CM EIP – Capital Markets – Excluded Investment Products – Securities, Collective Investment Schemes (EIP) and Foreign Exchange

Correct: The Treynor measure relates excess return to systematic risk (beta), implicitly assuming that nonsystematic risk has been eliminated through diversification. If a portfolio is inadequately diversified, it still carries significant firm-specific risk; the Sharpe measure captures this total risk (standard deviation), while the Treynor measure ignores it, leading to a misleadingly superior ranking.

Incorrect: The suggestion regarding cash flow timing is incorrect because cash flow management determines whether to use time-weighted or dollar-weighted returns, rather than affecting the choice between Sharpe and Treynor measures. The level of the risk-free rate is also incorrect because it is subtracted from the portfolio return in the numerator of both formulas, meaning a low rate would not cause the Treynor measure to be specifically misleading relative to the Sharpe measure. The option regarding risk-free assets is wrong because both measures require a non-zero risk component in the denominator to provide a meaningful performance ranking.

Takeaway: The Treynor measure is only suitable for evaluating well-diversified portfolios because it focuses exclusively on systematic risk, whereas the Sharpe measure is more appropriate for portfolios with significant nonsystematic risk.

Correct: Settlement on the following Tuesday is the right answer because the standard spot transaction convention requires delivery two business days after the trade date. Since Saturdays and Sundays are not considered working days in the foreign exchange market, a deal transacted on a Friday will have its first business day on Monday and its second business day on Tuesday.

Incorrect: Settlement on the following Monday is wrong because it only allows for one business day of processing, which does not meet the standard spot settlement timeframe. Settlement on the following Wednesday is wrong as it represents a three-day lag, which exceeds the standard two-day spot convention. Settlement on the same Friday is wrong because that would be a value-today transaction rather than a spot transaction.

Takeaway: Spot foreign exchange contracts are settled two business days after the transaction date, with weekends and public holidays extending the actual calendar duration.

Correct: Forward points are subtracted from the spot rate because the forward rate is at a discount. According to the interest rate parity principle, the currency with the higher interest rate (the base currency in this scenario) trades at a discount to the currency with the lower interest rate. This means the forward rate is lower than the spot rate, which is achieved by subtracting the forward points from the spot rate.

Incorrect: The statement that points are added to the spot rate for a discount is incorrect because adding points increases the rate, creating a premium rather than a discount. The claim that points are subtracted for a premium is wrong because a premium implies the forward rate is more expensive than the spot rate, which requires addition. The suggestion that points are added for a premium is incorrect in this specific scenario because a premium only occurs when the base currency has a lower interest rate than the counter-currency.

Takeaway: A currency with a higher interest rate trades at a forward discount (points subtracted), while a currency with a lower interest rate trades at a forward premium (points added).

Correct: The contribution of the asset allocation decision is calculated by multiplying the excess weight (the difference between the actual weight and the benchmark weight) by the benchmark return of that asset class. This calculation isolates the performance impact of the manager’s decision to overweight or underweight a specific asset class relative to the passive bogey, assuming only benchmark-level returns were achieved within that class.

Incorrect: The option involving the difference between returns multiplied by the actual weight describes the security selection decision, which measures the manager’s skill in picking specific assets. The option using the actual return instead of the benchmark return is incorrect because it conflates the allocation decision with the selection results. The option using the benchmark weight multiplied by the return difference is a misapplication of the attribution components and does not represent the asset allocation formula.

Takeaway: Performance attribution decomposes excess returns into asset allocation and security selection to identify the specific sources of a portfolio manager’s outperformance or underperformance relative to a benchmark.

Correct: Statement I is correct because the strategic asset allocation table specifically limits the maximum exposure to money market funds and government bonds to 50% of the portfolio. Statement III is correct because the investment mandate for very high-risk assets, including commodities and precious metals, is capped at a maximum of 5% to align with the client’s conservative risk profile.

