CMFAS M6a Exam Free Trial

This refers to the Required Margins, as determined by SGX, which must be maintained in a customer’s account subsequent to the deposit of Initial Margins for that customer’s positions in ES contracts.
Required Margin = Maintenance Margin + Additional Margin
The maintenance margin is computed by multiplying the prescribed margin rate with the ES contract value. The ES contract value will be derived based on the last traded price of the underlying security in the ready market. If the last traded price of the underlying is not available for today’s computation, the last traded price of the latest available date will be used. Initial margin is then computed by multiplying the maintenance margin by the IM:MM ratio prescribed by SGX or the Member.

I. ES contracts have 5x to 20x leverage whereas for contra trading the leverage is infinite.
II. In ES contract there is no financing cost for less than 35 days whereas for contra trading there is no financing cost for less than 3 days.
III. In ES contract, taking short positions up to the tenure of the contract whereas in contra trading there is Intra short selling is there.
IV. There is no borrowing cost for ES contracts.

Characteristics:
• Minimal redemption at expiry equivalent to the capital preservation.
• Level of capital preservation is defined as a percentage of the nominal (e.g. 100%). Capital preservation refers to the nominal only, and not to the purchase price.
• Value of the product may fall below its capital preservation during the lifetime.
• Participation in a positive performance of the underlying until knock-out.
• Possible payment of a rebate following a knock-out.
• Capped upside.

Effective gearing helps to quicken the calculation of the price movement of the CBBC in response to the price movement of the underlying asset. For instance, a CBBC with an effective gearing of 10 times means that for each 1% change in the price of the underlying asset, the theoretical price of the CBBC may increase or decrease by 10%.
Generally, the closer the strike price is to the spot price of a CBBC’s underlying asset, the higher will be the gearing ratio of the CBBC. This means that the CBBC will experience greater price fluctuations when the asset’s spot price is close to the strike price. Such a CBBC has a higher risk of being called.

1. Mandatory Call – CBBC may not be suitable for all investors and the investor must consider his investment objectives and risk appetite. If the CBBC is called when the Call Price is breached, the payoff for the Ncategory investor is zero and the Residual Value for the R-category investor may be small. Once the CBBC is called, it is irrevocable. The investor does not get to profit from or recover any losses if the price of the underlying asset bounces back.
2. Gearing Effect – As CBBCs are leveraged products, the investor is exposed to greater downside risk if the market conditions are unfavourable. Negative returns are magnified when compared to a direct investment in the underlying asset.
3. Limited Life – A CBBC typically has a limited lifespan (determined by issuer). The price fluctuates during the life of the instruments and may become worthless upon expiry or when a MCE occurs.
4. Price Movement – Trading Close to Call Price – While the CBBC closely follows the movement of the underlying asset price, under certain market conditions where there is a demand-supply imbalance or turbulence in the wider market, the delta being approximately equal to 1 ( ≅ 1) may not always hold. Furthermore, when the underlying asset is trading very near the call price, the price of the CBBC can be more volatile with wider bid-ask spreads and uncertain market liquidity.

1. Funds with Features that Aim to Preserve Capital Invested:
Depending upon the proportion of capital that the fund aims to conserve, the remaining amount can be allocated into risky assets or derivatives to synthetically access risky assets.
2. Formula Funds:
Formula funds are the funds where the final payout depends on a pre-defined, rule-based formula. It starts off with an objective based on an anticipated view and the final payout depends upon the realized market outcome. These products have the advantage of knowing from the start how investments would be allocated depending on the pre-determined formula. Typically, such funds can be set up to track indices.
3. Capitalized / Distribution Funds:
Capitalized funds (also known as accumulating or reinvesting funds) are funds where dividends from investments are automatically re-invested back into the fund. Distributing funds (also known as income funds) on the other hand pays out any dividends received to investors on a periodic basis.
4. Indirect Investment Policy Funds (Swap-based Funds) :
These funds provide investors with a return (either on such payout date(s) and/or at the maturity date) linked to the performance of the underlying asset. To gain exposure to the underlying asset, the fund will not invest directly (and/or fully) in the underlying asset. Instead the fund may invest part or all of the net proceeds of any issue of shares in one or more derivative transaction(s) in accordance with the “Investment Restrictions” set out in the prospectus. The investor’s return depends on the underlying asset’s performance and the performance of the derivative used to link the net proceeds from the issue of shares to the underlying asset.

