CMFAS CACS – Client Advisor Competency Standards (CACS) ​Paper 2 Exam

The Eurobond market has grown much more rapidly than the foreign bond market for several reasons. These reasons include the following:

– Eurobond issues are not subject to the regulations of the country in whose currency they are denominated.
– They can be brought to the market quickly and with less disclosure. This gives the issuer of the bonds greater flexibility to take advantage of favorable market conditions.

Foreign equity is traded on the U.S. exchanges in the form of American depository receipts (ADRs). ADRs represent a feasible, liquid way for U.S. investors to purchase stock in companies abroad. Foreign firms also benefit from ADRs, as they make it easier to attract American investors and capital, without the hassle and expense of listing themselves on U.S. stock exchanges.

The term risk-averse describes the investor who chooses the preservation of capital over the potential for a higher-than-average return. One of the basic tenets of finance is the concept of risk aversion; that is, an investor will demand a risk premium for bearing a certain level of risk, and the higher the risk associated with an investment, the greater will be the premium demanded over and above the riskless rate of interest.

An annuity is a series of payments made at equally spaced intervals of time. The income received from an annuity is taxed at regular income tax rates, not capital gains rates, which are usually lower.

The success of an economy is gauged by the extent of wealth creation. Economists and statisticians use several methods to track economic growth. Some economists posit that total spending is a consequence of productive output.

Like that of the former Soviet Union, in a command economy, all production and allocation decisions are made by a central planning authority. The planning authority is expected to estimate the resource requirements of various economic agents and then rank them in order of priority in relevance to social needs.

A project is considered to be worth the investment only if its expected rate of return is greater than the cost of the capital being invested. The threshold return, or the return above which the venture will be deemed profitable, is the cost of capital for the decision-maker.

The basic goal of every family office is to pool the resources of an extended family under one umbrella to achieve higher levels of wealth management. The family office uses in-house as well as outsourced resources to meet the financial goals as well as the tax obligations of the family.

Alfred Jones started his first hedge fund trading equities, where he would buy some stocks and sell short some other stocks. This strategy came to be known as the Long/Short Equity strategy. Long/short equity is an investment strategy that seeks to take a long position in underpriced stocks while selling short overpriced shares.

Relative value between government bonds of different maturities is referred to as the yield curve relative value. Yield curve relative value is a subset of the relative value arbitrage strategy.

A small-cap manager may suffer diseconomies of scale because of the following:

– Larger trades have increased price impact.
– The inflow of capital may encourage managers to abandon their core strategies.
– The need for increased numbers of staff may slow the decision-making process.

A potential solution is to split the allocation among several managers. However, identifying and monitoring suitable managers is an added burden and cost.

Structural (consistent, as opposed to one-time) government policies that can facilitate long-term growth include the following:

– Minimal government interference with free markets.
– Development of infrastructure and human capital, including education and health care.
– Facilitate competition in the private sector.
– Sound fiscal policy.
– Sound tax policies.

Unanticipated events that occur outside the normal course of an economy are referred to as exogenous shocks. Since the events are unanticipated, they are not already built into current market prices, whereas normal trends in an economy, which would be considered endogenous, are built into market prices.

Many emerging markets require a heavy investment in physical and human (e.g., education) infrastructure. To finance this infrastructure, many emerging countries are dependent on foreign borrowing, which can later create crisis situations in their economy, currency, and financial markets.

Adding an equal amount to each benchmark spot rate and value the bond with those rates is a method for deriving a bond’s yield spread to a benchmark spot yield curve that accounts for the shape of the yield curve.

A yield spread is the difference between a bond’s yield and a benchmark yield or yield curve. If the benchmark is a government bond yield, the spread is known as a government spread or G-spread.

Matrix pricing is a method used to estimate the yield-to-maturity for bonds that are not traded or infrequently traded. The procedure is to use the yield-to-maturity of traded bonds that have credit quality very close to that of a nontraded or infrequently traded bond and are similar in maturity and coupon, to estimate the required yield-to-maturity.

Viewed from the standpoint of a bond dealer, a reverse repo agreement refers to taking the opposite side of a repurchase transaction, lending funds by buying the collateral security rather than selling the collateral security to borrow funds.

