paper 7 - financial markets

C M Y CM MY CY CMY K

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Hong Kong Securities Institute© Hong Kong Securities Institute 2004

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This is an educational booklet only and does not provide legal advice or expert advice in whatsoever form.Every effort has been made to ensure its accuracy, however, no responsibility for loss occasioned to anyperson acting or refraining from action as a result of any materials in this publication will be accepted by thepublisher and/or individual contributors.

i © Hong Kong Securities Institute

Table of Contents

© Hong Kong Securities Institute ii

Paper 7 - Sample Questions

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1 © Hong Kong Securities Institute

About the sample questions

Sample Questions


Sample Questions

Question 3.

Which of the following is CORRECT about the process of intermediation?

I) Financial intermediaries may perform the function of “market maker”.

II) Electronic intermediation improves efficiency, fairness and transparency of the flow of funds in the financial system.

III) Intermediation dilutes resources and therefore prohibits economies of scale.

IV) Through intermediation, borrowers bear greater cost but lower risk in transactions.

A I) and II) only.

B III) and IV) only.

C I), II) and IV) only.

D II), III) and IV) only.

Question 4.

Which of the following is NOT an example of government monetary policy to affect interest rates?

A Buying and selling government securities in the interbank market via the central bank.

B Intervening in the foreign exchange market.

C Adjusting its expenditure and taxation policy, thus affecting the supply of and demand for funds.

D Imposing strict controls on the lending operations of financial institutions.



Question 5.

Which of the following are NOT COMMON functions of a bank?

I) Facilitating the mobilisation of both wholesale and retail funds.

II) Prudential supervision of fellow banks.

III) Enabling investors to save money in order to create wealth.

IV) Implementing the government’s fiscal policy.

A I) and II) only.

B I) and III) only.

C II) and IV) only.

D III) and IV) only.

Question 6.

To which of the following does credit risk MOST LIKELY refer?

A Exposure to loss resulting from the inability to convert collateral to an equivalent cash value.

B Exposure to changes in earnings as a result of fluctuations in interest rates.

C Exposure to loss due to the failure to comply with prescribed procedures and policies.

D Exposure to loss as a result of deterioration in a borrower’s ability to honour its obligations.


Sample Questions

Question 7.

Which of the following is NOT a PRIMARY objective of the Hong Kong Monetary Authority (HKMA)?

A To act as a financial intermediary between buyers and sellers of retail managed funds.

B To ensure a sound and transparent banking system in Hong Kong.

C To maintain a stable currency within the framework of the linked exchange rate system.

D To supervise the conduct and operations of authorised institutions.

Question 8.

Which of the following requirements for the minimum paid-up capital and the original term to maturity for deposits are applicable to deposit taking companies in Hong Kong?

A A HKD150 million minimum paid-up capital and no restriction on original term to maturity.

B A HKD25 million minimum paid-up capital and no restriction on original term to maturity.

C A HKD150 million minimum paid-up capital and original term to maturity of no less than three months.

D A HKD25 million minimum paid-up capital and original term to maturity of no less than three months.



Question 9.

By entering into repurchase agreements (repos) at specified rates with the Hong Kong Monetary Authority (HKMA), licensed banks and restricted licence banks are able to obtain intra-day liquidity to cover liquidity shortfalls. What name is given to such an arrangement between banks and the HKMA as described above?

A Liquidity insurance.

B Intra-day shortfall coverage.

C Discount window.

D Foreign exchange relief.

Question 10.

Which of the following is MOST LIKELY to be classified as a “direct control approach” in monetary policy?

A An increase in the level of direct taxes in the budget announcement.

B Trading of government securities in the interbank market between the central bank and licensed banks authorised to trade such securities by the government.

C A government’s appointment of its finance chief.

D Controlling interest rates on loans.


Sample Questions

Question 11.

Of which of the following organisations is the Hong Kong Futures Exchange (HKFE) a wholly owned subsidiary?

A The Stock Exchange of Hong Kong (SEHK).

B The Hong Kong Securities Clearing Company Limited (HKSCC).

C Securities and Futures Commission (SFC).

D The Hong Kong Exchanges and Clearing Limited (HKEx).

Question 12.

Which of the following statements is CORRECT?

A When the Hong Kong Monetary Authority (HKMA) sells USD to the currency board in return for HKD, the supply of HKD in the financial system increases, thus decreasing the interest rates of HKD.

B When the HKMA sells USD to the currency board in return for HKD, the supply of HKD in the financial system increases, thus increasing the interest rates of HKD.