Both retail and institutional investors can subscribe to structured funds, and not all schemes are offered to both types of investors. A fund scheme could float different classes of shares, depending upon the type of investors subscribing to the scheme. These differences are mainly due to the specific features with respect to sales, conversion, redemption charge, minimum subscription amount and dividend policy are different for different classes of investors.
Schemes offered only to institutional investors are not restricted schemes; restricted schemes are those offered only to accredited investors, other relevant persons, and those who subscribe with SGD 200,000 or more per transaction. In case of a retail offer of scheme, a prospectus in compliance with the SFA must be lodged and registered with the MAS. In the case of an offer to accredited investors and other relevant persons, a prospectus is not required.
In the case of an offer to institutional investors, an information memorandum is not required. MAS requires financial institutions and fund distributors to put in place formal policies and procedures to assess the nature of a new investment product and assess its suitability for targeted customer segments before distributing the product. The salesperson or representative providing financial advice also has a responsibility in advising on suitability of product to the investor.
Investors are advised to keep relevant considerations (risk/return structure, legal and tax) in mind before investing in any structured fund. The fund’s prospectus will contain relevant appendices that will describe the details of the structured fund. Investors should look at the relevant sections of the prospectus for information on the fund. Investors are advised to seek independent advice to assess the risk level and suitability of the fund before making their investment decisions.

In this method, the ETF purchases futures, options and other derivative instruments from other counterparty(ies) in exchange for the index performance. A derivative embedded ETF purchases derivative instruments from a third party and these instruments are contractual obligations that binds the issuer(s) to deliver the index performance to the fund. Investors therefore rely on the creditworthiness of the derivative issuer(s) to deliver the performance of the index to the fund. Derivatives can be used to gain exposure to markets that cannot be accessed by directly investing in the underlying. For example, some ETFs track restricted markets such as China and India which have foreign investment or tax limitations, so the ETFs may invest in market access products such as participatory notes (PNs
/ P-notes) to gain access to the underlying securities. P-notes are derivatives by third party providers which provide a return linked to an underlying security in the index. P-notes carry the credit risk of the issuer.
A derivative embedded ETF must comply with the net counterparty exposure requirements under the Code on CIS or UCITS, which allows a maximum of 10% net counterparty exposure. With this maximum net counterparty exposure, investors risk losing only up to 10% of the fund’s value if there is a counterparty default. Typically, the derivative issuer will deposit collateral for the 90% balance 90 with a third counterparty custodian, and the collateral will be owned by the ETF’s trustee.

Zero Coupon Fixed Income Plus Option Strategy (or “Zero Plus” Option):
A zero plus option strategy employs a zero coupon fixed income instrument, usually a zero coupon note with a call option on an underlying financial instrument. The underlying financial instrument can be an equity security, equity index, currency pair, commodity or commodity index. The performance of the underlying financial instrument determines the upside returns that the structured product investor gets. The key terms of a structured product using a zero plus option strategy are:
1. Reference Asset (or Financial Instrument) – The underlying financial instrument with which the performance of the structured product is linked;
2. Strike Price – The level of the underlying financial instrument / asset where participation in the performance of the underlying financial instrument kicks in;
3. Participation Rate – The percentage increase in the structured product’s return for every 1% upside performance of the underlying financial instrument; and
4. Fixing Date – The day where the closing level of the underlying financial instrument is used to determine the structured product’s pay-out at maturity.
As long as there is no credit event in the issuing bank, the investor will at least get back 100% of the principal sum. This strategy is also known as a capital preservation strategy. The return of this structured product is a function of the performance of the underlying asset over and above the strike price and the participation rate. If the product uses at-the-money options, then the strike price is the prevailing market price of the underlying financial instruments at the start of the product’s life. The fees for a structured product using a zero plus option strategy are usually embedded in the structure, and there is no separate fee that an investor has to pay.