Incorrect: Statement II is incorrect because Alpha is the excess return over the risk-adjusted required return (CAPM). Since the CAPM expected return is 10.2% and the past return is only 9.5%, the stock failed to generate Alpha. Statement IV is incorrect because the case study explicitly states that Mr. Koh is a conservative investor who prioritizes interest and dividend income over capital gains.

Takeaway: Strategic asset allocation must strictly adhere to a client’s risk-return profile, and investment performance must be evaluated against risk-adjusted benchmarks like CAPM to determine the presence of Alpha. Therefore, statements I and III are correct.

Correct: Statement I is correct because when forward points are quoted in descending order (e.g., 52/51), the market convention is to subtract these points from the spot rate to calculate the outright rate. Statement II is correct because when forward points are quoted in ascending order (e.g., 17/21), the convention is to add these points to the spot rate to derive the outright rate.

Incorrect: Statement III is incorrect because, according to the interest rate parity theorem, the currency of the country with the higher interest rates will trade at a forward discount, not a premium, to the other currency. Statement IV is incorrect because settlement risk in the foreign exchange market is specifically identified as occurring in the period 2 days before payment, not 5 days.

Takeaway: Outright forward rates are determined by adding ascending points or subtracting descending points from the spot rate, reflecting the interest rate differentials between the two currencies. Therefore, statements I and II are correct.

Correct: Statement I is correct because ordinary shareholders have a residual claim, meaning they are the last to receive assets only after tax authorities, employees, and creditors have been paid. Statement II is correct because limited liability ensures that a shareholder’s maximum loss is restricted to their original investment, protecting their personal assets from corporate creditors.

Incorrect: Statement III is incorrect because ordinary dividends are not guaranteed annual payments; their frequency and amount are discretionary and depend on the company’s performance and policy. Statement IV is incorrect because renounceable rights are specifically designed to be transferable and tradable, whereas only non-renounceable rights are non-transferable.

Takeaway: Ordinary shares offer ownership with limited liability and residual claims, but they do not provide guaranteed income or non-transferable rights in all corporate actions. Therefore, statements I and II are correct.

Correct: The statement regarding redemption at a premium and higher yields is correct because the call feature benefits the issuer by allowing them to replace expensive capital if interest rates fall. To compensate investors for this reinvestment risk, callable shares typically offer a higher yield, and the redemption price is often set above par to provide a premium to the holder upon call.

Incorrect: The claim that investors can force a buy-back when rates rise is incorrect because the call option is held by the issuer, not the investor, and is generally exercised when interest rates decline. The statement about settling unpaid dividends is incorrect because it describes the cumulative feature, which protects dividend rights rather than addressing redemption. The description of exchanging preference shares for ordinary shares is incorrect as it defines the convertibility feature, which is a separate optionality for the investor.

Takeaway: Callable preference shares provide issuers with the flexibility to redeem securities when interest rates drop, which is why these shares must offer higher yields to attract investors.

Correct: In a value-weighted index, bonus issues do not require manual divisor adjustments because the price decrease is offset by the increased share count. This occurs because the index value is derived from the total market capitalization (price multiplied by shares outstanding), which remains theoretically unchanged immediately following a bonus issue.

Incorrect: The statement regarding price-weighted indices is incorrect because high-priced shares, not low-priced shares, carry more weight and have a greater impact on the index value. The claim about equal-weighted indices is wrong because these indices assign the same importance to every stock regardless of its total market capitalization or share price. The description of the Straits Times Index as price-weighted is factually incorrect as it is a value-weighted index based on market capitalization.

Takeaway: Value-weighted indices automatically account for capital changes like bonus issues through their calculation method, whereas price-weighted indices require divisor adjustments to maintain continuity.

Correct: Cyclical shares are expected to perform well during an economic upturn and perform poorly during an economic downturn because their business performance is highly sensitive to the overall health of the economy.

Incorrect: The claim that interest-sensitive shares outperform during high interest rate periods is wrong because the source text explicitly states they are expected to underperform in such environments. The assertion that defensive shares experience the most growth during economic peaks is incorrect because these shares are valued for their resilience during downsides rather than peak growth. The description of value shares as index-tracking tools is false because value selection is an active strategy based on fundamental analysis, whereas index tracking is a passive strategy.

