SCI M9A – Life Insurance And Investment-Linked Policies II

Correct: Statement II is correct because the text states that if asset valuation is only performed monthly or quarterly, investors effectively cannot exit the fund between those specific valuation dates. Statement III is correct because an investor may suffer a loss in local currency terms due to exchange rate fluctuations, even if the product provides principal protection in its original foreign denomination. Statement IV is correct because the role of a market-maker is to act as the counterparty and provide liquidity when there is no other willing buyer in the market.

Incorrect: Statement I is incorrect because the text explicitly states that listing on an exchange does not guarantee liquidity, as thin trading volumes or a lack of market demand can prevent an investor from selling at a reasonable price.

Takeaway: Liquidity risk is influenced by both market demand and valuation frequency, while foreign exchange risk can result in principal losses in local currency terms despite foreign-denominated principal protection. Therefore, statements II, III and IV are correct.

Correct: Statement II is correct because synthetic ETFs use financial instruments to replicate index movements, allowing access to restricted markets or providing enhanced payouts. Statement III is correct because the creation and redemption mechanism ensures that as long as the underlying component stocks are liquid, the ETF units can be created and redeemed efficiently.

Incorrect: Statement I is incorrect because while the fundamental value of an ETF is based on its NAV, the actual transaction price is determined by market forces of supply and demand on the stock exchange. Statement IV is incorrect because unlisted index funds typically have higher front-end distribution costs (3% to 5%) compared to the lower brokerage commissions (0.25% to 0.5%) associated with trading ETFs.

Takeaway: ETFs provide greater pricing transparency and lower transaction costs than unlisted index funds, with liquidity supported by both market makers and the underlying asset creation process. Therefore, statements II and III are correct.

Correct: Statement I is correct because general market risk is driven by broad macroeconomic factors such as interest rates, inflation, and global conditions that affect the overall investment environment. Statement III is correct because the fixed income component of a structured product is specifically sensitive to interest rate movements and the credit standing of the issuer.

Incorrect: Statement II is incorrect because the source text explicitly states that issuer-specific risks, such as litigation or regulatory actions, can affect an entire industry sector rather than just a single entity. Statement IV is incorrect because central clearing party (CCP) guarantees are a feature of exchange-traded derivatives; for over-the-counter (OTC) derivatives, counterparty risk is typically mitigated through the use of collaterals.

Takeaway: Market risk for structured products includes both broad economic factors and issuer-specific events, while counterparty risk mitigation strategies differ between exchange-traded and OTC instruments. Therefore, statements I and III are correct.

Correct: Buying underlying securities from the market and exchanging them with the Fund Manager for new ETF units is the right answer because this describes the creation process. When market demand drives the price above the Net Asset Value (NAV), the Participating Dealer generates new supply through this mechanism to bring the market price back in line with the NAV.

Incorrect: Purchasing ETF units from the secondary market and returning them to the Fund Manager for the underlying securities is wrong because this describes the redemption process, which is used when the market price is lower than the NAV. Selling existing units without creation is wrong because it does not utilize the primary market mechanism to adjust the total supply of units in circulation. Requesting a cash dividend is wrong because price-NAV alignment is managed through the creation and redemption of units, not through corporate actions like dividend payments.

Takeaway: The primary market creation and redemption mechanism, managed by Participating Dealers, ensures liquidity and keeps the market price of an ETF close to its Net Asset Value.

Correct: Statement I is correct because the text defines a discount as occurring when the ETF market price is lower than the indicative Net Asset Value (iNAV). Statement III is correct because re-balancing is the mandatory process where an ETF adjusts its holdings to include or omit securities based on changes made by the index provider to ensure performance mirroring.

Incorrect: Statement II is incorrect because the text states that ETFs enjoy greater liquidity by trading throughout the day, whereas unit trust investors can only liquidate following a pricing that occurs at most once a day. Statement IV is incorrect because the text explicitly states that concentration risk is much higher for a single company investment compared to an ETF, which provides diversification across a group of companies.