Constant Proportion Portfolio Insurance (CPPI) Strategy:
A structured product (fund or note) using a CPPI strategy dynamically allocates funds between a “risk free” asset (i.e. a bond) and a risky underlying asset (i.e. an equity index, equity fund or hedge fund). Under CPPI, a floor value of the total portfolio is calculated at regular intervals. For a CPPI product, principal preservation is a key consideration and setting the appropriate floor value allows this objective to be achieved.
When the portfolio value drops to the floor, funds are allocated to the risk free asset, so that the investor can still receive the principal investment when the structured product matures. To better secure the principal, the manager may buy insurance from another financial institution (usually a bank) to guarantee the principal sum at maturity, for a yearly fee of 1-2%.

A structured product is considered a complex investment product, which may not be easily understood by some investors. Before participating in this product, the investor should consider the following factors:
1. Risk appetite of investor – This refers to the investor’s ability and willingness to take risk. Even though some structured products offer some capital preservation, there is still a possibility that the investor can lose all of his investment. The investor must be aware of this possibility when considering the product.
2. Liquidity needs – Early withdrawal may result in loss of part of the investment principal and returns. Investors must be prepared to keep the investment amount in the product until its maturity.
3. Product risks – Investors need to understand the scenarios that can cause the loss of their principal investments. This can be analyzed through understanding the nature of the product, the underlying financial instruments used and details of the product issuer.
4. Product returns – It is also important for the investors to understand how the returns are generated, by understanding how the underlying instruments perform under different market conditions.
5. Time horizon – The value of certain structured products will only be fully realized if they are held to maturity. Some structured products have a long time horizon, and investors must take this into account and ensure that such products are suitable for their overall investment strategy. Some structured products, on the other hand, have a profile such that their values decline over time due to time value decay, and may actually be worthless at or near their expiry dates.

Vega is the sensitivity of option value to changes in implied volatility. Vega indicates an absolute change in option value for a 1% change in volatility. For example, a vega of 0.090 indicates that the option’s theoretical value increases by 0.090 if the implied volatility increases by 1.0%. Alternately, the option’s theoretical value decreases by 0.090 if the implied volatility decreases by 1.0%. Vega is larger as the option is closer to being at-the-money. Hence, the option price becomes most sensitive to volatility when the option is at-the-money. Vega for both call and put options are positive – increased volatility leads to higher option prices.

Put Writing Strategies:
By selling or writing a put, the investor gives the other party (put buyer) the right to sell the shares at the strike price, if he chooses to exercise the option, to the put seller. The put writer receives a premium for writing the put, and earning a return is often the main motivation for using this strategy. The put writer may be in an uncovered position, or have a “short” put embedded in a structured product.
1. Uncovered – Uncovered put writing increases income by the premium collected. Some investors may write puts at a strike price equal to their target buying price for gaining entry into the stock. However, the price risk can be considerable as the investor is exposed to the downside volatility of the underlying stock.
2. Yield enhancement – When combined with the purchase of a fixed rate note, put writing enhances the yield of the note. Structuring a fixed income instrument with an embedded short put would result in a bull equity linked note.

The bull put spread is a vertical spread and is also known as the bull put credit spread (as a credit is received upon entering the trade). Bull put spreads can be implemented by selling a higher striking in-the-money put option and buying a lower striking out-of-the-money put option on the same underlying stock with the same
expiration date:
• Buy 1 OTM Put
• Sell 1 ITM Put
Other features of bull put spread include:
1. Upside → Limited upside profit. If the share price closes above the higher strike price on expiration date, both options expire worthless. The strategy earns the maximum profit which is equal to the credit taken in when entering the position.
2. Downside → Limited downside risk. If the share price drops below the lower strike price on expiration date, then the strategy incurs a maximum loss equal to the difference between the strike prices of the two puts minus the net credit received when putting on the trade.
3. Market View → Strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term.

