-time trading speed during market disruption.

For short option positions, the inherent characteristics of options mean that the positive effects derived from time decay (Theta) naturally counteract the negative effects associated with the rate of change of delta (Gamma). This automatic offset is a key consideration in managing the combined market risk exposure for such positions, as highlighted in the CMFAS Module 6A syllabus. While Theta and Gamma are distinct risk measures, their interaction for short options is specifically noted as an offsetting relationship, which simplifies the combined risk management to some extent.

When an investor’s Customer Asset Value for an Extended Settlement (ES) contract position falls below the Required Margins, the broker is obligated to issue a margin call. This call requires the investor to deposit additional funds or acceptable collateral to bring their Customer Asset Value up to at least the sum of the Initial Margins and Additional Margins. The investor is typically given two market days to meet this requirement. If the investor fails to provide the necessary margins within this timeframe, a critical consequence is that they will not be allowed to place orders for new trades, with the sole exception of trades specifically designed to reduce their existing risk. This mechanism is in place to protect both the investor and the clearing house from accumulating excessive losses. Automatic liquidation of positions or immediate suspension of all trading activities are generally not the first steps; a margin call precedes such drastic measures. Similarly, while additional margins are part of the calculation, they are not automatically debited, and the primary consequence for failing a margin call is the restriction on new, non-risk-reducing trades.

The Constant Proportion Portfolio Insurance (CPPI) strategy is designed to protect principal while allowing participation in upside potential. However, it has specific risks. One significant risk, as highlighted in the CMFAS 6A syllabus, occurs during prolonged periods of range-bound trading in the underlying risky asset. In such a scenario, the portfolio’s value may not appreciate sufficiently, or it might even decline slightly, causing the ‘cushion’ (total portfolio value minus floor value) to shrink. As the cushion diminishes, the allocation to the risky asset decreases (Multiplier x Cushion Value). If the portfolio value drops to the floor value, the CPPI mechanism dictates that the entire fund must be allocated to the risk-free asset to preserve the principal. This action, while protecting the principal, means the investor will miss out on any subsequent appreciation of the underlying asset if it eventually breaks out of the range-bound period. The multiplier in a CPPI strategy is constant, unlike Dynamic Proportion Portfolio Insurance (DPPI) where it can be variable. Furthermore, the high fees associated with structured products like CPPI are generally fixed or percentage-based and are not typically reduced due to market conditions like range-bound trading.

This question tests the understanding of the Constant Proportion Portfolio Insurance (CPPI) strategy, particularly when the portfolio value, after taking on leverage, declines to hit its predefined floor. In a CPPI strategy, the risky asset allocation is determined by a multiplier (M) times the cushion (Cushion = Portfolio Value – Floor). When the total portfolio value falls to the floor, the cushion becomes zero. Consequently, the calculated allocation to the risky asset becomes zero (M 0 = 0). This mandates that all funds be moved out of the risky asset and into the risk-free asset. In this specific scenario, the total portfolio value is calculated as the risky asset value ($96) minus the risk-free liability (-$10), which equals $86. Since the floor is also $86, the portfolio has hit the floor. The manager must liquidate all the risky assets ($96), use a portion of the proceeds ($10) to cover the existing risk-free liability, and invest the remaining amount ($86) into the risk-free asset to preserve the capital at the floor level.

A synthetic long stock position is constructed by simultaneously holding a long call option and a short put option on the same underlying asset, with identical strike prices and expiration dates. This combination is designed to replicate the payoff profile of directly owning the underlying stock. Consequently, it offers unlimited profit potential if the underlying stock price increases significantly and carries unlimited downside risk if the stock price falls substantially. This strategy is often considered a lower-cost alternative to purchasing the shares outright while maintaining similar market exposure. The other options describe different option strategies with distinct risk-reward profiles. For instance, a long put and short call create a synthetic short stock position. A long call and long put (straddle) profit from volatility, while a short call and short put (short straddle) profit from stability, both with different risk characteristics.

Extended Settlement (ES) contracts involve a high degree of leverage, which magnifies both potential gains and losses relative to the initial capital invested. To calculate the percentage loss relative to the initial margin, first determine the total value of the contract. For 1,000 shares at $12.00 per share, the total contract value is $12,000. The initial margin required is 10% of this value, which amounts to $1,200. When the price of the underlying shares drops by 4%, the per-share loss is 4% of $12.00, which is $0.48. For 1,000 shares, the total loss on the contract is $0.48 multiplied by 1,000, resulting in a $480 loss. To find the percentage loss relative to the initial margin, divide the total loss by the initial margin and multiply by 100%. This is ($480 / $1,200) 100%, which equals 40%. This demonstrates how a relatively small percentage movement in the underlying asset can lead to a significantly larger percentage change in the investor’s initial investment due to leverage.