Takeaway: ETFs offer intraday liquidity and diversification benefits, with their market prices kept close to the underlying NAV through the actions of participating dealers and the provision of iNAV data. Therefore, statements I and III are correct.

Correct: Statement II is correct because leverage (also known as gearing) is used to increase the potential rate of return, which multiplies gains but also magnifies losses. Statement III is correct because the reliability of any intended principal protection is directly affected by the credit risk of the protection-provider.

Incorrect: Statement I is incorrect because structured deposits are considered investment products and are specifically NOT subject to the protection of the Deposit Insurance Scheme in Singapore. Statement IV is incorrect because the price volatility of leveraged products is significantly greater than direct investments, not lower.

Takeaway: Investors in structured products must understand that leverage increases volatility and that principal protection is not absolute, as it depends on the creditworthiness of the provider. Therefore, statements II and III are correct.

Correct: Statement II is correct because regulatory risk is defined as the risk that legislation or regulations may change during the life of a financial contract. Statement III is correct because for OTC non-standard contracts, the level of collateral is not fixed by a central exchange but is instead subject to private negotiations between the counterparties.

Incorrect: Statement I is incorrect because having collateral does not fully eliminate risk; collateral risk exists if the initial exposure was not fully collateralised or if the collateral value depreciates over time. Statement IV is incorrect because legal risk refers to potential losses from the uncertainty of legal proceedings or bankruptcy, whereas the statistical measurement of how two securities move in relation to each other is known as correlation.

Takeaway: Collateral management requires ongoing monitoring of asset values and private negotiation in OTC markets, while legal and regulatory risks involve uncertainties regarding bankruptcy and legislative changes. Therefore, statements II and III are correct.

Correct: Statement I is correct because derivative-embedded synthetic ETFs utilize instruments like participatory notes (P-notes) and warrants to track an index. Statement III is correct because in a swap-based model, the ETF may hold a basket of securities that differs from the actual index components, using swaps to exchange performance.

Incorrect: Statement II is incorrect because leveraged and inverse ETFs are path-dependent; due to daily compounding, returns over periods longer than one day will likely differ from the simple multiple of the index return. Statement IV is incorrect because ETFs typically have lower management fees (less than 1%) compared to the 1-2% per annum usually charged by traditional unit trusts.

Takeaway: Synthetic ETFs use swaps or derivatives to track indices, but investors must understand that leveraged products are subject to path dependency and daily compounding effects. Therefore, statements I and III are correct.

Correct: The statement that a derivative is a delayed delivery agreement where the contract value is derived from an underlying asset without the holder owning that asset is correct. According to the M8A syllabus, a derivative’s value is dependent upon or derived from other underlying assets, and the holder does not own the underlying assets during the contract’s term.

Incorrect: The claim that a derivative provides immediate legal ownership is wrong because ownership only occurs if and when the contract is settled through physical delivery at a future date. The suggestion that a holder must physically possess the underlying asset at inception is wrong because derivatives are specifically used to manage risks or speculate on assets the party does not yet own. The idea that a holder collects dividends or interest directly from the underlying asset is wrong because the holder has no claim to the asset’s income streams since they do not own the asset itself.

Takeaway: A derivative is a delayed delivery agreement whose value is derived from an underlying asset, allowing for price exposure and risk management without immediate ownership of the asset.

Correct: The collateral might have been initially set below 100% of the exposure or its market value could have declined since it was pledged is the right answer because the source text explicitly identifies these two reasons for collateral risk. Specifically, it states that the value of collateral may be below the exposure if the exposure was not fully collateralized at the start or if the collateral’s value deteriorated over time.

Incorrect: The claim that the underlying index is always perfectly correlated with the collateral’s market price is wrong because the text notes that the basket of stocks held as collateral may not be correlated to the index. The statement regarding a regulatory requirement to maintain collateral at exactly 50% is wrong as no such specific percentage limit is mentioned in the text. The assertion that swap counterparties are legally prohibited from providing physical assets as collateral is wrong because the text describes the use of a basket of stocks as a common method for synthetic replication.

