Chapter 2 – Futures

1. There are certain risks involved in hedging in the forward or futures market. Which of the
following is TRUE?

a. Futures contracts have lower counterparty risk, while forward contracts carry the
credit risk of the counterparty.
b. Futures contracts have basis risk, whereas forward contracts do not.
c. Forward contracts have the risk of the exchange.
d. Forward contracts have interim partial settlements.

2. Advantages of futures contract over OTC instruments include:

a. More transparency in pricing.
b. Market liquidity.
c. Reduced credit risk.
d. Increased credit risk.

▪ (a) and (c).

▪ (b) and (c).
▪ (a), (b) and (c).
▪ (a), (b) and (d).

3. What is the economic importance and impact of the Futures Market?

a. Futures are not standardized contracts therefore not readily available.

b. Futures market is both a less active and important source of vital market information.
c. Participants can use contracts to leverage on long or short positions.
d. Participants cannot use contracts to leverage on long positions.

4. Spot GBP/USD is trading at 1.2422. Given the annualised US interest rates at 1.799 and
annualised British interest rates at 0.70444. What should be the theoretical price for a 1-year
forward contract?

a. 1.2557.
b. 1.2487.
c. 3.1743.
d. 0.9989.

5. What are the factors affecting basis in the market of a futures contract?

a. Cost / return of Carry.

b. Non-difference in coupons between fixed income instruments.
c. Market rates versus administrated rates.
d. Yield curve changes.
▪ (a) and (d).
▪ (a), (c) and (d).
▪ (a), (b) and (c).
▪ (b) and (c).

Chapter 3 – Futures Strategies

6. Using bond futures to hedge a bond portfolio is more complicated because in the case of US
T-bonds futures, there are certain options embedded for the sellers and these include delivery
timing and choice of deliverable bonds. As a result, we would expect that the futures pricing is
__________ than the implied by the cash and carry arbitrage.

a. Lower.
b. Higher.
c. Same.
d. Not enough information provided.

7. Which are the main investment and trading strategies used in the futures market?

a. Outright trades.
b. Hedging.
c. Spread trades.
d. Bid trades.

▪ (a), (b) and (c).

▪ (b), (c) and (d).
▪ (a), (c) and (d).
▪ (a), (b), (c) and (d).

8. A local company wishes to take a 6-month USD 50 million loan and the prevailing the
6-month USD lending rate is 2.15%. The September Eurodollar futures contract is trading at
98.15. At the time of entering the hedge, the price of September Eurodollar futures is 98.65.

Assuming that the interest rate on the loan is correlated one to one with the Eurodollar, and the
company intends to fully hedge its interest rate exposure using September futures. Calculate
the number of contracts that will be needed to execute the hedge.

a. 25.
b. 50.
c. 100.
d. 150.
9. Calculate the hedge ratio required to hedge the interest rate on a 6-month loan for USD 100
million. Assume that the interest rate on the loan is correlated one-to-one with the Eurodollar
rate of the nearest 90-day Eurodollar futures contract. Assume a stack hedge is employed.

a. 200.
b. 20.
c. 2.
d. 0.2.

10. A player in the financial markets who sells contracts to manage his cash market exposure
while holding the underlying stock is a/an:

a. Arbitrageur.
b. Hedger.
c. Market maker.
d. Speculator.

Chapter 4 – Options
11. There are positive relationships between the value of a call option and __________.

a. Interest rates.
b. Time to expiration of the call option.
c. Dividend rate of the underlying stock.
d. Volatility of the underlying stock.

▪ (a) and (c).

▪ (a) and (b).
▪ (a), (c) and (d).
▪ (a), (b) and (d).

12. The exercise price of a call option is $50. The price of the call is $6, and it expires in 3
months. The current share price is $54. What is the intrinsic value?

a. $50.
b. $4.
c. $54.
d. $6.

