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

Correct: Statement I is correct because operating leases represent significant long-term financial commitments that should be treated as debt to reflect the firm’s true leverage. Statement IV is correct because accounting standards generally require debt to be reported at historical cost rather than being adjusted for changes in market interest rates.

Incorrect: Statement II is incorrect because a higher interest coverage ratio means the firm has more earnings relative to its interest obligations, which actually signifies lower financial risk. Statement III is incorrect because the debt-to-total assets ratio is intended to be a comprehensive measure and therefore includes all assets, including intangibles, in its calculation.

Takeaway: Leverage and coverage ratios help investors assess a firm’s ability to meet its long-term obligations and the impact of fixed costs on its overall financial stability. Therefore, statements I and IV are correct.

Correct: Advising the company to increase its average inventory levels is the most appropriate action because an exceptionally high inventory turnover ratio, especially when accompanied by lost sales and stockouts, indicates that the firm is not carrying enough stock to meet customer demand.

Incorrect: Maintaining the current lean inventory strategy is incorrect because the scenario explicitly mentions that the company is losing sales, meaning the current strategy is detrimental to revenue. Performing a write-down of obsolete stock is wrong because obsolete or slow-moving items would result in a low inventory turnover ratio, not a high one. Investigating the use of fully depreciated fixed assets is incorrect because that factor is a consideration for the total asset turnover ratio, not the inventory turnover ratio.

Takeaway: While a high inventory turnover ratio typically indicates efficiency, an excessively high ratio relative to the industry can be a sign of inadequate inventory levels that lead to lost sales and operational inefficiencies.

Correct: The re-allocation of shares from institutional to retail investors through a clawback provision is a significant risk because it often results in a lack of institutional support in the secondary market. Large institutional investors provide stability and liquidity, so a higher concentration of retail holders can lead to more volatile price action once trading commences.

Incorrect: The statement regarding increasing the total number of shares to stabilize the price describes the over-allotment or Greenshoe option, not a clawback. The statement about preventing pre-IPO investors from selling describes the lock-up or moratorium period, which is a separate confidence-building measure. The suggestion that it provides a guaranteed minimum allocation is a misconception; clawbacks are triggered by high demand but do not guarantee specific quantities to all applicants.

Takeaway: A clawback provision shifts the share distribution toward retail investors, which may negatively impact the stock’s price stability due to reduced institutional participation in the secondary market.

Correct: Statement I is correct because Level 2 ADRs are listed on major US exchanges such as the NYSE or NASDAQ to provide trading liquidity but do not involve the issuance of new shares for capital raising. Statement II is correct because Level 3 ADRs are specifically used when a foreign issuer intends to raise new capital by offering new shares to investors through a listed program in the US market.

Incorrect: Statement III is incorrect because not all depositary receipts possess two-way fungibility; while all are backed by underlying shares, the ability to convert back and forth between the receipt and the share may be restricted. Statement IV is incorrect because unsponsored ADRs are issued by depositary banks without a formal agreement with the foreign company, whereas sponsored ADRs (Levels 2 and 3) require a formal deposit agreement between the issuer and the bank.

Takeaway: While all listed ADRs provide market visibility, only Level 3 programs allow for new capital raising, and investors must verify specific features like fungibility and sponsorship which affect their legal rights and liquidity. Therefore, statements I and II are correct.

Correct: Statement I is correct because for financial entities like banks or insurance firms, book value is a fundamental determinant of share price as their assets are often liquid investments. Statement II is correct because the Price-to-Sales ratio provides a viable valuation metric for start-up companies that have not yet achieved profitability or positive earnings.

Incorrect: Statement III is incorrect because the presence of off-balance sheet activities, such as operating leases, actually obscures a company’s true financial position and is a sign of lower financial statement quality. Statement IV is incorrect because cash flow is generally viewed as less subjective and less prone to accounting manipulation than earnings, making the Price-to-Cash Flow ratio a more robust alternative to the Price-Earnings ratio.

Takeaway: Valuation ratios must be selected based on the specific characteristics of the industry, and high-quality financial statements are characterized by transparency and the absence of hidden liabilities. Therefore, statements I and II are correct.