C When the HKMA sells USD to the currency board in return for HKD, the supply of HKD in the financial system decreases, thus decreasing the interest rates of HKD.

D When the HKMA purchases USD from the currency board with HKD, the supply of HKD in the financial system increases, thus decreasing the interest rates of HKD.



Question 13.

Which of the following is NOT a method of raising equity finance?

A Private placements.

B Equity Charters.

C Initial Public Offerings.

D Dividend reinvestment.

Question 14.

To which of the following does the Hong Kong Exchanges and Clearing Limited’s “Pilot Programme” of May 2000 refer?

A The commencement of the Dual Vetting System with the Securities and Futures Commission (SFC) for listing applications.

B Allowing certain NASDAQ and AMEX listed stocks to be listed on the Stock Exchange of Hong Kong (SEHK) for trading purposes.

C The advent of the AMS/3 on the SEHK.

D The establishment of the Growth Enterprise Market (GEM) as a wholly owned subsidiary of the SEHK.


Sample Questions

Question 15.

Paul has 800 shares in Calfritz Ltd. before a 1 for 4 bonus issue is announced. If the shares were traded at HKD2.00 immediately before the bonus issue, what is the price of Paul’s shares immediately after the bonus issue?

A HKD1.20

B HKD1.40

C HKD1.60

D HKD1.80

Question 16.

When is the par value of a share issued by a company determined?

A It is determined 7 days after the share is first traded on the stock exchange.

B It is determined at the time the company is incorporated.

C It is determined when the market price of the share has reached the required minimum level.

D It is determined when the statutory amount of transactions of the share on the stock exchange has been reached.



Question 17.

What is the MAIN purpose of having the Growth Enterprise Market (GEM) in addition to the Main Board of the Stock Exchange of Hong Kong (SEHK)?

A The GEM serves as a “contingency” trading platform for the Main Board, and vice versa, in the event of a severely crippling market disruption.

B The Main Board is for professional investors whereas the GEM is for retail investors.

C All IPOs are listed on the GEM for a probation period before they qualify for a Main Board listing.

D Sizable companies with proven profitability records are listed on the Main Board while the GEM caters for smaller companies that do not qualify for a Main Board listing.

Question 18.

In 1998, the Hong Kong Government entered the market to stave off currency speculation during the Asian financial crisis. As a result, which of the following happened?

A The establishment of the Tracker Fund of Hong Kong (TraHK) to dispose of the shares acquired by the Hong Kong Government.

B The establishment of the Tracker Fund of Hong Kong (TraHK) to finance the operation of tracking and pre-empting possible future attacks from international speculators.

C The establishment of the Hang Seng Index Fund (HKIF) to dispose of the shares acquired by the Hong Kong Government.

D The establishment of the Hang Seng Index Fund (HKIF) to finance the operation of tracking and pre-empting possible future attacks from international speculators.


Sample Questions

Question 19.

Calculate the total amount of a deposit of HKD8,000 after 2 years if invested at a compound interest rate of 7% per annum, compounding quarterly.

A HKD8,282.45

B HKD9,159.20

C HKD9,191.05

D HKD13,745.49

Question 20.

In order to encourage retail investment and to develop a liquid and active debt market, which of the following were listed on the Stock Exchange of Hong Kong (SEHK) by the Hong Kong Monetary Authority (HKMA) in 1997?

A Equity Linked Instruments (ELI).

B Exchange Fund Notes (EFN).

C Exchange Traded Funds (ETF).

D Negotiable Certificates of Deposit (NCD).



Question 21.

For which of the following does the Central Moneymarkets Unit (CMU) NOT provide clearing and settlement services?

A Exchange Fund Bills.

B Forward Rate Agreements.

C Commercial Bills.

D Hong Kong Mortgage Corporation Notes.

Question 22.

ABC Ltd. is hiring John, a licensed corporate finance professional, to assist the expansion of ABC. Which of the following services are MOST LIKELY provided by John?

I) Restructuring the corporate structure of ABC.

II) Providing financial advice to ABC.

III) Managing ABC’s investment portfolio.

IV) Executing stock purchase orders placed by ABC in a stock exchange.

A I) and II) only.

B I) and IV) only.

C II), III) and IV) only.

D I), II) and IV) only.


Sample Questions

Question 23.