13. Which of the following statement is TRUE about Theta and Vega?

a. Theta measures the change in asset price with respect to time while Vega measures the
volatility of the option’s portfolio.
b. Vega measures the change in asset price with respect to time while Theta measures the
volatility of the option’s portfolio.
c. Vega is positive for long calls and short puts.
d. Vega is positive for a long volatility investment position with call or put options.

14. Which of the following statements about zero cost options are TRUE?

a. Since the option is zero cost, it is possible to buy as much as possible to take advantage of
its zero-cost structure without having to worry about the risk associated with it.
b. Zero cost structures give unlimited profits and limited losses.
c. A zero-cost collar is defined as buying a protective put and selling an out-of-the-money
covered call.
d. A zero cost (costless collar) option is sold with a strike price where the premium received is
equal to the premium paid for the put purchased.

▪ (b) and (c).

▪ (a) and (d).
▪ (a) and (c).
▪ (c) and (d).

15. A trader buys a Nikkei 225 futures contract at 10,000, a put struck at 9500 (premium is 200)
and sells a call struck at 10500 (premium is 190). What is the synthetic position created by the
trader?

a. Bull spread.
b. Bear spread.
c. Ratio put spread.
d. Short call.

Chapter 5 – Structured Warrants and Daily Leveraged Certificates

16. Which of the following will increase the value of both a call option and a put option?

a. Increase in the exercise price.

b. Increase in volatility.
c. Increase in interest rates.
d. Decrease in time to maturity.

17. The warrant premium is affected by:

a. The length of time before expiration date.

b. The size of the cash dividends paid on the underlying share.
c. The intrinsic value of the warrant.
d. The credibility of the individual buyer.
▪ (a), (b) and (d).
▪ (a), (b) and (c).
▪ (b), (c) and (d).
▪ (a), (b), (c) and (d).

18. A call warrant with an exercise price of $1.00 is trading at $1.20. One warrant converts to
one share. What is its conversion price?

a. $1.00.
b. $1.20.
c. $2.20.
d. $0.20.

19. The warrant is trading at $0.40. The exercise price is $0.80. The share price is $2.40. What
is its gearing? (Assume that the warrant is company-issued; in practice they all have a
conversion ratio of 1, unless otherwise stated.)

a. 2X.
b. 6X.
c. 3X.
d. 5X.

20. Company A’s warrant is trading at $0.35; its exercise price is $0.50 while the share price is
$0.65. What is its intrinsic value?

a. $0.80.
b. $0.15.
c. $0.30.
d. $1.00.

21. The market price of Company B's common share is $5 and the exercise price of the warrant
is $3.50. Two warrants can be converted into one common share. The warrant price is currently
trading at $2. What is the warrant premium?

a. 10%.
b. 50%.
c. 57%.
d. 100%.

Chapter 6 – Barrier Options, Binary Options and Callable Contracts

22. For a single “knock out”, up-and-out call barrier option, the barrier level is:

a. Below the current spot price of the asset.

b. Equal to the current spot price of the asset.
c. Equal to the strike price.
d. Above the current spot price of the asset.

23. Which of the following statements are CORRECT?

a. For a Category-N callable bull/bear contracts (CBBC), there is no residual value when a
mandatory call event occurs
b. For a Category-R CBBCs, there is always a positive residual value when a mandatory call
event occurs
c. The Category-N CBBC call price is always equal to the strike price
d. The Category-R CBBC call price is always different from the strike price

▪ (a), (b) and (c).

▪ (b), (c) and (d).
▪ (a), (c) and (d).
▪ (a), (b) and (d).

24. In a double “knock-out” barrier option, the barrier levels ________________.

a. For both barriers are higher than the strike price for a call option.
b. For both barriers are lower than the strike price for a call option.
c. Will vary as there will be two strike prices with one barrier level for each strike price.
d. Will vary as there will be one barrier level above the strike price and another barrier level
below the strike price.

25. All the following are common features of callable bull/bear contracts (CBBC) and structured
warrants except one. Which characteristic is TRUE for CBBC products but NOT for structured
warrants?

a. Call price specified.

b. Fixed maturity period.
c. No margin requirement.
d. Traded on an exchange.