Correct: Statement I is correct because money market instruments are specifically defined by having an original maturity period of one year or less. Statement II is correct because the medium-term note category captures debt issues with original maturities between one and ten years. Statement III is correct because long-term bonds are those that are originally issued with a maturity of ten years or more.

Incorrect: Statement IV is incorrect because the classification into money market instruments, medium-term notes, and long-term bonds is based on the instrument’s original maturity at the time of issue. While a bond’s remaining life decreases over time, moving from long-term to short-term as it approaches maturity, it remains classified as a bond and does not change its fundamental product category to a money market instrument.

Takeaway: Debt securities are categorized into maturity segments based on their original term at issuance, and these classifications remain distinct even as the instrument approaches its maturity date. Therefore, statements I, II and III are correct.

Correct: A preference share is the right answer because, while it is legally classified as an equity security, it is viewed as a hybrid instrument. This is due to it having features of both fixed income (fixed dividend payments) and equity (ownership interest).

Incorrect: Ordinary shares are incorrect because they are pure equity instruments defined by residual claims and limited liability rather than fixed income traits. Depositary receipts are incorrect because they are vehicles for investing in foreign companies rather than hybrid instruments with fixed dividends. Defensive shares are incorrect because they are a sub-class of ordinary shares based on market behavior, not a distinct hybrid legal structure.

Takeaway: Preference shares are classified as hybrid securities because they combine the legal form of equity with the predictable income stream typically associated with fixed-income products.

Correct: The return on assets calculated before interest is the most appropriate metric because it is specifically designed to separate management or operational efficiency from financing decisions. By using profit before interest, an analyst can compare the efficiency of companies that have different capital structures without the results being distorted by their specific debt levels.

Incorrect: The return on equity is incorrect because it measures the return on the capital provided by shareholders and is significantly affected by the firm’s use of debt, making it a poor tool for isolating operational efficiency. The net profit margin is incorrect because it is calculated after interest and taxes, meaning it reflects the firm’s financing choices rather than just its ability to manage assets. The earnings per share on a fully diluted basis is incorrect as it focuses on the potential return to shareholders under a worst-case scenario of share issuance and does not measure asset management efficiency.

Takeaway: Return on assets expressed before interest allows analysts to evaluate a firm’s operational efficiency independently of its financing decisions and capital structure.

Correct: Statement II is correct because Eurobonds are international debt instruments that are managed by an international syndicate and offered to investors in several countries simultaneously. Statement III is correct because the domestic bond market in Singapore is specifically comprised of Singapore Government Securities and bonds issued by local Singaporean corporations.

Incorrect: Statement I is incorrect because the Singapore Government typically operates on a balanced budget and does not need to issue bonds to finance its spending; instead, it issues securities to build a liquid market and establish a benchmark yield curve. Statement IV is incorrect because while many bonds trade over-the-counter, retail-specific bond issues in Singapore are generally listed on the exchange to facilitate access for individual investors.

Takeaway: Understanding the specific motivations for government issuance in Singapore and the structural definitions of domestic versus international bond markets is fundamental for fixed-income analysis. Therefore, statements II and III are correct.

Correct: Statement I is correct because recognizing the full value of a contract upon receiving only a small deposit is an aggressive revenue recognition practice that overstates current income. Statement II is correct because including non-operating gains, such as the sale of a subsidiary, in operating income masks the true performance of the core business. Statement III is correct because capitalizing recurring maintenance expenses instead of recording them as immediate costs understates expenses and artificially inflates the profit figure.

Incorrect: Statement IV is incorrect because increasing an allowance for doubtful accounts is a prudent and realistic accounting practice that reflects potential credit losses, which generally indicates higher, rather than lower, quality of earnings.

Takeaway: High-quality earnings must be realistic and sustainable; analysts should be alert to aggressive revenue recognition and improper expense capitalization that artificially boost reported profits. Therefore, statements I, II and III are correct.

Correct: Leverage ratios are the right answer because they specifically indicate how much a firm relies on external debt and whether its earnings are sufficient to cover fixed financial obligations like interest payments.