Takeaway: While collateral is used to mitigate counterparty risk in synthetic ETFs, investors remain exposed to potential shortfalls if the collateral is not 100% of the exposure or if its value declines.

Correct: Statement I is correct because the source text explicitly identifies expenses as a risk factor where fees and charges of the long/short portfolio may more than offset the paired performance, leading to negative returns. Statement II is correct because the secondary market level of ETFs is subject to stock exchange oversight, which specifically includes meeting disclosure requirements and following trading rules.

Incorrect: Statement III is incorrect because the source warns that in cash management, an investor may receive less than their initial capital after fees or suffer capital losses in a downtrend market. Statement IV is incorrect because fiduciary obligations of the trustee and fund manager apply at the primary market level, not the secondary market level.

Takeaway: Understanding the distinction between primary market fiduciary duties and secondary market exchange oversight, as well as the impact of internal expenses on swap returns, is essential for evaluating structured fund risks. Therefore, statements I and II are correct.

Correct: Statement II is correct because the source text states that some structured products contain covenants allowing for early termination if the size of the product becomes too small. Statement III is correct because if a derivative counterparty defaults or becomes insolvent, the issuer may be unable to meet its payment obligations, which triggers an early or mandatory redemption of the notes.

Incorrect: Statement I is incorrect because investor-initiated early redemption is not always permitted; it depends on the specific contract terms which may prohibit it entirely. Statement IV is incorrect because early redemption triggered by features like knock-out levels or callable bonds does not guarantee principal protection; instead, the structured product may suffer substantial losses upon such termination.

Takeaway: Early redemption of structured products can be triggered by investors, issuers, or specific asset features, and typically exposes the investor to market value adjustments or significant losses of principal. Therefore, statements II and III are correct.

Correct: Statement I is correct because futures are standardized instruments traded on exchanges, while forwards are non-standardized contracts traded over-the-counter (OTC). Statement IV is correct because under Free-On-Board (FOB) terms, the buyer is responsible for arranging and paying for transportation costs, which are added to the quote price.

Incorrect: Statement II is incorrect because the cost of carry is referred to as a premium when it is positive and a discount when it is negative, not the other way around. Statement III is incorrect because futures are subject to daily mark-to-market processes and margin requirements, whereas forward contracts typically settle gains or losses only on the delivery date.

Takeaway: While futures are standardized and exchange-traded with daily settlements, forwards are customizable OTC contracts where pricing is determined by the spot price plus the cost of carry. Therefore, statements I and IV are correct.

Correct: Statement I is correct because the source defines a derivative as a financial asset where the value is based on the performance of an underlying asset that the investor does not yet own. Statement II is correct because the text specifies that cash settlement is the only method available when the underlying is intangible, such as a stock index, where physical delivery is impossible.

Incorrect: Statement III is incorrect because the source states that only 2% to 5% of contracts are settled through physical delivery, not 20% to 25%. Statement IV is incorrect because the leverage effect inherent in derivatives typically results in a higher rate of return (or loss) on the invested amount compared to a direct investment in the underlying asset.

Takeaway: Derivatives allow for leveraged exposure to underlying assets and are most commonly settled through cash or offsetting positions rather than physical delivery. Therefore, statements I and II are correct.

Correct: Providing instant and cost-efficient diversification for the majority of the portfolio is the right answer because the core-satellite strategy utilizes ETFs as the core component to gain broad, diversified market exposure in a cost-effective manner, while the satellite portion is used for targeted outperformance.

Incorrect: The suggestion that the core component is used to generate significant alpha through specific security selection is wrong because that describes the role of the satellite investments, not the core ETFs. The claim that ETFs eliminate all market volatility through derivatives is incorrect as ETFs are subject to the volatility of their underlying assets and are often used to track, rather than eliminate, market movements. The idea that ETFs ensure the net asset value always matches the market price is wrong because market forces on the stock exchange can cause the trading price to deviate from the fund’s actual NAV.