26. What are the DISADVANTAGES of barrier options?

a. Low risk of loss of premium if barrier conditions are breached.

b. High risk of loss of premium if barrier conditions are breached
c. Investor is exposed to counterparty risk on the issuer which arises when dealing in OTC
products.
d. Barrier options are not over-the-counter (OTC) products which investor do not pay option
premium.

▪ (a) and (c).

▪ (b) and (c).
▪ (c) and (d).
▪ (b) and (d).

Chapter 7 – Structured Deposits and Other Structured Products

27. What should investment professionals consider when helping clients invest in structured
products?

a. Risk appetite.
b. Investment experience and knowledge.
c. Investment horizon.
d. Liquidity needs.

▪ (a), (b) and (c).

▪ (a), (c) and (d).
▪ (b), (c) and (d).
▪ (a), (b), (c) and (d).

28. What would be the purposes and uses of OTC Structured Products?

a. Structured products can be customized to meet needs that cannot be fulfilled by standard
traditional investments.
b. Structured products provide optimization of yield and returns.
c. Structured products are an alternative rebalancing investment to the direct purchase of the
underlying asset.
d. Structured products allow clients to gain leveraged exposure that can potentially augment
gains using a smaller investment outlay.

▪ (a), (b) and (c).

▪ (a), (b), (c) and (d).
▪ (b), (c) and (d).
▪ (a), (c) and (d).

29. Which of the following are structured products?

a. Accumulators.
b. Callable range accrual notes.
c. Step-up digital options.
d. Equity linked notes.

▪ (a), (c) and (d).

▪ (b), (c) and (d).
▪ (a), (b), (c) and (d).
▪ (a), (b) and (d).
30. Which of the following instruments can be used as the principal component of a structured
note?

a. AAA rated bond.

b. Common shares.
c. Range accrual deposit.
d. Zero-coupon or corporate bonds.

▪ (a), (c) and (d).

▪ (b), (c) and (d).
▪ (a) and (d).
▪ (b) and (c).

31. A structured product offered a minimum 100% return of capital at the end of the investment
term, plus 80% of any rise in the FTSE100 index. If the index rose by 40% over the period than
the investor would receive back his initial capital in full plus an additional return of 32%. What is
the participation rate?

a. 32%.
b. 104%.
c. 80%.
d. 100%.

Chapter 8 – Structured Notes

32. The underlying instruments of a structured note could include products that are related to
movements of ___________.

a. Interest rates.
b. Equities.
c. Indices.
d. Maturity dates.

▪ (a), (b) and (c).

▪ (b), (c) and (d).
▪ (a), (c) and (d).
▪ (a), (b), (c) and (d).

33. A range accrual note is a structured note where a client receives a higher return if:

a. The reference index is within a certain range.

b. The reference index is beyond a certain range.
c. The coupon rate is within certain range.
d. The coupon rate is beyond certain range.
34. Which structured note would typically be structured with a principal preservation feature?

a. Range accrual note.

b. Dual currency investment.
c. Inverse floater note.
d. Exchange-traded note.

35. Which of the following statements describe a structured note?

a. A structured note is a debt instrument, whose return characteristics are linked to the
performance
of other underlying instruments.
b. A structured note is governed under the Securities and Futures Act.
c. A structured note has return characteristics that are not linked to the performance of other
underlying instruments.
d. A structured note is governed by the Guidelines of Outsourcing.

▪ (a) and (d).

▪ (b) and (d)
▪ (a), (b) and (c).
▪ (a) and (b).

36. Investors buy structured notes mainly because they want yield enhancement and market
access. Which of the following factors should an investor consider before investing?

a. Own liquidity needs.

b. Terms and condition of the structured note.
c. Fees and charges of the structured note.
d. Risk and return.

▪ (a), (c) and (d).

▪ (a), (b) and (c).
▪ (b), (c) and (d).
▪ (a), (b), (c) and (d).