Incorrect: Liquidity ratios are wrong because they focus on the company’s ability to meet immediate, short-term financial obligations rather than long-term debt structures. Operating efficiency ratios are incorrect as they measure how effectively management utilizes assets to generate revenue. Profitability ratios are wrong because they evaluate the firm’s earnings performance relative to sales or capital invested, rather than its financing structure.

Takeaway: Leverage ratios provide insight into a company’s long-term financial stability by measuring its debt levels and its ability to service fixed financial costs.

Correct: The statement regarding income bonds is incorrect because income bonds are actually classified as junior or subordinated debentures rather than senior secured debt. They are specifically structured to allow an issuer to omit or delay interest payments if the company’s earnings are too low, which places them lower in the priority of claims compared to secured or general creditors.

Incorrect: The description of serial bonds is accurate as they represent a bundle of bonds issued simultaneously but with different maturity dates. The classification of Treasury bills as discount securities and longer-term bonds as coupon securities correctly reflects the standard market division based on a one-year maturity threshold. The definition of a bond trust deed is also correct, as it serves as the formal contract outlining issuer obligations and investor rights while appointing a trustee for oversight.

Takeaway: Bondholders must distinguish between different levels of security and maturity structures, noting that income bonds are junior instruments that offer issuers flexibility in interest payments during financial difficulty.

Correct: The statement that Bond Y will likely offer a higher yield than Bond X to compensate for limited price appreciation is correct. A call provision is a disadvantage to investors because it limits the bond’s upside price potential in a falling interest rate environment and exposes the investor to reinvestment risk. To attract investors despite these drawbacks, issuers must offer a higher yield compared to similar non-callable bonds.

Incorrect: The suggestion that Bond Y would offer a lower coupon rate is incorrect because lower coupons are typically associated with put provisions, which benefit the investor, not call provisions which benefit the issuer. The claim that Bond Y has greater upside price potential is wrong because the call price effectively acts as a ceiling on the bond’s market value; investors will not pay much above the call price if the bond is likely to be redeemed. The idea that a call provision is the same as a sinking fund is incorrect; a call is an option for the issuer to use at their discretion, whereas a sinking fund is a mandatory requirement intended to reduce credit risk for the investor.

Takeaway: Callable bonds carry higher yields than non-callable bonds to compensate investors for the risk of early redemption and the resulting cap on potential capital gains when interest rates fall.

Correct: Statement I is correct because zero coupon bonds do not make periodic interest payments, which removes the risk of having to reinvest cash flows at lower future market rates. Statement III is correct because floating rate bonds have coupon rates that adjust periodically based on a benchmark, making them suitable for investors who need to match income with liabilities that also fluctuate with interest rates.

Incorrect: Statement II is incorrect because zero coupon bonds are actually more sensitive to interest rate changes than coupon-bearing bonds of the same maturity, as their entire value is realized only at the end of the term. Statement IV is incorrect because convertible bonds typically offer lower yields than straight bonds, as the bondholder accepts a lower interest rate in exchange for the valuable option to convert the debt into company shares.

Takeaway: Investors must balance the benefit of eliminating reinvestment risk in zero coupon bonds against their high price volatility, while recognizing that special features like conversion rights usually result in lower coupon yields. Therefore, statements I and III are correct.

Correct: The Composite Leading Index (CLI) is designed as a predictive tool to forecast growth and contraction in an economy. While it is effective at signaling when an expansion or recession might occur (identifying turning points), it does not provide information regarding the scale or magnitude of those economic shifts.

Incorrect: The description of indicators peaking and troughing simultaneously with the business cycle refers to Coincident Indicators, which describe the current state of the economy rather than predicting the future. The mention of tracking performance after the aggregate economy refers to Lagging Indicators, which confirm trends that have already occurred. The idea that the CLI provides precise quantitative forecasts of Gross Domestic Product (GDP) percentage changes is incorrect because the index is a directional warning tool, not a tool for measuring specific growth magnitudes.

Takeaway: Leading indicators are useful for identifying the timing of economic turning points but should not be used to estimate the specific size or intensity of the expected change.

Correct: Stock market peaks and troughs generally precede the turning points of general business activity as investors discount future earnings. This occurs because the market is forward-looking; investors anticipate future economic conditions and adjust their positions based on expected growth or contraction before those changes are reflected in broad economic data.

