CMFAS M6a Exam Free Trial Set Two

Corporate Actions:
Since ES contracts derive their values from underlying securities, corporate events on the underlying securities can affect the value of the corresponding ES contracts. SGX makes full corporate action adjustment to an ES contract for which the Book Closure Date of the corporate event on the underlying security is before the settlement day.
The objective of full corporate action adjustments is to make adjustments to ES contracts to reflect the impact of corporate events so that the contract value after the event will be, as far as practicable, equivalent to the value before the event.
There are 2 main methods of adjustments:
1. Adjustment to the contract multiplier – When a corporate event results in shareholders obtaining an increase/decrease in the number of shares, this change will be reflected by a similar increase/decrease in the contract multiplier for the respective ES contracts.
2. Adjustment to the settlement price to post corporate event price – When a corporate event results in shareholders obtaining an increase/decrease in the number of shares that will increase/decrease the share value/price, price adjustment will be made to the settlement price of the ES contract.

Autocallable products contain knock-out options, which are usually found in products with longer maturities. They can automatically terminate (be knocked-out) and be called by the issuer before maturity if the underlying assets are at or above the initial (or other predetermined) levels on specific observation
dates.
he underlying assets linked to autocallable products can be equities, baskets of stocks, indices, interest rates, currencies, commodities or other asset classes. Many autocallable products incorporate a conditional capital protection feature, where the investor receives the principal amount of their investment, plus a pre-determined payout in the form of a coupon, if the product is redeemed early.
Autocallable structured funds can have features that give investors some capital preservation while offering them the ability to earn a market-linked investment return. This provides investors with some level of security that they will get back the initial investment amount at the maturity date if the markets decline.

A Note on Final Settlement Methodology:
The final settlement price of the Singapore Government Bond futures is based on the prices of the selected bonds in the basket, provided by the Singapore Government Securities Dealers for the Monetary Authority of Singapore’s (“MAS”) daily fixing of the Singapore Government Bonds on the last trading day.
From the prices contributed to MAS for each bond in the basket, the arithmetic mean of the bid and offer prices shall be calculated, after discarding the 3 highest and 3 lowest bids and the 3 highest and 3 lowest offers, and converted to yield, rounded to the nearest 8 decimal places.
The final yield for all bonds in the selected basket, rounded to the nearest 5 decimal places, is derived from the yield for each bond in the basket after weighting the yield of the benchmark bond in the selected basket by 60% or such other weighting as may be prescribed by the Exchange. The remaining weighting shall be equally distributed over the remaining yields.

Complex options are also called “exotic” options. Some of the flexible features of such options include:
1. Timing of option exercise – It can be other than the final expiry date (European) or the ability to exercise it at any time before expiration (American) but at specific intervals before the expiration date or triggered by the occurrence of an event;
2. Uncertainty as to time of expiration – This can be other than the final expiry date which is stipulated at the time of issuance, or it can be triggered by the occurrence of an event;
3. Payoff computation – The price level at which the payoff is calculated can be a number other than the actual spot price;
4. Conditional events or trigger points – If the price level of the underlying asset touches or crosses a trigger point, it will affect the option’s validity, and have an impact on the final payoff
5. Underlying assets – The variety can extend beyond traditional asset classes and market indices to include alternative investments, such as commodities, real estate, and market indicators like volatility;
6. Multi-currency features.

This is the most common type of barrier option, where there is one barrier. When the barrier level is reached, the option gets “knocked out.”
The barrier level is the call price, and with respect to the strike price:
• For a call barrier option, the call price is HIGHER than or EQUAL to the strike price.
• For a put barrier option, the put price is LOWER than or EQUAL to the strike price.

Settlement by Delivery of Underlying Securities:
Settlement of ES contracts takes place by way of delivery of the underlying securities on the 3rd business day after the Last Trading Day (LTD+3). At LTD+3, ES contracts are settled in the same manner as ready market contracts. Payment and receipt of the purchase and sale consideration respectively will take place in accordance with the current practice of the ready market.
If the seller of the ES contract does not have any or sufficient underlying securities of the ES contract on Settlement Date, CDP will commence buying-in of the underlying securities and the current procedures for buying-in under the CDP Clearing Rules will apply to such buying-in.