Chapter 9 – Structured Funds

37. Which of the following statements are TRUE about structured funds?

a. A combination of equity and fixed income securities and/or derivatives, which achieve specific
risk-return profiles or cost savings.
b. Structured funds range from simple to highly complex funds and cover a wide range of risk
exposures.
c. Structured funds offer some capital preservation and are not designed to earn a market linked
return.
d. Structured funds are not governed by the Code on Collective Investment Schemes under the
Securities and Futures Act.

▪ (a) and (b).

▪ (b), (c) and (d).
▪ (a), (b) and (d).
▪ (a), (b), (c) and (d).

38. A Structured Fund combines both ________ and ________ to provide investors with a
degree of both capital preservation and capital appreciation.

a. Fixed income products; derivatives.

b. Fixed income products, equity products.
c. Alternative assets; derivatives.
d. Commodities; equity products.

39. Which of the following parameters can be used to judge the performance of any fund?

a. Sharpe ratio.
b. Total expense ratio (TER).
c. Underlying asset.
d. Share class.

▪ (a) and (b).

▪ (a), (c) and (d).
▪ (a), (b) and (c).
▪ (a), (b), (c) and (d).

40. What is the ADVANTAGE of investing in a structured fund using the constant proportion
portfolio insurance (CPPI) strategy?

a. It has a capital preservation feature.

b. In a range bond market, the manager would be able to buy low and sell high.
c. It has lower fees as compared to a direct investment in the underlying asset.
d. It may not have a 100% exposure to the underlying asset in day one.

Chapter 10 - Contracts for Differences (CFDs)

41. If an investor has a negative view on a stock and believes the stock price will fall. What
products will allow him to profit from this view?

a. Callable bull/bear contracts or CFDs only.

b. CFDs or options only.
c. Options or callable bull/bear contracts only.
d. CFDs, options or callable bull/bear contracts.

42. Which statement regarding CFDs and equity futures is INCORRECT?

a. CFDs have counterparty risk but equity futures do not.

b. CFDs can be extended by the investor for as long as the investor wishes but equity futures
have a fixed maturity date.
c. CFDs have implicit financing cost as part of its price whereas the financing cost for equity
futures is explicitly computed.
d. CFDs are entitled to dividends and equity futures have no dividend entitlements.

43. What are terms of a CFD?

a. Underlying asset.
b. Price of the underlying asset.
c. Number of units of the underlying asset specified in the contract.
d. Volatility of the currency

▪ (a), (b) and (d).

▪ (a) and (d).
▪ (b), (c) and (d).
▪ (a), (b) and (c).

44. An investor using a CFD trading strategy involving dividend capture should look for
companies ______________.

a. That are start-ups and early growth stage.

b. That do stock splits and issue scrip dividends regularly.
c. That have strong earnings and a high payout ratio.
d. Whose price performance is strongly driven by macroeconomic factors.

45. Which of the following statements about CFDs and futures contract is TRUE?

a. CFDs are mostly traded OTC whereas equity futures are traded on exchanges.
b. Both CFDs and equity futures have counterparty risk.
c. Both CFDs and equity futures are entitled to dividends.
d. CFDs have margin and leverage whereas equity futures have no margin and leverage.

Chapter 11 – Key Products and Investment Risks for Derivatives and Structured Products
46. Trading in a CFD in an international stock outside the investor’s home country has:

a. No financing cost.
b. No leverage risk.
c. Market risk.
d. Credit risk.

▪ (a) and (c)

▪ (b) and (d).
▪ (c) and (d).
▪ (a) and (b).

47. Which of the following types of credit default are classified under the International Swaps
and Derivatives Association?

a. Restructuring.
b. Failure to pay.
c. Obligation acceleration.
d. Obligation deceleration.

▪ (a), (b) and (c).

▪ (b) and (c).
▪ (a) and (d).
▪ (a), (b) and (d).