Debbie has just set up a new investment fund which is authorised by the Securities and Futures Commission (SFC). The fund focuses on investing in high growth stocks. After implementing her investment strategies, Debbie finds the following:

� There are only 10 investors contributing to Debbie’s fund

� All cash raised has been allocated equally among 6 PRC concept companies

� The stock prices of these 6 companies have increased by 150% in the past 2 years

� The fund owns about 25% of the ordinary shares in 3 of the 6 companies

Debbie’s compliance officer finds that her fund is not in full compliance. Which of the following are instances of mis-compliance of the fund?

I) The number of investors investing in the fund has not yet reached the minimum required by law.

II) The allocation limit of the fund’s net asset value in a single company’s securities has been exceeded.

III) The high growth rate of these companies indicates that Debbie’s investment strategy is too risky for a managed fund.

IV) The fund should not hold more than 10% of the ordinary shares of any one of these companies.

A I) and II) only.

B II) and IV) only.

C III) and IV) only.

D I), II) and III) only.



Question 24.

Simon is in his late 30s. In order to meet his financial goals in the next 30 years, Simon has asked Daisy to design an investment scheme for him. Which of the following financial service personnel would Daisy MOST LIKELY be?

A Corporate financier.

B Fund manager.

C Stockbroker.

D Retail financial planner.

Question 25.

Which of the following are essential procedures involved in the process of creating a financial plan by a retail financial planner?

I) Analyse the client’s financial status and risk tolerance.

II) Compile a financial plan that meets the client’s objectives.

III) Provide margin financing for the client to implement stock investments according to the financial plan.

IV) Monitor and review the performance of the client’s stock investments and revise investment strategies as needed.

A I) and II) only.





Sample Questions

Question 26.

Mr. Hung has inherited a large amount of wealth from his parents. He has decided to invest a portion of his wealth in managed funds. Which of the following is NOT a valid reason for Mr. Hung to invest in managed funds?

A To gain access to professional investment management services.

B To increase the exposure of his portfolio to a wider range of investment instruments.

C To have a tailor-made investment portfolio designed exclusively for him by a fund manager.

D To gain access to markets which are not directly accessible to retail investors in the stock market.

Question 27.

Which of the following statements is INCORRECT?

A A corporate finance professional should possess a high level of knowledge in finance, including accounting, company law, and taxation.

B Through the privatisation of government-owned companies, the competitiveness and efficiency of a particular industry will be enhanced.

C All companies engaging in dealing in securities and futures in Hong Kong must be licensed by or registered with the Securities and Futures Commission (SFC).

D Investors in a managed fund must be consulted before the investment manager executes his investment strategies and decisions.



Question 28.

Which of the following transactions utilises risk management techniques?

I) The purchase of financial instruments to hedge an existing portfolio.

II) The sale of options to reduce exposure to a particular industry.

III) Increasing receivables through an increase in inventory turnover.

IV) Exchanging your fixed interest payable for a counter-party’s floating interest payable.

A I), II) and III) only.

B I), II) and IV) only.

C I), III) and IV) only.


Question 29.

Jason is a fund manager and forecasts that the recent high inflation rate will induce the central bank to post an interest rate hike. The portfolio he is currently managing has a weighting of 20% in floating-rate debt securities, 40% in fixed-rate debt securities and 40% in equity securities. Based on his forecast, which of the following actions would be MOST APPROPRIATE for Jason to take?

A Inform the investors of his fund and seek their advice on the most suitable strategy.

B Unwind his portfolio and wait for the appropriate time to invest the cash on hand in these markets again with the same weighting.

C Increase investment in equity securities of companies which have large amounts of outstanding loans on their balance sheets, and reduce the weighting of debt securities in his portfolio.

D Reduce his investment in both fixed-rate debt securities and equity securities while increasing his investment in floating-rate debt securities.


Sample Questions

Question 30.

Which of the following statements is INCORRECT?

A The Hong Kong Mortgage Corporation Limited (HKMC) is responsible for providing mortgage services to homeowners in Hong Kong.

B The Securities and Futures Commission (SFC) regulates all retail managed funds marketed in Hong Kong.

C The Hong Kong Monetary Authority (HKMA) supervises all authorised financial institutions in Hong Kong.

D The Insurance Authority supervises the insurance industry in Hong Kong.

Question 31.

Mason purchases 50,000 shares of XYZ Company and offers these shares to his broker as collateral in order to borrow more funds with which to purchase additional shares. What is this securities trading process called?

A Mark-to-market.

B Securities margin financing.

C Risk management.

D Exposure netting.



Question 32.

Which of the following BEST describes the “Delivery versus Payment” system for securities transactions?