The permanent income hypothesis asserts that consumer spending is mostly driven by long-run income expectations, not cyclical swings in wealth. If income temporarily declines, consumers continue to spend (from savings) as longterm income expectations are more stable.

Unanticipated events that occur outside the normal course of an economy are referred to as exogenous shocks. Since the events are unanticipated, they are not already built into current market prices, whereas normal trends in an economy, which would be considered endogenous, are built into market prices.

Goals-based approaches are geared toward asset allocations for subportfolios, which help individuals or families achieve lifestyle and aspirational financial objectives. Each sub-portfolio will have a unique asset allocation designed to meet the stated goals.

Asset segregation is the evaluation of investment choices individually, rather than in aggregate. Asset segregation is the separation of assets from a larger group. Asset segregation is essential for protecting clients’ assets in case of insolvency of the financial institution where the client holds its assets.

Individualist investors have a self-assured approach to investing. They gain information from a variety of sources and are not averse to devoting the time needed to reconcile conflicting data from their trusted sources. They are also not afraid to exhibit investment independence in taking a course of action. Individualist investors place a great deal of faith in hard work and insight and have confidence that their long-term investment objectives will be achieved.

The term personal trust refers to trusts established by an individual, who is called the grantor. Personal trusts are not in and of themselves an investment strategy but rather an important tool for implementing certain aspects of an investment strategy (e.g., gifting). The appeal of personal trusts lies in the flexibility and control with which the grantor can specify how trust assets are to be managed and distributed, both before and after the grantor’s demise.

Investment decisions incorporate the decision maker’s expectations concerning factors and events believed to affect investment values. The decision-maker finally integrates these views into expectations about the risk and return prospects of individual assets and groups of assets.

In portfolio management, the feedback step has two components:

– Monitoring and rebalancing: Monitoring and rebalancing involve the use of feedback to manage ongoing exposures to available investment opportunities so that the client’s current objectives and constraints continue to be satisfied.
– Performance evaluation: Investment performance must periodically be evaluated by the investor to assess progress toward the achievement of investment objectives as well as to assess portfolio management skills.

A typical IPS includes the following elements:

– A brief client description.
– The purpose of establishing policies and guidelines.
– The duties and investment responsibilities of the parties involved.
– The statement of investment goals, objectives, and constraints.
– The schedule for review of investment performance as well as the IPS itself.
– Performance measures and benchmarks to be used in performance evaluation.
– Any considerations to be taken into account in developing the strategic asset allocation.
– Investment strategies and investment style(s).
– Guidelines for rebalancing the portfolio based on feedback.

The principles of behavioral finance recognize the following individual investors behaviors:

– Individual investors exhibit loss aversion.
– Individual investors hold biased expectations.
– Individual investors practice asset segregation.

Tax strategies are ultimately unique to the individual investor and the prevailing tax code. These are the valid tax strategies:

– Tax deferral which seeks to defer taxes and maximize the time during which investment returns can be reinvested.
– Wealth transfer strategies seek to reduce taxes due to a transfer of assets.
– Tax avoidance, which is to avoid taxes when legally possible.
– Tax reduction, which looks for opportunities to reduce the impact of taxes.

The different statistical methods include:

– Historical statistical approach, which involves the use of sample estimators.
– Shrinkage estimation, which involves taking a weighted average of a historical estimate of a parameter and some other parameter estimate.
– Time-series estimators, which involves forecasting a variable on the basis of lagged values of the variable being forecast and often lagged values of other selected variables.
– A multifactor model is a model that explains the returns to an asset in terms of the values of a set of return drivers or risk factors.

The Sharpe ratio is calculated using the formula:
\[
\text{Sharpe Ratio} = \frac{\text{Return} – \text{Risk-Free Rate}}{\text{Standard Deviation}}
\]
Assuming a risk-free rate of 3%:
– For Option A:
\[
\text{Sharpe Ratio} = \frac{8\% – 3\%}{12\%} = \frac{5\%}{12\%} = 0.4167
\]
– For Option B:
\[
\text{Sharpe Ratio} = \frac{6\% – 3\%}{8\%} = \frac{3\%}{8\%} = 0.375
\]
Option A has a higher Sharpe ratio, indicating a better risk-adjusted return. Thus, the correct answer is (a) Option A.