Investors must be aware of the implications of higher risk-return structures and agree to take on additional risks to meet their investment objectives. In addition, they should at least consider the following before choosing to invest in a structured note:
1. Liquidity – The amount invested usually will not be fully redeemable during the tenure of the structured note. Early withdrawal will result in loss of part or the entire principal invested;
2. Risk – Structured notes have higher risks due to the different layers involved. Investors should understand the higher risks and have the risk appetite for it;
3. Returns – Returns are tied to various underlying instruments in the structured note. Investors should be aware that their returns will vary based on the performance of the underlying instruments and there are possibilities that the instruments’ principal values will be affected;
4. Terms and conditions – Investors should at least review the terms and conditions, which will explain their obligations and risks that they are subjected to; and
5. Fees and charges – Investors should be informed of fees and charges before investing in the structured notes. The management fee is likely to be higher than standard financial instruments due to the note’s complexity. For any underlying instruments used, it is likely that a transaction cost will be incurred for every transaction. Investors need to understand how these costs are passed on to them.

In constructing a discount certificate:
• The premium received from the sale of the calls is greater than the cost incurred from the purchase of a zero-strike option.
• This amount is passed on to the investor at the time of investment and the product is issued at a discount to face value, so that the investment sum he puts in is less than the amount an investor pays for a similar reverse convertible.
• The discount certificate investor gets part of his return in the form of a discount to the face value at the time of making the investment.
• At maturity or redemption, he will not receive a full a coupon payout but receives the face value of the certificate (assuming no credit or market events occur).

Traditional Valuation Approach:
Under this approach, the investor does not directly value the embedded option in the convertible bond. The steps are as follows:
1. Compute the Conversion Value:
2. Compute the Minimum Value.
3. Compute the Conversion Price & Premium.
4. Assess the Downside Risk
5. Compute the Premium Payback Period

Market risk for a structured deposit depends on the underlying asset:
a) Equity linked – The underlying share, basket of shares, share index or basket of indices, may not move in the direction and/or by the expected amount. If the returns are capped, the investor may forego
potentially higher returns that you could have received from investing directly in the underlying asset.
b) Bond linked – The underlying bond, basket of bonds, bond index or basket of bond indices, may not move in the direction and/or by the amount forecasted.
c) Interest rate linked – Returns depend on the direction and/or amount by which interest rates move. If returns are capped, the investor bears the risk of foregoing potentially higher returns that you could
have received from investing directly in the underlying asset.
d) Credit linked – The investor’s return is exposed to the counterparty or credit risk of specified entities, and to changes in the market value of the underlying collateral should a credit event occur.

Gamma indicates an absolute change in delta. Gamma is the sensitivity of delta to changes in the underlying asset price. Therefore it is the 2nd order relationship between the option price and its underlying asset price:
Gamma = ∂2V/∂S
All gamma values are positive because the values change in the same direction as delta (i.e. a higher gamma means a higher change in delta and vice versa). The signs change with positions or trading strategies because the underlying risk will vary for buyers and sellers of options. All net buying (long) strategies will have positive gamma and net selling (short) strategies will have negative gamma. For example, a short call seller has a negative gamma position, with downside exposure. The call buyer is positive gamma, with potential for upside gains.

Foreign Exchange (FX) Warrants:
The price of a FX warrant is driven by the changes in the exchange rate between the two underlying currencies. Similar to currency options, FX warrant holders have the right to exchange an amount of one currency into another currency at a specified exchange rate before or on a specified date.
FX warrants are suited to investors who have a particular view on FX rates, either to hedge their currency exposure or speculate on currency movements. Before trading FX warrants, the investor has to identify which currency pair he wants trade, of which one currency is considered bullish and the other currency bearish, relative to one another. For example, for the USD/JPY pair, if the investor is bullish on USD and bearish on Yen, he will buy USD/JPY call warrants. Another investor who believes that the Japanese Yen will appreciate against USD will buy USD/JPY put warrants.
FX warrants are cash settled and have features similar to other structured warrants. FX warrants are leveraged instruments where returns can be magnified when the FX market moves favourably. However, losses can be compounded if exchange rates move in the opposite direction from what the investor had anticipated. Investors
should monitor FX movements closely and be aware of the macroeconomic factors which influence global and local economic activity, political developments, etc. Currencies of some countries which are endowed with abundant natural resources can be very responsive to moves in commodity prices, such as Australia and Canada.