Takeaway: In a core-satellite investment strategy, ETFs are typically used as the core to provide efficient diversification, while specific securities are used as satellites to seek higher returns.

Correct: The high watermark is a mechanism designed to ensure that a fund manager only earns performance fees after any previous losses have been fully recouped, meaning fees are only paid on new net profits.

Incorrect: The description of a minimum rate of return that must be exceeded refers to a hurdle rate, which is a different performance threshold. The requirement for managers to invest their own personal wealth is a practice used to align interests and mitigate risky behavior, but it is not the high watermark. Limiting the total amount of leverage relates to the fund’s investment flexibility and risk management strategies rather than the performance fee structure.

Takeaway: A high watermark protects investors by ensuring that performance-based fees are only paid when the fund’s value exceeds its previous peak, preventing fees on the recovery of past losses.

Correct: Statement I is correct because the variation margin is defined as the specific amount required to restore the margin account to the initial margin level once the maintenance margin threshold is breached. Statement IV is correct because hedgers prioritize price protection and certainty over the potential to profit from favorable market price fluctuations, effectively locking in their costs or revenues.

Incorrect: Statement II is incorrect because a margin call is only triggered when the account balance falls below the maintenance margin level; if the balance is below the initial margin but above the maintenance level, no call is made. Statement III is incorrect because the description of producers and consumers using futures to lock in prices for physical delivery defines hedgers, whereas speculators seek to profit from price volatility and provide liquidity.

Takeaway: Margin accounts require restoration to the initial level when maintenance thresholds are breached, and market participants are categorized by whether they seek to mitigate risk (hedgers) or profit from it (speculators). Therefore, statements I and IV are correct.

Correct: Utilizing leverage and investing in sub-investment grade debt are defining features of guaranteed hedge funds. According to the syllabus, these funds can achieve exposures over 100% of capital (e.g., 140%) and seek higher yields through lower-quality bonds compared to retail guaranteed funds.

Incorrect: The suggestion that these funds hold a higher percentage of bonds is incorrect; they usually hold 80% or less, while retail funds may hold up to 90%. The idea that they offer short-term liquidity is false, as they typically have 5-to-10-year maturities and early redemption after two years leads to capital losses. The claim that derivative costs are eliminated is wrong because the guarantee involves significant direct costs, including call options and administrative fees.

Takeaway: Guaranteed hedge funds distinguish themselves from retail versions through the use of leverage and a higher tolerance for credit risk in their fixed-income component.

Correct: The market is in backwardation and the difference is known as the basis is the right answer because the source text defines backwardation as a situation where the futures price is lower than the spot price, often caused by temporary shortages. It also explicitly defines the basis as the difference between the spot price and the futures price.

Incorrect: The options mentioning contango are wrong because contango refers to a market state where the futures price is higher than the spot price, which contradicts the scenario provided. The option mentioning margin is wrong because margin refers to the cash outlay or collateral required to maintain a position, not the price difference. The option mentioning spread is wrong because the specific terminology used in the text to describe the difference between spot and futures prices is the basis.

Takeaway: In futures markets, the basis represents the gap between spot and futures prices, while backwardation describes the specific condition where spot prices exceed futures prices.

Correct: Statement I is correct because relative value strategies seek to reduce market risk by taking offsetting positions in related securities to profit regardless of market direction. Statement II is correct because long/short equity strategies involve taking positions based on expected price movements rather than specifically hedging related stocks as in relative value strategies.

Incorrect: Statement III is incorrect because Global Macro funds profit from shifts in global economies and government policies, whereas focusing on corporate actions like mergers is the hallmark of Event-driven strategies. Statement IV is incorrect because short-sell funds are described as among the riskier funds due to the potential for unlimited risk, even though they can serve as a hedging tool in a portfolio context.

Takeaway: Hedge funds utilize diverse strategies ranging from market-neutral relative value to high-risk short-selling, requiring investors to understand the specific mechanics and risks of each approach. Therefore, statements I and II are correct.