Incorrect: The statement that markets lag behind the business cycle is incorrect because the stock market is a leading indicator, not a lagging one that waits for official data. The idea that markets are perfectly synchronized with the business cycle is wrong because it ignores the anticipatory nature of investing, where prices move based on expectations rather than just current output. The claim that market trends are decoupled from the business cycle is incorrect because macroeconomic activity fundamentally determines the level and quality of the earnings and dividends that drive security prices.

Takeaway: The stock market typically serves as a leading indicator of the economy, with its peaks and troughs occurring before the actual turning points in the business cycle.

Correct: Statement I is correct because bonds with higher coupon rates generate larger periodic cash flows that must be reinvested at current market rates, thereby increasing the portfolio’s exposure to reinvestment risk. Statement II is correct because interest rate risk and reinvestment risk have an inverse relationship; while rising rates decrease the market price of a bond, they simultaneously allow the investor to reinvest coupon payments at higher yields, which helps to partially mitigate the price loss.

Incorrect: Statement III is incorrect because interest rate risk and reinvestment risk do not fully offset each other; the price impact of a rate change is generally more significant than the reinvestment effect, meaning the total return will still be affected. Statement IV is incorrect because reinvestment risk is actually more significant for longer holding periods, as the cumulative effect of reinvesting multiple coupons over time has a greater impact on the final return than it does for short-term holders.

Takeaway: Reinvestment risk is most significant for high-coupon bonds and long-term investors, acting as a partial but incomplete hedge against the price volatility caused by interest rate movements. Therefore, statements I and II are correct.

Correct: Advising the client that the bond is non-investment grade is correct because Standard & Poor’s classifies only the top four rating categories (AAA, AA, A, and BBB) as investment grade. Any rating of BB or lower is categorized as non-investment grade, also known as high-yield or junk bonds, which are characterized by significant speculative risks.

Incorrect: The statement that BB is the lowest tier of investment grade is wrong because BBB is the actual threshold for the lowest investment-grade rating. Suggesting the bond is a safe investment because it is less vulnerable than other speculative bonds is incorrect because, despite being relatively stronger than a B or CCC rating, a BB rating still indicates major uncertainties and exposure to adverse conditions. Classifying the bond as investment grade based on current capacity to meet commitments is wrong because the investment-grade status is determined by the specific rating category assigned, not just the immediate ability to pay.

Takeaway: Investment-grade status is strictly limited to bonds rated BBB and above, while ratings of BB and below indicate speculative characteristics and higher credit risk.

Correct: Singapore’s monetary policy is classified as an exchange-rate centered regime because its open economy makes the exchange rate a more effective tool for managing inflation and international competitiveness. In this framework, the money supply is endogenous, meaning it is determined by market demand rather than being a primary policy target set by the central bank.

Incorrect: A money-supply centered regime targets the quantity of money in circulation, which is not the primary focus in Singapore’s open economy where money supply is endogenous. An interest-rate centered regime, common in countries like the United States, involves setting independent targets for lending rates, which is not possible in Singapore as interest rates are tied to the exchange rate policy. Velocity is a socially determined factor in the Quantity Theory of Money and is not an operational target for central bank policy.

Takeaway: Singapore’s unique economic structure requires a policy classification that prioritizes exchange rate management over independent interest rate or money supply targets.

Correct: Investors demanding higher interest rates to compensate for risk is the right answer because when a budget deficit is expected to grow indefinitely, it increases the perceived risk of the government’s debt, causing bond yields to rise.

Incorrect: The statement regarding the multiplier effect is wrong because while spending can stimulate further economic activity, it does not automatically or immediately generate enough tax revenue to cancel out a deficit. The claim that the impact is muted because deficits are always financed by past surpluses is incorrect because governments often must resort to borrowing through bond issues when surpluses are insufficient. The idea that bond yields will decrease is wrong because higher debt levels and persistent deficits typically lead to higher borrowing costs rather than improved creditworthiness.

Takeaway: Long-term, persistent budget deficits tend to drive up interest rates and bond yields as investors require higher compensation for the increased risk of government borrowing.