A spread combines both a long and a short position, executed at the same time in related futures contracts. The purpose of the strategy is to mitigate the risks of holding only a long or a short position.
Margin requirements tend to be lower due to the more risk adverse nature of spread trades. However, a spread may be vulnerable to both legs moving in the opposite direction of what the trader may have anticipated, therefore resulting in losses.

Buying a calendar spread means:
i. Buying 1 nearer delivery month (Leg 1); and
ii. Selling 1 further delivery month (Leg 2).

• The delta of the call option is a value between 0 to 1.Every increase in the underlying asset price results in a rise in the value of the call option. A decrease in the underlying price would result in a decrease in the call option value.
• The delta of the put options is negative and has a value between -1 to 0. An increase in the underlying asset price results in a decrease in the value of the puts.

Money market instruments are short-term debt instruments issued by governments, financial institutions and corporations that are highly liquid and less risky. The minimum denominations of these securities are relatively large and the size of the transactions can be substantial. The maturities of money market securities range from one day to one year and are often less than 90 days.

The payoff from a derivative over a given period of time will depend on the performance of the underlying asset(s), which could include interest rates, foreign exchange rates, stock index values, commodity prices, stock prices or other variables, such as the occurrence or non-occurrence of a specified event.

Differences between Equity Index Futures and Stocks:
1. Underlying: Cash index for Equity Index Futures and ownership of shares in a company for stocks.
2. Settlement: Daily mark-to-market for Equity Index Futures and Fixed settlement for stocks.
3. Risk: Leverage can magnify gains as well as losses by several fold for Equity Index Futures and stocks depends on market volatility of index.
4. Short Selling: No borrowing of shares for Equity Index Futures.

Hedgers:
Hedgers have a position in the underlying asset or commodity. They use futures to reduce or limit the risk associated with an adverse price change. Producers, such as farmers, often sell futures on the crops they raise, to hedge against a drop in commodity prices. This makes it easier for producers to do long-term planning.

Market Makers:
Market makers are trading firms that have contractually agreed to provide liquidity to the markets, continually providing both bids (an expression to buy) and offers (an expression to sell), usually in exchange for a reduction in trading fees. Increasingly, the electronic market makers as a group provide much of the market liquidity that allows large transactions to take place without effecting a substantial change in price. Market makers often profit from capturing the spread, the small difference between the bid and offer prices over a large number of transactions, or by trading related futures markets that they view to have price or profit opportunities.

Proprietary Trading Firms:
Proprietary trading firms, also known as prop shops, profit as a direct result of their traders’ activity in the marketplace. These firms supply their trader swith the education and capital required to execute a large number of trades per day. By using the capital resources of the prop shop, traders gain access to more leverage than they would if they were trading on their own account. They also gain access to research and strategies developed by larger institutions.

1. Outright trades:
An investor can simply decide to buy or sell a futures contract, thereby wagering that the price of the underlying asset will rise or fall. Outright trades are familiar to most equity investors and are easy to understand.
2. Hedging:
The trader sells a futures contract to offset positions he/she holds in the cash market. For instance, if you have a large portfolio of U.S. stocks that you do not want to sell for tax reasons but fear a sharp market decline, you could sell S&P 500 index futures as a hedge against a market decline.

3. Basis trades – This is an arbitrage trading strategy where the trader takes opposing long and short positions in the two securities to profit from the convergence of their values. The strategy is called basis trading because it aims to profit off very small basis point changes in value between two securities.

4. Spread trades:
A spread combines both a long and a short position, executed at the same time in related futures contracts. The purpose of the strategy is to mitigate the risks of holding only a long or a short position.