Takeaway: Active sector rotation involves adjusting portfolio weights among cyclical, defensive, and interest-sensitive shares based on their predicted performance during different stages of the business cycle.

Correct: 1.67 times is the right answer because it correctly applies the acid test ratio formula. First, current liabilities are determined by dividing current assets ($18,000) by the current ratio (2.5), which equals $7,200. The acid test ratio is then calculated by subtracting inventories ($6,000) from current assets to find the quick assets ($12,000) and dividing that figure by the current liabilities ($7,200).

Incorrect: The value of 0.83 times is wrong because it represents the ratio of inventory alone to current liabilities. The value of 2.50 times is wrong as it is simply the current ratio, which fails to exclude inventory from the liquidity assessment. The value of 1.25 times is wrong because it results from an incorrect mathematical application of the asset and liability figures provided in the scenario.

Takeaway: The acid test ratio provides a more stringent measure of a company’s short-term liquidity by excluding inventories, which may not be easily converted to cash.

Correct: REITs are passive investment vehicles required to distribute at least 90% of their annual income to provide steady yields. This is the right answer because the source text explicitly states that REITs are property trusts that are legally obligated to distribute at least 90% of their annual income and function as passive investment vehicles.

Incorrect: The statement regarding business trusts being restricted to property is wrong because the source text clarifies that business trusts are not restricted in their investments, unlike REITs. The claim that unit trusts are typically listed is incorrect because most unit trusts in Singapore are not listed, meaning the manager is the primary source for redemption. The suggestion that business trusts cannot pursue aggressive strategies is false, as the text states they can pursue more aggressive strategies than REITs.

Takeaway: REITs are specifically designed for income-focused investors due to their legal obligation to distribute at least 90% of their annual income.

Correct: Statement I is correct because the time-weighted return method effectively neutralizes the impact of external cash flows, such as frequent withdrawals, making it the most accurate measure of a manager’s investment skill. Statement II is correct because an increase in Treasury bill yields raises the discount rate used by investors, which typically results in a contraction of price-earnings multiples for equity securities.

Incorrect: Statement III is incorrect because issuers are incentivized to redeem callable preference shares when market interest rates fall, as this allows them to refinance their capital at a lower cost. Statement IV is incorrect because the Sharpe performance measure is defined as the ratio of excess return to the standard deviation of the portfolio, rather than the difference between actual and CAPM-predicted returns.

Takeaway: Accurate performance measurement requires selecting metrics like time-weighted returns to account for cash flows, while equity valuations must consider the inverse relationship between interest rates and P/E ratios. Therefore, statements I and II are correct.

Correct: Statement I is correct because the text defines the discount rate as the rate of return that could be earned on alternative investments if the company already has the money. Statement IV is correct because annuities are defined as a series of fixed cash flows at a stated frequency, with mortgage payments provided as a specific example.

Incorrect: Statement II is incorrect because discounting is the process of finding the present value of a future sum, not the future value of a current sum (which is compounding). Statement III is incorrect because the text specifies that the actual discount rate must be at least the risk-free government bond yield with the same maturity, not lower than it.

Takeaway: Discounting determines the present value of future cash flows using a discount rate that reflects opportunity cost and risk, while annuities represent consistent, fixed-frequency payments. Therefore, statements I and IV are correct.

Correct: The calculation for Singapore Dollars assumes a 365-day year, while US Dollars assume a 360-day year is the right answer because the day-basis for interest computation varies by currency. According to the provided text, Singapore Dollar interest is based on a 365-day basis, whereas US Dollar interest is based on a 360-day basis.

Incorrect: The statement that SGD uses 360 days and USD uses 365 days is wrong because it reverses the standard conventions for these specific currencies. The claim that both currencies use a 365-day year is incorrect because it ignores the specific 360-day convention used for USD. The claim that both currencies use a 360-day year is incorrect because it fails to account for the 365-day basis required for SGD.

Takeaway: When calculating simple interest, the denominator (day-basis) depends on the currency, with SGD typically using 365 days and USD using 360 days.