Correct: Price continuity and market depth are the missing characteristics because they ensure that a security can be traded without causing a significant change in price. Depth refers to the presence of many orders at prices close to the current market price, which directly supports price continuity by preventing large price swings during a transaction.

Incorrect: Marketability is wrong because the scenario states the bond can be sold quickly, which is the definition of marketability. Internal efficiency and transparency are wrong because they refer to low transaction costs and the availability of data rather than the volume of orders. Information efficiency and transaction speed are wrong because they describe how prices react to news and the speed of processing, not the depth of the order book.

Takeaway: A liquid market requires both marketability for speed and sufficient depth to ensure that large trades do not cause significant, non-information-based price changes.

Correct: Classifying the sector as being in the stabilization and market maturity phase is the right answer because the scenario describes growth in line with the economy, standardized products, and tight profit margins. For a client seeking high growth, this stage is inappropriate as rates of return typically match the competitive level rather than exceeding it.

Incorrect: The mature growth phase is wrong because that stage involves profit margins declining from high levels toward normal levels, rather than being already tight and standardized. The deceleration and decline phase is wrong because it is characterized by growth falling below the economic average and the emergence of substitutes, which was not stated. The rapid accelerating growth phase is wrong because it features high demand and limited competition, the opposite of the intense competition described.

Takeaway: Investors should distinguish between maturity and growth phases to ensure their sector selections match their specific return requirements and risk profiles.

Correct: Halving the annual required yield and doubling the number of years is the standard market practice for valuing zero-coupon bonds. This approach ensures that the valuation is consistent with the semi-annual coupon payment frequency typical of most fixed-income securities, allowing for direct comparison between different bond types.

Incorrect: Using the full annual yield with the actual number of years is incorrect because it ignores the standard semi-annual compounding convention used by market participants. Dividing the annual yield by the face value is a nonsensical calculation that does not reflect the present value of future cash flows. Using the annual yield as the discount rate while doubling the periods is mathematically wrong as it applies a higher-than-intended discount rate over the total duration.

Takeaway: To maintain consistency with standard coupon bonds, zero-coupon bonds are valued by halving the annual yield and doubling the number of periods to maturity.

Correct: The rapid accelerating growth stage is the correct classification because this phase is defined by a surge in demand and awareness following the pioneering phase. During this time, the limited number of surviving firms face reduced competition, leading to order backlogs, high profit margins, and earnings that can more than double from their initial low levels.

Incorrect: The early development stage is incorrect because it is characterized by modest sales growth and very small or negative profit margins due to high initial costs. The mature growth stage is wrong because, although sales growth remains above the economic average, the rate of growth is no longer accelerating. The stabilisation and market maturity stage is incorrect as it describes a period where demand is fully met and the industry’s growth rate typically slows down to match the general economy.

Takeaway: The rapid accelerating growth stage is distinguished by the combination of high profit margins and accelerating earnings growth as firms capitalize on rising market demand with limited competition.

Correct: Reducing holdings in durable goods while increasing weightings in public utilities is the most appropriate strategy because it shifts the portfolio from cyclical to defensive industries. Cyclical industries, such as those producing cars and refrigerators, are heavily impacted by economic contractions as consumers postpone large purchases. In contrast, defensive industries like utilities are the least affected by recessions because demand for their services remains constant regardless of the economic climate.

Incorrect: Increasing allocations to growth industries like mobile devices or game applications is less appropriate for risk mitigation because, while they may grow, they do not offer the same stability as defensive sectors during a contraction. Shifting into real estate and financial services is incorrect because these are interest-sensitive industries whose performance is tied to interest rate expectations rather than providing a hedge against a general recession. Maintaining exposure to automotive and refrigerator industries is wrong because these are cyclical durable goods that typically perform poorly when the economy is heading into a recession.

Takeaway: To protect a portfolio during an economic downturn, investors should prioritize defensive industries that provide essential services and reduce exposure to cyclical industries that rely on discretionary consumer spending.

Correct: Explaining that the bond’s price will decline toward par and that yield-to-maturity is a more comprehensive measure is correct because, holding all other factors constant, a bond trading at a premium must see its price converge downward to its par value by the maturity date. Yield-to-maturity is a more meaningful measure of return than current yield because it accounts for both the annual interest income and the capital loss realized as the premium price moves toward par.