48. Which of the following factors contribute to Basis Risk?

a. The asset, whose price is to be hedged, may not be exactly the same as the asset underlying
the futures contract.
b. The hedger may be uncertain about the exact date when the asset will be bought.
c. The hedge may require the futures contract to be closed out well before its expiration date.
d. The size and unit of measurement of futures contracts may not correspond with the size of
the underlying hedged position.

▪ (a), (b) and (d).

▪ (a), (c) and (d).
▪ (b), (c) and (d).
▪ (a), (b), (c) and (d).

49. What are the key risks involved in investing in structured products?

a. Market risk.
b. Liquidity risk.
c. Reinvestment risk.
d. Currency risk.

▪ (a) and (b).

▪ (a), (b), (c) and (d).
▪ (b) and (c).
▪ (a) and (c).

50. Market risk will be affected by:

a. Macroeconomic factors such as interest rates or inflation rates.

b. Volatility in currency rates.
c. Political factors such as government instability.
d. The sudden departure of the CEO of a large corporation.

▪ (a), (b) and (c).

▪ (b), (c) and (d).
▪ (a), (c) and (d).
▪ (a), (b), (c) and (d).

Chapter 12: Case Studies

Case Study 12.1 Enhanced Yield with Currency Investments
Mrs Goh is a high net worth individual who has most of her investments in three currencies
(USD, GBP and SGD).

Assume that it is 26 September 2017. Mrs Goh has observed that the USD has weakened
against most currencies this year, and that the USD has fallen by more than 6% against the
SGD. She would like to get a higher yield on her USD deposits to offset some of the exchange
rate loss. She is hoping for a quick rebound in USD in the short term but believes that the USD
will weaken against SGD and GBP over the longer term. She would have no problem if some of
her USD deposits are converted to SGD or GBP.

Mrs Goh would like to keep her currency deposits as investments in currency. She is tired of the
low deposit rates and is looking to generate a higher yield on her currency investment. She is
looking at a dual currency investment (DCI) using either the USD/SGD and GBP/USD currency
pair. Details shown below:

In this case, although Mrs Goh is a Singaporean, she will be using USD as the base currency
for her investments for both currency pairs. The bank will usually structure conversion to the
weakening currency. So, if the USD weakens against both, there is no conversion. Hence you
will note that the strike prices are set in such a way that they will take effect on weakening from
the current spot rates to the strike price level.

Assume that Mrs Goh invests in the 11% USD/SGD 3-month DCI with an initial investment of
USD 1 million from her USD account. Suppose the details of the DCI are
Question 1
How much SGD will Mrs Goh receive if the spot rate at expiry is 1.3300?

a. SGD 990,271.74.
b. SGD 1,000,000.00.
c. SGD 1,027,500.00.
d. SGD 1,366,575.00.

Question 2
Assume the spot rate at expiry is 1.38. How much USD will be in Mrs Goh’s account?

a. USD 1,380,000.00.
b. USD 1,120,000.00.
c. USD 1,300,000.00.
d. USD 1,027,500.00.

Question 3
Since Mrs Goh does not mind receiving SGD, how much SGD will be in her account if the spot
rate at expiry is 1.41?

a. SGD 1,438,500.00.
b. SGD 1,027,500.00.
c. SGD 1,417,950.00.
d. SGD 1,448,775.00.

Let’s review the same situation from the side of the bank, which is often not visible to the client.

From various exchanges we can get a 3-month quote on the USD put price for 3 months at
1.3800. Suppose we find out the 3-month USD call/SGD put struck at 1.3800 can be sold at the
price of 0.0250.
Question 4

Should the bank offer the USD/SGD DCI to Mrs Goh?

a. Yes, because the contract delivers a 2.86% return over the 3-month period to the client.
b. Yes, because the contract yields an annualized return that is higher than the annual interest
of 11% offered by the bank to the client.
c. No, because the contract delivers a yield that is higher than the 1.1258% SGD 3-month
interest that the bank can obtain from the market.
d. No, because the contract delivers a yield that is higher than the 1.3919% USD 3-month
interest that the bank can obtain from the market.