A Values of collateralised securities are recalculated to reflect the latest market value.

B Exposure to a gain position is offset with a loss position.

C The transactions can only be settled when sufficient funds are received.

D A contract between a buyer and a seller is novated by an exchange so that the exchange becomes the counter-party for both the buyer and the seller.

Question 33.

Which of the following are the MAIN implications to be drawn from the case of Metallgesellschaft’s failure in 1993?

I) Senior management need to understand the nature of the company’s investment tools and strategies.

II) Hedging tools should be carefully selected in order to match the company’s underlying exposure.

III) Sufficient cash reserves should be in place if leveraged instruments are to be utilised in the management of the company’s portfolio.

IV) Disperse risk by diversifying the company’s business amongst different industries.

A I) and II) only.

B II) and IV) only.

C I), II) and III) only.



Sample Questions

Question 34.

After John has purchased a portfolio of short-term debt securities, the prices of the debt securities have dropped significantly due to a major increase in interest rates implemented by the government. To which type of risk is John’s portfolio exposed?

A Market risk.

B Credit risk.

C Strategic risk.

D Operational risk.

Question 35.

When a note-issuing bank in Hong Kong issues Hong Kong Dollar notes, (i) with whom should it deposit the equivalent amount of USD and (ii) what will the bank receive in return?

A (i) the Federal Reserve of the United States; (ii) a bankers’ acceptance.

B (i) the Federal Reserve of the United States; (ii) a negotiable certificate of deposit.

C (i) the Hong Kong Monetary Authority (HKMA); (ii) a certificate of indebtedness.

D (i) the Hong Kong Monetary Authority (HKMA); (ii) a promissory note.



Question 36.

Which of the following activities utilise the advantages of derivatives?

I) A fund manager buys call options to minimise the impact of the expected short-term market fluctuation on his portfolio.

II) A trader purchases spot gold contracts and immediately transacts an opposite trade of an equal amount in the futures market.

III) A corporation redeems cash from a managed fund in order to increase the liquidity of its pension portfolio.

IV) An investor uses futures contracts to magnify the size of his portfolio.

A I) and III) only.



D I), II) and IV) only.

Question 37.

Which of the following descriptions about derivatives is INCORRECT?

A The HKFE Clearing Corporation Limited (HKCC) performs the settlement of contracts traded through the Hong Kong Futures Automated Trading System (HKATS).

B A Forward Rate Agreement (FRA) locks in the future borrowing and lending rate for the contracted parties.

C A futures contract has customised features and is contracted directly between the buyer and the seller.

D The exercise rights of an option always belong to the holder of the option.


Sample Questions

Question 38.

It is now December. Yuletide Limited expects to receive HKD100 million at the end of February for sales of Christmas trees. The company plans to invest all receivables in fixed-interest securities. However, it is expected that interest rates will fall in January. Which of the following is the MOST APPROPRIATE strategy for Yuletide to adopt in order to guarantee the return of its future investment at the current interest rate level?

A Enter into a fixed to floating interest rate swap.

B Enter into a floating to fixed interest rate swap.

C Enter into a forward rate agreement.

D Do nothing because falling interest rates will benefit its investment.

Question 39.

Assuming that:

Spot GBP/USD: GBP1.0000=USD1.5123

GBP 3-month annual interest rate: 3.95%

USD 3-month annual interest rate: 2.35%

Given the above information, what is the theoretical rate for a 3-month GBP/USD forward contract?

A 1.4890

B 1.5063

C 1.5183

D 1.5359



Question 40.

Country XYZ declares that it will fix its currency to the Euro. Under this arrangement, which of the following are CORRECT regarding XYZ’s financial system?

I) In order to operate an effective fixed exchange rate regime, XYZ may have difficulty controlling its domestic interest rates.

II) The central bank of XYZ may intervene in the currency market to stabilize and influence the direction of its currency. XYZ’s exchange rate regime can be called a “dirty floating-rate regime”.

III) When there is a surplus of foreign currency in a local bank at the end of a business day, the central bank of XYZ will buy foreign currency from that bank.

IV) Net daily foreign currency positions are accumulated and settled on a monthly basis.

A I) and III) only.

B II) and IV) only.

C I) and IV) only.

D II), III) and IV) only

Question 41.

What is the nominal interest rate if interest is paid quarterly and the effective annual interest rate is 3.546%?

A 3.40%

B 3.45%

C 3.50%

D 3.51%


Sample Questions

Question 42.