Incorrect: The suggestion that the price will remain stable at a premium is wrong because all bonds must be redeemed at par, forcing the price to adjust over time. The claim that the price will increase further is incorrect as premium bonds naturally lose value as they approach maturity to reach par. The statement that yield-to-maturity ignores the timing of cash flows is false; yield-to-maturity specifically uses the present value of all future cash flows and their timing to determine the rate of return.

Takeaway: A bond’s price converges to its par value as it approaches maturity, and yield-to-maturity is the preferred measure for total return as it incorporates these price changes and the timing of all cash flows.

Correct: A bond with a lower coupon rate, a lower yield, and a longer remaining time to maturity is the right answer because these three specific conditions maximize a bond’s duration. Duration measures how much a bond’s price will change in response to small interest rate movements; the lower the cash flows received early (low coupon) and the further in the future the final payment (long maturity), the more sensitive the bond’s present value becomes to rate fluctuations.

Incorrect: The option describing a bond with a higher coupon, higher yield, and shorter maturity is wrong because these characteristics collectively minimize duration, making the bond the least sensitive to interest rate changes. The option featuring a lower coupon but higher yield and shorter maturity is wrong because while a lower coupon increases sensitivity, the higher yield and shorter maturity significantly reduce it. The option with a higher coupon, lower yield, and longer maturity is wrong because the higher coupon provides more cash flow earlier in the bond’s life, which reduces its overall price sensitivity compared to a lower coupon bond.

Takeaway: To identify the bond with the highest price sensitivity to interest rate changes, look for the combination of the lowest coupon, the lowest yield, and the longest time to maturity.

Correct: Statement I is correct because technical analysis is fundamentally based on the principle that a security’s price is determined by the interaction of supply and demand. Statement III is correct because technical analysts assume that information does not reach all market participants simultaneously, leading to a gradual adjustment in prices that creates identifiable trends over time.

Incorrect: Statement II is incorrect because technical analysts believe that irrational factors, such as investor emotions and market sentiment, persist and drive trends, whereas it is fundamental analysts who typically view these factors as having only a temporary impact. Statement IV is incorrect because technical analysis focuses on market action and price patterns rather than attempting to calculate the intrinsic or fair value of a security, which is the goal of fundamental analysis.

Takeaway: Technical analysis is built on the assumption that prices move in trends due to the gradual flow of information and the persistent influence of both rational and irrational market forces. Therefore, statements I and III are correct.

Correct: Statement I is correct because it inaccurately describes the Liquidity Preference Theory, which actually posits that the yield curve should be upward sloping to compensate investors for the higher price volatility associated with long-term securities. Statement III is correct because it wrongly identifies the minimum value of a convertible bond as the lower of its components, whereas the floor price is actually the greater of its investment value or its conversion value.

Incorrect: Statement II is incorrect because it is a factually true statement; the Market Segmentation Theory assumes that yields for different maturities are determined independently by the supply and demand within specific maturity segments. Statement IV is incorrect because it is a factually true statement; under the Expectations Theory, a downward sloping yield curve is the direct result of the market anticipating that future interest rates will fall.

Takeaway: Yield curve theories explain the relationship between maturity and interest rates based on risk and expectations, while the floor price of a convertible bond is established by the higher of its bond or equity components. Therefore, statements I and III are correct.

Correct: Viewing the rally as potentially weak and monitoring for a reversal is the right action because technical analysis suggests that price increases must be supported by high volume to show strong demand. When volume contracts during a rally, it indicates that the upward momentum lacks broad investor participation and enthusiasm, making the trend vulnerable.

Incorrect: The suggestion to confirm a bullish continuation is wrong because low volume during a price rise is a warning sign of weakness, not a sign of strength or lack of sellers. The idea that the primary trend has already shifted to a bear market is incorrect because a trend change requires specific price patterns like lower highs and lower lows, not just a volume decrease. The claim that volume should be ignored is wrong because volume is a key indicator used to measure the intensity of supply and demand alongside price movements.

Takeaway: Trading volume serves as a measure of investor conviction, where a divergence between rising prices and falling volume often warns of an exhausting trend and a potential reversal.