Case Study 12.2 Taking Advantage of Short-Term Downside Volatility

It is the 3rd quarter of 20X1. The markets are uncertain if the Federal Reserve will start rapidly
raising interest rates to fight inflation. Your client, Brian, believes that global equities will be sold
off ahead of the upcoming December FOMC meeting. The market seems poised for a
correction, but longer-term fundamentals point towards more room for the equities market to rise
in 20X2. Brian is convinced that the markets will adopt a risk-off approach for the next 2 months
and safe haven asset classes will dominate. He wants to take advantage of the increased
volatility in the markets.

Brian is an aggressive investor and risk-taker, who would like to “bet” on a major correction of
the U.S. market and possibly global markets within the next 2 months. Brian is asking for ideas
to take advantage of the likely developments.

Assume that Mrs Goh believes that the GBP/USD exchange rate will weaken i.e., the USD will
strengthen against the GBP in the near term (quick rebound expected).

She has decided to invest in a standard GBP/USD DCI with the following details:
Question 5

How much USD will be in Mrs Goh’s account if the spot rate at expiry is 1.2800?

a. USD 1,000,000.00.
b. USD 1,009,230.76.
c. USD 1,025,000.00.
d. USD 1,032,230.77.

Question 6

What will be the annualized return for Mrs Goh if the spot rate at expiry is 1.26?

a. 1.62%.
b. 1.39%.
c. 2.62%.
d. -2.62%.

Question 1
As Brian’s advisor, which of the following actions should you check and confirm before you
execute any trades on his behalf? (Select all options that apply)
a. Brian’s understanding of the risk of each of the investment instruments. b. Potential changes
in internal limits as market conditions change.
c. Brian’s positions with other financial services institutions.
d. Brian’s willingness to trade at his maximum leverage levels.

Question 2

Which of the following can help to mitigate or manage Brian’s risk? (Select all options that apply)

a. Limits and buffers.

b. Margins.
c. Shorting the VIX futures exchange-traded fund (ETF).
d. Educating the client.

Question 3

Which of the following possible strategies would be appropriate for Brian? (Select all options
that apply)

a. Long a put option.

b. Short a futures contract.
c. Short a leveraged inverse Daily Leveraged Certificate (DLC) contract.
d. Short a volatility futures ETF.

Case Study 12.3 Portfolio Protection

Assume it is now 22 September 2017. A portfolio manager, William, has benefited from
investing in a few blue-chip shares in Singapore. He owns Capital Land, DBS and OCBC
shares.

William does not foresee a major correction but would like to protect the remainder of his
portfolio against anything more than a 7% decline. He thinks that current markets valuations are
slightly overstretched in the near term and will be susceptible to corrections. He would like to
keep the rest of these stocks for the longer term since they are blue chips but at the same time,
he would like to reduce downside risk for the portfolio and hopefully get some additional yield.

The year-to-date performance of the portfolio of stocks is shown in Table 12.3.

Assuming a 7% decrease in stock prices, the stock prices would be as follows: DBS $19.17,
OCBC $10.37, and Capital Land $3.36. The two structured warrants that would have the
possibility of being in-the-money are (B) DBS MB EPW171204 and (D) OCBC BK MB
EPW180301. We want to pick the warrants with put exercise prices that are closest to current
prices. Furthermore, both structured warrants selected will give some protection for about 2
months until early December.

William could also wait until another favourable set of structured warrants is issued in the next
few months to establish a proper hedge to cover the rest of the year until January (i.e.;
assuming issuers / market makers of structured warranted offer attractive enough pricing and
strike price levels for the warrants).

Question 1
Which combination provides more price protection?
a. A, B and C.
b. A, C and E.
c. B, D and E.
d. C, D and E.
Question 2

Which combination provides more time protection?

a. A and D only.
b. A, D and E.
c. B, C and E.
d. A, B, C and D.

Question 3
Which of the following offers protection for William’s portfolio? (Select all options that apply)

a. Short MSCI SG Futures.

b. Buy an equity linked note (ELN).
c. Buy a tailored put option on the OTC market.
d. Lend the shares and get interest.