Correct: Statement I is correct because the time remaining until expiration represents the time value of the warrant, which directly influences the premium. Statement II is correct because expected dividends on the underlying shares affect the share price and thus the warrant’s valuation. Statement III is correct because the premium is defined as the difference between the warrant’s market price and its intrinsic value. Statement IV is correct because the supply of warrants, determined by the number issued, can impact market pricing and the resulting premium.

Incorrect: None of the statements are incorrect. According to the CMFAS Module 6 syllabus, all four factors—time to expiry, dividend distributions, intrinsic value, and the total issuance size—are recognized as key determinants that affect the premium of a warrant.

Takeaway: The premium of a warrant is a dynamic value influenced by a combination of time decay, underlying asset characteristics, intrinsic worth, and market supply factors. Therefore, I, II, III & IV is correct.

Correct: A VIX reading below 20 generally suggests that the market expects a period of relative stability in the near term is the right answer because the Chicago Board of Exchange (CBOE) Volatility Index measures the market’s expectation of 30-day volatility, and the source text explicitly states that values less than 20 indicate relative stability.

Incorrect: The statement that a VIX above 30 indicates low fear is wrong because values over 30 signify high volatility and the index is specifically known as the ‘investor fear gauge.’ The claim that 25 is a threshold for distinguishing mature from emerging markets is wrong because the VIX measures volatility rather than classifying market development levels. The assertion that the VIX reflects historical twelve-month volatility is false because it tracks the market’s expectation of the upcoming 30-day volatility rather than historical data.

Takeaway: The VIX serves as a key indicator of market sentiment, where higher values signal increased investor fear and expected volatility, while lower values suggest stability.

Correct: The requirement that the required rate of return must be greater than the infinite growth rate of the dividends is the right answer because the Constant Growth Model formula uses (k – g) as the denominator; if the required return (k) is not strictly greater than the growth rate (g), the result is mathematically meaningless or negative.

Incorrect: The suggestion that the growth rate must be higher than the required return is wrong because it would result in a negative denominator in the Gordon Model, which the text explicitly identifies as producing meaningless results. The claim that the first year’s dividend must equal the current dividend is incorrect as the model assumes dividends grow at a constant rate ‘g’, meaning the expected dividend (D1) is typically higher than the current dividend (D0). The statement that the model requires a finite holding period is false because the Constant Growth Model is specifically designed to value a stream of dividends expected to be paid over an infinite period.

Takeaway: For the Constant Growth Model to be valid, the required rate of return must exceed the constant growth rate to ensure the formula yields a positive and finite intrinsic value.

Correct: Dividing the total debt of the firm by the value of its total assets is the correct method for calculating the Debt to Total Assets Ratio. This leverage ratio indicates the percentage of a company’s assets that are provided by creditors rather than owners, reflecting the firm’s long-term solvency and financial risk.

Incorrect: Dividing total debt by total shareholders’ equity defines the Debt/Equity Ratio, which compares creditor financing directly to owner financing. Dividing current assets by current liabilities is the Current Ratio, which is a liquidity measure rather than a leverage ratio. Subtracting inventories from current assets and dividing by current liabilities is the Quick Ratio, which measures immediate solvency by excluding less liquid assets.

Takeaway: Leverage ratios like the Debt to Total Assets Ratio help investors understand a firm’s financial structure and its ability to meet long-term obligations by measuring reliance on borrowed funds.

Correct: The valuation results may be skewed if current market prices are at extreme levels during the time of analysis because relative valuation relies on comparing a share’s price to current market multiples which may be temporarily inflated or depressed.

Incorrect: The estimation of discount rates and growth duration are specific challenges associated with absolute valuation (DCF) rather than relative valuation. The flexibility to adjust cash flows for changing growth rates is listed as an advantage of absolute valuation, not a disadvantage of relative valuation. Stating that the approach is not widely accepted is factually wrong, as relative valuation is a core method used alongside absolute valuation in the financial industry.

Takeaway: While relative valuation is useful for market comparison, its accuracy is limited by market volatility and the necessity of finding truly comparable peer entities.