Arbitrage between Forward Rate Agreements (FRAs) and Futures:
A forward rate agreement (FRA) is the over-the-counter (OTC) equivalent of futures. Since they are quoted over the counter, FRAs can be tailored to the exact needs of the users in terms of the maturity date and contract amount.
Arbitrage between futures and FRAs is risk-free only when the value dates for the two correspond. Even then it must be remembered that using futures requires more careful liquidity management due to margin calls. In the interbank market, a direct quotation will have a spread of 1-3 basis points spread while the futures normally have a spread of 1 basis point. This gives the price-maker an opportunity to arbitrage between futures and FRAs.
When the arbitrage is between futures and FRAs with different value dates, there will always be residual basis risks or fixing risks. To minimize these risks, care should be taken to ensure that no calendar events (e.g. the financial year-end, share settlement date, etc.) or no release of important economic data (e.g. unemployment figures, consumer price index, etc.) will take place between the 2 dates.

The writer will receive a premium from the buyer and is obliged to deliver the share when the option is exercised. The greater the increase in the price of the underlying share, the higher the losses incurred by the call writer. The payoff to the call writer is exactly the mirror image of the call holder.
i. Breakeven – The call option writer breaks even (net profit = 0) if the underlying share price rises above the exercise price by an amount equal to the option price. Note that the breakeven point for both the call option buyer and writer is exactly the same.
ii. Maximum Gain – The maximum gain for a call writer is equal to the price of the option sold. This only happens when the underlying share price is equal to or less than the option’s exercise price.
iii. Maximum Loss – The maximum loss for a call option writer is, theoretically, unlimited. This happens when the underlying share price rises above the exercise price plus the option price; the higher the underlying share price, the greater the loss to the option writer.

In creating synthetic securities, it is assumed that:
i. Dividends are zero;
ii. Strike prices are the same for calls and puts;
iii. Expiration dates are the same for calls and puts; and
iv. Number of shares of stock must equal the number of shares represented by the options.

Derivatives can be used to implement investment views and provide investors to access broader investment
opportunities. Typical uses of derivatives include:
• Hedging or insuring against risk;
• Speculating, or adopting a view on the future direction of the market;
• Arbitraging, or taking advantage of price differentials between two or more markets to make a profit;
• Changing the nature of an asset or liability to meet specific needs that cannot be met from the standardized
financial instruments available in the markets; or
• Creating synthetic positions without incurring the costs of buying or selling the underlying assets.

Initial Margin – When buying or selling futures contracts, an investor does not need to pay for the entire contract at the time the trade is initiated. Instead, the investor makes a small upfront payment (initial margin), to initiate a position.

Additional Margin – Based on mark-to-market procedures of the exchange, each trading account is credited or debited at the end of each trading day, and checked to ensure that the trading account maintains the appropriate margin for all open positions. If the balance in the margin account falls below the maintenance level, an additional margin call is issued and the account must be returned to the initial margin level immediately or by a stipulated time.

The number of warrants needed to be exercised to buy or sell one unit of the underlying security is referred to as the conversion ratio. If the conversion ratio to buy the shares of ABC is 5:1, the warrant holder needs 5 warrants to purchase 1 share.

A fund trustee must be independent of the fund manager and its main role is to look after the interests of the unit-holders. The trustee’s main responsibilities include:

– Working in a fiduciary capacity and being accountable to the investors.
– Ensuring that the fund manager manages the CIS in accordance with the investment objective and restrictions as laid out in the trust deed and prospectus.
– Ensuring that the accounting records are kept properly and the CIS is audited after which the unit-holders receive the semi (within 2 months from the end of the period covered by the accounts or reports) and annual reports (within 3 months from the end of the period covered by the accounts or reports) in time.
– Taking legal ownership of all assets in the CIS and ensures that these assets are held independently from the fund management company.
– If there are any breaches, informing MAS within 3 business days after becoming aware of the breach.
– Minimizing the risk of mismanagement by the fund manager and ensuring that the fund is managed in the interest of the unit-holders.