Question 4

Which of the following portfolio protection strategy is accompanied by immediate settlement

obligations?

a. Short MSCI SG Futures.

b. Tailored long put, OTC.
c. Lend the shares and get interest.
d. Tailored short call, OTC.

Case Study 12.4 ELNs Offering Yield and Buying Blue Chips at a Discount
Your client, Mr Sunjoyo, is interested in accumulating more OCBC shares. However, the market
has already risen significantly and many blue-chip stocks in Singapore enjoyed double-digit
growth over the last 12 months. Mr Sunjoyo wants to acquire more OCBC shares around 12.50
but is waiting for a major market pull-back to accumulate the shares.

The current price of OCBC shares is SGD 13.30 and Mr Sunjoyo is interested in accumulating
OCBC shares. Table 12.4.1 sets out the feature of the Equity-Linked Note structure for Mr
Sunjoyo.
Question 1

If OCBC’s share price at expiry of the ELN is SGD 12.40, what would be Mr Sunjoyo’s
annualized return/yield?

a. 0.00%.
b. 10.66%.
c. 7.16%.
d. - 6.01%.

Question 2

What is Mr Sunjoyo’s annualised return / yield if the share price is SGD 12 at expiry?

a. 12.18%.
b. 7.16%.
c. - 6.29%.
d. 1.54%.

Question 3

What is the break-even price level for Mr Sunjoyo for the ELN? (Answer is to be rounded to the
nearest 2 decimal places)

a. SGD 12.50.
b. SGD 13.30.
c. SGD 13.48.
d. SGD 12.19.
Case Study 12.5 More Yield in Quiet Currency Markets with Some Degree of Capital
Preservation
Your client, Robert, believes that the AUD/USD will be range bound for the next 3 months
between AUD/USD 0.7600-0.8200. He was offered the following Double No-Touch structure to
secure a higher yield. Robert has USD 2 million to invest.

In this range accrual, as long as the currency AUD/USD stays within the range of
0.7600-0.8200, the bank will pay 6% for the days the currency is within range. If the exchange
rate falls outside the range i.e., below 0.7600 or above 0.8200, Robert will only receive 1% p.a.
for this period.

Question 1
What will be the annualized yield if the exchange rate stays within the range for 2 months?

a. 2.67%.
b. 4.32%.
c. 6.00%.
d. 1.00%.

Question 2

What strategies can help you offer Robert a cheaper structure or a higher maximum yield?
(Select all options that apply)

a. Widen the range.

b. Skew the range to either side.
c. Reduce the minimum yield requirement.
d. Reduce the maturity period.

Question 3

Assume that Robert was wrong in his prediction and the currency AUD/USD stays outside the
range at expiry. How much would he receive from the bank?

a. 2.67%.
b. 4.33%.
c. 6.00%.
d. 1.00%.

Case Study 12.6 Equity Accumulator

Your client, Harry, received a proposal to buy an accumulator on ABC Ltd (ABC), a blue-chip
stock which he is comfortable owning. There are mixed equities research views about ABC, and
you do not think that this is a good stock because you see a structural change in the industry
that might cause ABC’s stock price to fall. Harry points out that the offer looks interesting
because the accumulation of the strike price over time is at a 10% discount from its current
price.

Discuss the risks and features of the accumulator with Harry.

Question 1

Assume that ABC share price stays above the strike price for 12 days but on trading day 13, the
closing price reaches the knock-out barrier. How many shares will be delivered to Harry on the
settlement month?

a. 230,000 shares.
b. 130,000 shares.
c. 120,000 shares.
d. 220,000 shares.

Question 2

Assume that ABC share price stays above the strike price for 20 days in the 1st month. In the
2nd month, ABC share price stays above the strike price but closes at the knock-out barrier on
trading day 13.
What is the total cost of the accumulated shares?

a. SGD 320,000.
b. SGD 330,000.
c. SGD 299,000.
d. SGD 130,000.