Correct: Monitoring the credit quality of the investment bank and the diversification of debt securities is essential because the guarantee’s value depends on the provider’s ability to pay. If the debt securities are issued by the same entity providing the guarantee, the fund faces significant concentration risk, reducing the effective protection.

Incorrect: The option regarding historical performance and fee layers focuses on costs and returns rather than the structural integrity of the guarantee itself. The option concerning conversion ratios and stock prices describes the mechanics of a convertible arbitrage strategy, which is distinct from evaluating a third-party guarantee. The option about short position volatility and rebalancing frequency addresses market risk management within a strategy rather than the creditworthiness of the guarantor.

Takeaway: The strength of a guaranteed fund is limited by the credit risk of the guarantor and the diversification of the assets used to back that guarantee.

Correct: The fund is exposed to the risk that the swap provider may default on its contractual obligations to the fund is the right answer because structured ETFs using synthetic replication rely on derivative contracts, which introduces the risk that the counterparty fails to perform.

Incorrect: The claim regarding tracking accuracy is wrong because synthetic ETFs often achieve lower tracking error than physical ETFs by avoiding the costs of buying and selling individual securities. The statement about holding physical securities is incorrect because synthetic replication specifically uses derivatives instead of owning the underlying assets. The assertion that collateral is prohibited is wrong because regulatory frameworks generally require or permit collateral to be held to reduce counterparty risk.

Takeaway: A key distinction of structured ETFs using synthetic replication is the presence of counterparty risk, which arises from the fund’s reliance on a third party to deliver the index return.

Correct: The gains from the stock portfolio will likely be offset by the losses incurred on the short futures position is the right answer because a short hedge involves selling futures to protect a long position; when the market rises, the value of the physical stocks increases while the short futures position loses value, resulting in a neutral net position.

Incorrect: The suggestion that portfolio losses are offset by futures gains is incorrect because it describes the outcome of a market decline, not a market rise. The claim that futures gains will exceed portfolio losses is wrong because a hedge is designed to neutralize price movements rather than provide speculative profit. The assertion that losses are limited to a premium is incorrect because futures contracts carry unlimited downside risk, unlike options which have limited risk.

Takeaway: Short hedging with futures aims to eliminate both downside risk and upside potential by creating offsetting positions in the cash and futures markets.

Correct: The statement regarding obligation is correct because the holder of a futures or forward contract is contractually bound to fulfill the terms on the settlement date. In contrast, options and warrants grant the holder the right to buy or sell but do not impose a legal obligation to do so, allowing the holder to let out-of-the-money contracts expire.

Incorrect: The statement about physical delivery is incorrect because stock indices are intangible assets and are settled in cash rather than through the delivery of individual stocks. The statement regarding exercise timing is incorrect because it describes the difference between American and European exercise styles rather than the fundamental distinction between futures and options. The statement about guaranteed profits is incorrect because futures contracts involve leverage and market risk, which can lead to significant losses if the market moves against the position.

Takeaway: The primary distinction between futures and options lies in the obligation to perform; futures holders must settle the contract, while option holders have the discretion to exercise their rights.

Correct: Statement I is correct because the payoff of an Asian option is specifically defined as being based on the average price of the underlying asset over a preset period, rather than the price at maturity. Statement III is correct because a chooser option grants the investor the right to select whether the instrument functions as a call or a put option by a predetermined date.

Incorrect: Statement II is incorrect because while a forward-start option becomes effective at a future date, the premium for the contract is actually paid today, not at the future effective date. Statement IV is incorrect because binary options pay a fixed, predetermined amount or nothing at all, whereas the payoff based on the difference between the strike and spot price describes a standard plain vanilla option.

Takeaway: Exotic options differ from plain vanilla options by incorporating specific conditions or triggers, such as averaging prices or allowing choices, which adds complexity to their valuation and payoff structures. Therefore, statements I and III are correct.

Correct: Writing a covered call provides a premium that acts as immediate income and offsets losses if the stock price falls. However, if the stock price rises above the strike price, the investor must deliver the shares, meaning their profit is capped at the strike price plus the premium received.