The scenario describes a situation where the asset being hedged (the specific bonds to be issued) does not perfectly match the underlying asset of the futures contract (different maturities, coupon structures) and there is uncertainty about the exact hedging date. These are precisely the conditions that give rise to basis risk. Basis risk is the risk that the basis (difference between spot price of the asset to be hedged and the futures price of the contract used) will change unexpectedly, thereby making the hedge imperfect. Credit risk relates to the risk of default by a counterparty, which is not the primary concern highlighted by the asset mismatch and timing uncertainty. Liquidity risk pertains to the inability to buy or sell an asset quickly enough without significantly affecting its price, which is also not the core issue described. Operational risk involves failures in internal processes, people, and systems, or from external events, which is not directly addressed by the scenario’s focus on asset characteristics and timing.

The scenario describes a concern about lower trading volume and wider bid-ask spreads in futures contracts with settlement dates further in the future, leading to potential difficulties in closing out positions under adverse conditions. This directly relates to liquidity issues associated with longer-dated contracts. A maturity limit is specifically designed to address this by restricting exposure to contracts that are further out in time, where liquidity typically thins. An open contracts limit controls the total number of positions but doesn’t specifically target the illiquidity of distant maturities. A maximum loss limit sets a threshold for acceptable losses but doesn’t prevent the underlying liquidity problem. A stress test limit assesses portfolio performance under extreme scenarios, which is a broader risk tolerance measure, not a specific control for illiquidity in longer-dated contracts.

The question describes two distinct investment product strategies. The first product, characterized by a fund manager’s active and discretionary decisions on asset allocation based on ongoing market analysis, aligns with the definition of a traditional mutual fund. Traditional mutual funds rely heavily on the fund manager’s expertise and active management to achieve investment objectives. The second product, engineered to replicate a specific market performance or provide a synthetic return, often incorporating derivatives and adhering to a pre-set, rule-based investment approach, precisely describes a structured fund. Structured funds are created through financial engineering to achieve specific risk/return profiles or capital preservation, often using static or rule-based allocation decisions and derivatives to replicate underlying asset performance. Therefore, the fundamental distinction is between a traditional mutual fund and a structured fund.

The long call butterfly spread and long put butterfly spread are neutral market strategies. They are entered when an investor anticipates that the underlying stock will not experience significant price movements (neither rise nor fall much) by expiration. These strategies offer limited profit potential, typically maximized when the underlying asset’s price remains at the middle strike price at expiration, and also feature limited risk, capped at the initial debit paid to establish the position. Other strategies like a long straddle or long strangle are used when an investor expects high volatility and significant price movement in either direction. A bear call spread is a bearish strategy, anticipating a decline in the underlying asset’s price.

To determine the total profit or loss from this hedged position, we must consider both the short stock position and the long call option. 1. Profit/Loss from the short stock position: The investor short sold the stock at $50.00 and the stock price at expiration is $55.00. Since the price increased, the short position incurs a loss. Loss = Short Sale Price – Expiration Price = $50.00 – $55.00 = -$5.00. 2. Profit/Loss from the long call option: The call option has a strike price of $52.00 and the stock price at expiration is $55.00. Since the expiration price ($55.00) is greater than the strike price ($52.00), the call option is in-the-money and will be exercised. Intrinsic Value = Expiration Price – Strike Price = $55.00 – $52.00 = $3.00. Net Profit/Loss from Call = Intrinsic Value – Premium Paid = $3.00 – $3.00 = $0.00. 3. Total Profit/Loss: Summing the profit/loss from both components: Total Profit/Loss = Profit/Loss from Short Stock + Profit/Loss from Call Option = -$5.00 + $0.00 = -$5.00. Therefore, the investor incurs a total loss of $5.00.

When a futures contract experiences a significant price movement and reaches its daily price limit, several mechanisms come into play. Firstly, 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. If a trader sustains a loss, their account balance is reduced. If this reduction causes the account to fall below the minimum performance bond requirements, the trader will receive a margin call, requiring them to either add more funds or reduce their positions. Secondly, regarding price limits, the exchange sets these to regulate dramatic price swings. If a contract settles at its limit, the exchange may widen the limit for the next trading session to facilitate transactions and help prices reflect the current market environment. Trading is generally allowed within the price limits, and positions are not automatically closed out or trades reversed simply because a limit is hit, unless specific rules for extreme situations are met (e.g., a cooling-off period for SiMSCI, after which limits may be removed). Losses are recognized daily, not deferred.