The strike price (also referred to as the exercise price) is the fixed or contracted price at which the call option buyer has the right to purchase the underlying asset, or the put option buyer has the right to sell the underlying asset.

The process of dividing investments into different kinds of assets such as equities, fixed income, money market, commodities, real estate, etc is known as asset allocation. The aim of asset allocation is to optimize the risk/reward tradeoff based on an individual or institution’s investment objectives, risk tolerance, and investment horizon.

Value-at-Risk (VAR) is a statistical technique used to measure and quantify the level of financial risk within the investment portfolio over a specific time. VaR is used by investment and risk managers to measure and control the level of risk which the fund undertakes.

Gearing ratio = Share price / (Warrant price x Conversion ratio)

Gearing ratio for David’s call warrant = $10.00 / ($0.50 x 2)
Gearing ratio = 10

The general term that refers to all the financial instruments used by investors aiming to offset the potential changes in the fair value or cash flows of their hedged items is Hedging Instrument. A hedging instrument is a designated financial instrument whose fair value or related cash flows should offset changes in the fair value or cash flows of a designated hedged item.

Given that:
The new price of a share = $7.00
Quantity of shares purchased = 10,000
Commission rate = 0.5%

Total value of sale = Share price x Quantity of shares purchased
Total value of investor’s sale = $7 x 10,000 = $70,000

Commission = Total value of sale x commission rate
Commission = $70,000 x 0.5% = $350

If the current market price of the underlying asset of a call option is higher than the strike/exercise price of the call option, that call option is said to be in-the-money. This means that the option holder has the opportunity to buy the security below its current market price. Therefore, if the strike price of a call option is $100 and the current market price of the underlying asset is $105, that call option is said to be in-the-money.

Most structured warrants are automatically exercised and settled in cash on the expiration date. The proceeds are calculated based on the difference between the market price of the underlying asset and the exercise price.

Cash settlement per call warrant is calculated as (share price – exercise price) / conversion ratio
Call warrant cash settlement = ($30 – $25) / 2 = $5/2
Call warrant cash settlement = $2.50

Cost of one share = $3.00
Quantity of shares purchased = 1,000

Total value of purchase = Cost of share x Quantity of shares purchased
Total value of Violet’s purchase = $3.00 x 1,000 = $3,000.00

The initial cost of one share = $3.00
The new price of a share = $3.50
Quantity of shares purchased = 1,000
Commission rate = 0.5%

Total value of sale = Share price x Quantity of shares purchased
Total value of Violet’s sale = $3.50 x 1,000 = $3,500.00

Commission = Total value of sale x commission rate
Commission = $3,500 x 0.5% = $17.50

Gearing ratio = Share price / (Warrant price / Conversion ratio)
Gearing ratio for put warrant = $7.00 / ($0.20/2)
Gearing ratio = 70

Given that Delta = 30% = 0.3
Effective gearing = Gearing ratio x delta
Effective gearing = 70 x 0.3 = 21 times

The total value of purchase = Number of shares x Price of one share
The total value of the investor’s purchase = 1,000 x $3.00 = $3,000

Value of commission = Number of shares x Price of one share x Commission rate
Commission = 1,000 x $3.00 x 0.5% = $15.00

The intrinsic value of a call option is defined as the price of the underlying asset, less the option’s strike price, and benefits.

The intrinsic value of the call option = Market price of the underlying asset – Strike price of the underlying asset
Intrinsic value = $107 – $105 = $2

U.S Treasury bill is a short-term interest rate future contract. The price of short-term interest rate futures is calculated using the formula:
P = 100 x (1-R). Where R = annualized interest rate for that period and P = Price.

The price (P) of the U.S Treasury bill would be:
P = 100 x (1-0.08)
Price = 92