Incorrect: The claim about unlimited upside and reduced capital describes a long call strategy, which utilizes leverage to maximize gains. The idea that it guarantees no loss if the stock falls to zero is false; the premium only provides a small buffer (such as S$100 offsetting a S$400 loss), leaving the investor exposed to significant downside. Describing it as an aggressive strategy for massive surges is incorrect because the strategy specifically limits gains during price increases, making it a conservative approach.

Takeaway: A covered call is a conservative strategy that generates income and reduces risk by capping the investor’s potential for profit in exchange for an upfront premium.

Correct: High brokerage fees and the failure of brokers to pay interest on short sale proceeds are the primary reasons because the text specifically identifies these as factors that erode the narrow profit margins of arbitrage for small investors. Additionally, the text notes that timing is critical, and delays can turn potential gains into losses.

Incorrect: The claim that the strategy is high-risk is wrong because the text describes convertible bond arbitrage as low-risk, which makes leverage an attractive option for investors. The mention of regulatory prohibitions on merger transactions is wrong because the text focuses on market and cost-based barriers rather than legal restrictions. The idea that positions must be held to maturity is wrong because the strategy is designed to profit from price fluctuations and spreads before the bond matures.

Takeaway: Individual investors face significant hurdles in arbitrage strategies due to high transaction costs and the critical need for rapid trade execution.

Correct: The risk that the announced merger or acquisition transaction fails to complete is the right answer because the strategy relies on the deal closing to capture the spread; if the deal “breaks,” the target company’s stock price typically falls back to its pre-announcement level or lower, resulting in a significant loss.

Incorrect: The risk of a sudden market downturn is wrong because the text states that merger arbitrage returns are largely uncorrelated to the overall movement of the stock market. The risk of the acquirer’s stock price rising is wrong because, although it impacts the short position, the primary variable and most significant risk identified in the text is the transaction falling through. The risk of the target price remaining flat is wrong because a stable price near the offer level is the intended outcome for the arbitrageur to realize a profit.

Takeaway: The primary risk in a merger arbitrage strategy is the “deal break” risk, where the failure of a transaction to complete causes the target company’s stock price to drop sharply.

Correct: Purchasing a put option on the stock already held to create a protective put position allows an investor to eliminate downside risk while maintaining exposure to unlimited upside. According to the Singapore Module 8A syllabus on Collective Investment Schemes, this strategy is considered conservative because the put option acts as insurance, ensuring the investor can sell the stock at the strike price even if the market price falls significantly, effectively creating a profit pattern similar to a long call.

Incorrect: Writing a call option against the existing stock position is wrong because it creates a covered call, which caps the maximum profit at the strike price plus premium, thereby failing to meet the investor’s objective of retaining unlimited gains. Selling a naked put is wrong because it is a strategy used to acquire stock at a discount and does not provide any protection for existing holdings; instead, it increases the investor’s total downside exposure. Liquidating the stock position and buying a call option is wrong because it involves selling the underlying asset rather than hedging the current shares, which changes the fundamental nature of the investment.

Takeaway: A protective put is a conservative strategy that combines a long stock position with a long put to eliminate downside risk while maintaining exposure to unlimited upside gains.

Correct: Statement I is correct because as illustrated in the text, the net cost for a naked put seller is the exercise price minus the premium received (S$10 – S$1 = S$9). Statement II is correct because the maximum risk for a long put is limited to the premium paid, whereas shorting a stock involves potentially unlimited losses if the price rises.

Incorrect: Statement III is incorrect because a naked call seller faces unlimited downside risk and their profit is strictly limited to the premium received. Statement IV is incorrect because if the stock price rises above the exercise price, the put buyer will not exercise the right to sell, meaning the seller is not required to purchase the stock.

Takeaway: While long options strategies limit risk to the premium paid, naked selling strategies involve limited profit potential and significant or unlimited risk exposure. Therefore, statements I and II are correct.