PVC Corp is issuing a 2.5-year bond with a face value of HKD100 million and a coupon rate of 2.5% payable semi-annually. Assuming that the yield-to-maturity of similar bonds is 2.5%, what is the fair price of the bond issued by PVC?

A HKD88 million

B HKD100 million

C HKD102 million

D HKD106 million

Question 43.

What is a bond generally called when its coupon rate is set to vary against a predetermined benchmark rate?

A Floating rate bond.

B Fixed rate bond.

C Benchmarked coupon bond.

D Predetermined coupon bond.



Question 44.

An investor finds a newly issued bond offering a slightly higher yield than the risk-free rate. Which of the following statements is MOST APPROPRIATE in describing this newly issued bond?

A There is no risk premium applied to the bond.

B The issuer has a very high credit rating.

C The market anticipates that interest rates will rise slightly in the near future.

D The bond is issued by the US government outside the US.

Question 45.

While plotting the yield curves of selected debt securities of the same type, Paul finds that the yields of short-term securities are generally higher than the yields of longer term securities. Which type of yield curve does this situation illustrate?

A A positive yield curve.

B An inflationary yield curve.

C A deflationary yield curve.

D An inverse yield curve.


Sample Questions

Question 46.

A credit card company pools its credit card receivables together and issues an asset-backed security using those receivables as collateral. Which of the following BEST describes this situation?

I) Issuance of this kind of asset-backed security indicates that the credit card company is in serious financial difficulty.

II) New funds are raised for the company through the issuance of this asset-backed security but the principal and interest on the security must be repaid from the cash flows generated by the credit card receivables.

III) This kind of security is commonly known as commercial paper and is a typical way for a corporation to finance its expansion or working capital needs.

IV) The credit card company transforms its assets into marketable securities through securitisation.

A I) and II) only.

B II) and III) only.

C II) and IV) only.

D III) and IV) only.



Question 47.

The International Bank for Reconstruction and Development and the International Finance Corporation decide to jointly issue a 10-year bond with fixed interest to assist the reconstruction of Iran after the earthquake in late 2003. Which of the following is/are CORRECT description(s) of this bond?

I) This is a semi-government bond which is perceived as a low risk investment.

II) This is a supranational bond and commonly holds a high credit rating.

III) Trading of this bond is settled through the Real Time Gross Settlement System (RTGS) which links the banks with Euroclear.

IV) Investment in this bond is likely to enjoy an exemption from profits tax applicable in Hong Kong.

A I) only.

B I) and IV) only.

C II) and IV) only.


Question 48.

Which of the following are NOT COMMON characteristics of both rights issues and bonus issues?

I) New shares are issued to existing shareholders.

II) Free shares are issued to existing shareholders.

III) A source of funds for the underlying company.

IV) The shareholding of non-subscribing shareholders will be diluted.

A I) and II) only.





Sample Questions

Question 49.

Which of the following are INCORRECT?

I) The Central Clearing and Settlement System (CCASS) is responsible for maintaining stock accounts for stock exchange participants in Hong Kong.

II) The Hong Kong Securities Clearing Company Limited (HKSCC) provides custodial and share registrar services for stock exchange participants in Hong Kong.

III) Employees’ stock options issued by the underlying company provide a guaranteed source of equity finance for the issuer.

IV) All securities traded on the Stock Exchange of Hong Kong (SEHK) are settled through the CCASS on a “T+2” basis.

A I) and II) only.




Question 50.

After several years of economic recession, Country X is now facing a severe budget deficit. The government of Country X decides to reduce government spending and to increase the income tax rate in order to balance its budget. What is the LIKELY impact on the economy upon implementation of this policy?

A The economy will be worse off as the result of a contractionary fiscal policy.

B The economy will be worse off as the result of a contractionary monetary policy.

C The economy will be improved as the result of an expansionary fiscal policy.

D The economy will be improved as the result of an expansionary monetary policy.



Question 51.

Which of the following comprises features from both equity and debt securities?

A Debentures.

B Mortgage-backed securities.

C Convertible notes.

D Currency swaps.

Question 52.

Which of the following statement(s) is/are CORRECT?

I) Under the Maastricht Treaty, the USD was pegged to gold at a fixed price of USD35 per ounce.

II) One of the main objectives of the Bretton Woods system was to establish a mechanism for the reconstruction of Europe.

III) The breakdown of the Bretton Woods system was due to severe budget deficits resulting from the United States’ involvement in the Vietnam War in the 1970s.