Correct: Statement I is correct because the coefficient of variation (CV) is defined as the standard deviation divided by the expected return, measuring risk per unit of return. Statement II is correct because market risk includes losses from price movements in equities, interest rates, FX, and volatility. Statement III is correct because counterparty risk involves the failure to honor contractual agreements, including issuer defaults and changes in credit standing. Statement IV is correct because operational risks include systems failures, technical glitches, and complexities from high-frequency trading.

Incorrect: There are no incorrect statements in this selection as all four accurately reflect the definitions and classifications of risk and return metrics provided in the regulatory text.

Takeaway: Understanding the distinction between different risk categories and the application of the coefficient of variation is essential for evaluating investment performance on a risk-adjusted basis. Therefore, all of the above statements are correct.

Correct: Statement I is correct because total return is defined as the sum of current income (such as dividends or interest) and capital gain or loss. Statement II is correct because the expected rate of return is the weighted average of all possible returns, where the weights are the probabilities assigned to each outcome. Statement III is correct because the source text identifies variance and standard deviation as the most widely used statistical measures of risk, representing the dispersion of actual returns.

Incorrect: Statement IV is incorrect because the source text explicitly states that the smaller the dispersion of the distribution of actual returns about the average return, the lower the risk of the investment. Therefore, a larger dispersion would indicate higher risk, not lower risk.

Takeaway: Total return accounts for both income and price fluctuations, while investment risk is statistically measured by the degree of dispersion (volatility) of returns around the expected average. Therefore, statements I, II and III are correct.

Correct: Statement I is correct because according to the constant-growth model, the required rate of return (k) is in the denominator of the P/E ratio formula; therefore, an increase in k leads to a lower P/E ratio. Statement II is correct because the dividend payout ratio (D/E) is in the numerator of the P/E formula, meaning a higher payout ratio results in a higher P/E ratio, all else being equal. Statement IV is correct because preference shares are treated as perpetuities with fixed dividends, and the zero-growth model (Dividend / Discount Rate) is the standard method for determining their value.

Incorrect: Statement III is incorrect because the provided text states that if the intrinsic value is lower than the market price, the share is considered overvalued and should be avoided or sold. A share is only considered undervalued and a candidate for purchase if its intrinsic value is greater than its market price.

Takeaway: The P/E ratio is positively correlated with the dividend payout and growth rates but negatively correlated with the required rate of return, while intrinsic value determines if a stock is over or undervalued. Therefore, statements I, II and IV are correct.

Correct: Statement I is correct because the text states that the spread between the required rate of return (k) and the expected growth rate (g) is the crucial relationship, and any decline in this spread leads to an increase in the share’s computed value. Statement III is correct because the provided examples demonstrate that a small 1% change in either the growth rate (g) or the required rate of return (k) produces a significant impact on the estimated value of the share.

Incorrect: Statement II is incorrect because the growth rate (g) is calculated by multiplying the retention rate by the return on equity (ROE), not the dividend payout ratio (the retention rate is the portion of earnings not paid out as dividends). Statement IV is incorrect because the multiple-growth model is specifically used for firms that do not have a constant growth rate, such as those with supernormal growth periods or those that pay no dividends initially.

Takeaway: The Dividend Discount Model is highly sensitive to the spread between the required rate of return and the growth rate, with the latter being a function of a firm’s retention rate and its return on equity. Therefore, statements I and III are correct.

Correct: Statement I is correct because interest rates and P/E ratios share an inverse relationship; as interest rates rise, the required rate of return (k) increases, which causes the P/E ratio to decline. Statement III is correct because, according to the PEG ratio rule of thumb, a value of less than 1 is generally indicative of an undervalued share.

Incorrect: Statement II is incorrect because if a company reports a net loss, the denominator of the P/E ratio becomes negative, rendering the resulting figure meaningless for valuation. Statement IV is incorrect because the P/B ratio is specifically best suited for companies with significant tangible fixed assets or financial institutions like banks, rather than service-based firms dominated by intangible assets.