The ROE is calculated using the formula:
\[
\text{ROE} = \frac{\text{Net Income}}{\text{Total Equity}}
\]
Given:
\[
\text{ROE} = \frac{1,500,000}{10,000,000} = 0.15 = 15\%
\]
Thus, the correct answer is (c) 15%.

The gain or loss from a forward contract is determined by the difference between the forward rate and the spot rate. Here, the forward rate is higher than the spot rate (1.3500 – 1.3400 = 0.0100), resulting in a gain. Forward foreign exchange contracts must comply with the regulations under the Securities and Futures Act 2001 to manage risks effectively.

The profit is calculated by multiplying the difference between the selling rate and the buying rate by the amount of currency traded. Here, the profit is (1.2300 – 1.2000) 1,000,000 = 30,000 USD. This calculation is essential for understanding foreign exchange trading outcomes and is regulated under the Securities and Futures Act 2001.

The Debt-to-Equity Ratio is calculated as:

\[
\text{Debt-to-Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Shareholders’ Equity}}
\]
A ratio of 0.5 means that for every dollar of equity, there is 50 cents of debt. This indicates a conservative approach to leveraging, with relatively low debt compared to equity.

For Fund A, the management fee and performance fee are applied to the return. Assuming the performance fee is applied to the return after the management fee:

– Management Fee: \(10\% \times 1.5\% = 0.15\%\)
– Performance Fee: \((10\% – 0.15\%) \times 15\% = 1.485\%\)
– Net Return for Fund A: \(10\% – 0.15\% – 1.485\% = 8.365\%\)

For Fund B, the flat fee is:

– Net Return for Fund B: \(10\% – 2.0\% = 8.0\%\)

Fund A offers a slightly higher net return due to its lower flat fee structure.

Net return is calculated by subtracting the expense ratio from the annual return. For Fund A, the net return is \(8\% – 1.5\% = 6.5\%\), and for Fund B, it is \(7.5\% – 1\% = 6.5\%\). Despite both funds having the same net return of 6.5%, Fund B has a lower expense ratio, making it more favorable due to lower costs. Refer to the Singapore CMFAS guidelines on cost-effectiveness in investment recommendations.

NAV per share is calculated as \( \frac{\text{Total Assets} – \text{Total Liabilities}}{\text{Shares Outstanding}} \). Hence, NAV per share = \( \frac{5,000,000 – 500,000}{400,000} = \frac{4,500,000}{400,000} = 12.50 \).

The P/E ratio is used to assess how much investors are willing to pay for each dollar of earnings. A lower P/E ratio (Company A) may indicate undervaluation, while a higher P/E ratio (Company B) may suggest overvaluation. However, this interpretation depends on future earnings expectations and other factors. Thus, option c) provides the most accurate perspective. Options a), b), and d) do not account for the underlying factors affecting P/E ratios.

For a fund with $10,000 in assets, Fund X charges a flat fee of $500. Fund Y, with a 1% fee structure, charges $100 (1% of $10,000). Thus, Fund X charges $400 more than Fund Y, not $500. Option a) is correct. Options b), c), and d) do not reflect the correct calculation of the fee difference.

Return on equity (ROE) measures the profitability of a company relative to shareholders’ equity. A decline in ROE often indicates lower profit margins or reduced net income, which adversely affects the ratio. Option d) correctly identifies this reason. Options a), b), and c) do not accurately explain the decline in ROE.

The standard deviation is calculated using the formula for sample standard deviation, which involves finding the square root of the average squared deviations from the mean. The correct formula is given in option (a), where the deviations from the mean are squared, averaged, and then square-rooted. This method is aligned with statistical practices for assessing risk under the CMFAS standards.

To calculate the fund’s net return, subtract the expense ratio from the gross return: 12% – 0.5% = 11.5%. This calculation reflects the actual return to investors after accounting for the costs associated with managing the fund, consistent with CMFAS expense and return calculations.

A higher Sharpe Ratio indicates better risk-adjusted performance. Since the fund’s Sharpe Ratio of 1.2 exceeds the benchmark’s Sharpe Ratio of 1.0, the fund offers superior performance relative to the amount of risk taken, as per CMFAS risk-adjusted performance standards.

Currency risk, or exchange rate risk, arises from fluctuations in the currency exchange rates between the investor’s home currency and the foreign currencies of the investments. According to SFA regulations, investors should assess currency risk when holding international investments to understand potential impacts on returns.