Question 3

What is Harry’s gain at the settlement day?

a. SGD 96,000.
b. SGD 156,000.
c. SGD 46,000.
d. SGD 196,000.

Case Study 12.7 Taking Advantage of Volatility in the Commodities Market

You have an accredited investor, Brandon, who is interested in trading gold, silver and the USD
because of the upcoming volatility expected over the next few weeks.

Gold prices corrected when the U.S. Federal Reserve (Feds) first indicated that it would start
reducing its balance sheet by reducing new U.S. Treasury issues as they mature, potentially
causing a decrease in money supply and effectively moving interest rates up. Rising interest
rates usually result in a stronger USD and weaker gold and silver prices. The Feds suggested
that further rate hikes are on the cards next year.

On the flipside, physical gold demand has trended upwards despite the last two US interest rate
hikes and given the uncertainties about the current U.S. government and an equities market
which is perceived to be overdue for correction, gold as a safe-haven currency may benefit from
the flight to safety in the coming months. At the same time, Brandon noticed that gold was
reacting more to USD than silver with gold trading at a wider premium over silver.

Suppose a major set of economic data is expected to be released in two days which can drive
prices either way. The Federal Open Market Committee (FOMC) is also meeting in 3 days and
their comments will either raise or lower the probability of a further rate hike at the end of the
year. Hence, Brandon is expecting a major rise or fall of the USD and a similarly significant fall
or rise in the prices of precious metals.

Question 1

What strategy could Brandon adopt, based on his views of the currency market?

a. Long put gold option.

b. Long gold straddle.
c. Short call gold option.
d. Short gold straddle.

Question 2

The straddle could be structured as:

a. Long call and Long put with strike price @ 1.2005.

b. Long call @ 1.2005 strike price and Long put @ 1.0495 strike price.
c. Long call @ 1.0495 strike price and short put @ 1.2005 strike price.
d. Short call @ 1.2005 strike price and long put @ 1.0495 strike price.

Question 3

What combination of options spreads strategies can Brandon undertake based on his
investment outlook?
(Select all options that apply)
a. Combine a bull call gold spread and a bear put gold spread.
b. Combine a bear call gold spread and a bear put gold spread.
c. Combine a bull call gold spread and a bull put gold spread.
d. Combine a bull call gold spread and a bear call gold spread.

Case Study 12.8 Taking Advantage of Varying Interest Rate Movements

Tracy is a bond portfolio manager who notices that the US Treasury Yield Curve is flattening out
(i.e., the spread between long-term and short-term interest rates is decreasing). She expects
the curve to invert slightly over the next few months into the next year with short rates rising
faster than long rates. This example is shown in Figure 12.8.

Tracy would like take advantage of the difference in the pace of change along the yield curve
using a constant maturity swap (CMS), also known as a yield curve swap.

A CMS is a variation of the regular interest rate swap in which the floating portion of the swap is
reset periodically against the rate of a fixed maturity instrument. Unlike a vanilla interest rate
swap (IRS), where the floating rate (usually LIBOR) is reset against the fixed rate of the IRS, in
a CMS, the floating rate (usually LIBOR) is reset against the rate of a long-term instrument with
a fixed and constant maturity. The duration of a CMS is unchanged throughout its life, unlike a
vanilla IRS. Hence, CMS can be used by investors who have a view on the direction of the
shape of the yield curve; steepening or flattening.

Question 1
What trend is exhibited by Figure 12.8?
a. Interest rates are not expected to move much.
b. A falling interest rate environment.
c. A rising interest rate environment.
d. Insufficient information to answer the question.

Question 2

What can Tracy do to take advantage of how yields are changing? (With the client expecting a
flattening out of the yield curve, what can the client do to take advantage of how yields are
changing?)

a. Swap the long end for the short end (Pay the long end, receive the short end).
b. Swap the short end for the long end (Pay the short end, receive the long end).
c. No action is needed given the current environment.
d. Swap out of the interest rate market.