Takeaway: Equity valuation requires understanding the inverse relationship between interest rates and P/E ratios, while utilizing PEG and P/B ratios to address the limitations of earnings-based metrics. Therefore, statements I and III are correct.

Correct: Verifying the potential value and financial soundness is the right answer because the purpose of analyzing financial statements is to confirm a company’s viability and value after it has been identified as a potential investment through broader economic and industry analysis.

Incorrect: The suggestion that financial analysis replaces economic or industry analysis is wrong because fundamental analysis requires a top-down approach involving all three stages. The claim that a well-run company guarantees a good investment is wrong because the text notes that market value may already reflect growth potential, making it a poor investment. The suggestion that statements provide real-time valuation for all future volatility is wrong because statements are historical records used to help determine, rather than provide, future timing and volatility.

Takeaway: Financial statement analysis serves to verify the financial soundness and business viability of a company within the broader context of a top-down fundamental analysis.

Correct: Statement I is correct because the coefficient of variation is defined as a relative risk measure that calculates risk per unit of return, which is essential when comparing investments with different expected returns. Statement III is correct because the syllabus explicitly states that high-frequency trading (HFT) relies on computer technology and operational infrastructure, which can lead to higher operational risks. Statement IV is correct because the investment mandate, or investment policy statement, is the framework used to set risk control limits and procedures for managing a diversified portfolio.

Incorrect: Statement II is incorrect because standard deviation is an absolute measure of volatility; the syllabus specifies that when evaluating investments with varying rates of return, the coefficient of variation is required to provide a proper relative risk assessment.

Takeaway: Effective risk management requires using the coefficient of variation for relative comparisons across different asset classes and adhering to the risk limits defined within an investment policy statement. Therefore, statements I, III and IV are correct.

Correct: Statement I is correct because the P/B ratio is well-suited for companies with liquid assets like banks whose assets can be readily converted to cash. Statement II is correct because sales figures are generally less subject to manipulation compared to earnings.

Incorrect: Statement III is incorrect because the text states that companies with intangible assets, such as proprietary research knowledge, cannot be fairly measured using book value. Statement IV is incorrect because a lower P/S ratio is not necessarily a positive indicator as it may indicate the company is unprofitable.

Takeaway: While P/B and P/S ratios offer stability and are less prone to manipulation than EPS, they must be used cautiously when evaluating companies with high intangible assets or poor profitability. Therefore, statements I and II are correct.

Correct: Statement II is correct because the net profit margin is calculated by dividing Net Income ($27,000) by Sales ($120,000), which results in 22.5%. Statement III is correct because the financial statements show a positive Net Income of $27,000 on the Income Statement, while the Statement of Cash Flows reports a net cash outflow from operating activities of ($490,000).

Incorrect: Statement I is incorrect because the current ratio actually deteriorated from 1.70 in 2012 ($85,000 / $50,000) to 1.38 in 2013 ($90,000 / $65,000), indicating a decline in short-term liquidity. Statement IV is incorrect because the total debt-to-equity ratio decreased from 0.54 in 2012 ($100,000 / $185,000) to 0.48 in 2013 ($100,000 / $210,000), representing a reduction in financial leverage.

Takeaway: A company can report significant accounting profits while simultaneously experiencing negative cash flows from operations, which may signal potential liquidity issues or aggressive revenue recognition. Therefore, statements II and III are correct.

Correct: Non-cash items like deferred revenue are not taken into consideration is the right answer because the Price to Cash Flow ratio is based on actual cash movements, which means it ignores accounting entries that do not involve cash, such as deferred revenue.

Incorrect: The statement that cash flows are typically more volatile than earnings is wrong because the text states they are generally more stable. The claim that the ratio is highly dependent on accounting methods is incorrect as cash flows are independent of such methods. The idea that it is primarily for young companies is wrong because the text does not restrict its use this way and notes that the Price to Sales ratio is suited for mature companies.

Takeaway: The Price to Cash Flow ratio is valued for its stability and independence from accounting methods, but it is limited by its exclusion of non-cash items like deferred revenue.