IV) Under the currency board system, for each Hong Kong dollar printed in Hong Kong, the note issuing banks must deposit an equivalent amount of USD with the Central Currency Backup Fund (CCBF) managed by the Hong Kong Monetary Authority (HKMA).

A I) only.

B II) and III) only.




Sample Questions

Question 53.

Why is a transaction in the derivatives market COMMONLY called a “zero sum game”?

A The risk measuring technique of Value-at-Risk eliminates the overall uncertainty of a portfolio.

B The participation of an exchange in the clearing and settling of derivatives transactions through the novation process eliminates the total risk of the buyer and seller.

C Any gain to a party in a derivative transaction represents a loss to the counter-party.

D Arbitrage opportunities can be exploited by using derivatives to generate zero-risk profit.

Question 54.

Which of the following transactions DOES NOT involve a derivatives instrument?

A A fund manager plans to reduce the risk of profit when disposing of his equity portfolio in 3 months. He enters into an equity forward agreement with an investment bank.

B While buying back its debt securities from the market, a company issues a series of stock options with different maturity dates to bondholders.

C A trader buys 1,000 ounces of gold in the spot market and simultaneously sells futures contracts of the equivalent amount to arbitrage the price differences.

D A shareholder receives 3 new shares for every old share he holds as the result of a stock split made by the relevant company.



Question 55.

Four stocks within the same industry have the following performance characteristics:

Stock Expected return Standard deviation

I 5% 0.25

II 5% 0.30

III 8% 0.25

IV 8% 0.30

Which ONE of the stocks provides the BEST investment opportunities for a rational investor?

A Stock I.

B Stock II.

C Stock III.

D Stock IV.

Question 56.

Investment bank Faulty is reviewing a swap contract with Company A. After a senior management review, it is found that the contract contains certain terms with no legal effect. Under the contract, Faulty will be subject to significant exposure when interest rates move slightly. In addition, the shares of Company B which have been offered to Faulty as collateral by Company A have been suspended from trading by the stock exchange as the result of an accounting investigation. If Faulty executes this contract with Company A, what risks is Faulty exposed to?

A Legal risk, market risk and liquidity risk.

B Operations risk, strategic risk and credit risk.

C Systemic risk, reputation risk and liquidity risk.

D Legal risk, market risk and credit risk.


Sample Questions

Question 57.

Which of the following business practices is/are considered to be the result of PRUDENT corporate governance?

I) All transactions are required to be recorded by a detailed written document.

II) The implementation of detailed risk management systems, processes and procedures.

III) Stringent supervision and control by directors and senior management of the company.

IV) Involvement of traders in settlement procedures to ensure that all transaction details are accurate.

A IV) only.

B I) and III) only.


D I), III) and IV) only.

Question 58.

A fund manager analyses the performance of a portfolio under his management by using extreme scenarios. Which type of test is the fund manager performing?

A Value-at-Risk.

B Stress testing.

C Cash position analysis.

D Extreme option position analysis.



~End of the Sample Questions Section~

Answers



Question Answer Question Answer Question Answer

1 C 21 B 41 C

2 C 22 A 42 B

3 C 23 B 43 A

4 C 24 D 44 B

5 C 25 C 45 D

6 D 26 C 46 C

7 A 27 D 47 C

8 D 28 B 48 D

9 C 29 D 49 B

10 D 30 A 50 A

11 D 31 B 51 C

12 A 32 C 52 B

13 B 33 C 53 C

14 B 34 A 54 D

15 C 35 C 55 C

16 B 36 D 56 A

17 D 37 C 57 C

18 A 38 C 58 B

19 C 39 B 59 B

20 B 40 A 60 B

Explanations


Paper 7 - Sample Questions Question 1 As shown in the demand/supply diagram, the supply and demand curves meet at the

equilibrium point.

Question 2 As shown in the flow of funds diagram, the household sector is mainly a lender of funds in the economy.

Question 3 III) is a made-up theory.

Question 4 Taxation and government spending are areas of fiscal policy.

Question 5 II) Supervision of banks is performed by central banks or monetary authorities. IV) Fiscal policy is implemented by respective governmental departments.

Question 6 A refers to liquidity risk. B refers to market risk. C refers to operational risk. D refers to credit risk, which is the correct answer.

Question 7 As a regulator, the Hong Kong Monetary Authority (HKMA) does not involve itself in retail intermediation activities.

Question 8 Authorised institutions in Hong Kong have to fulfill requirements in certain categories. Deposit taking companies must have a minimum paid-up capital of HKD25million. They can only accept time deposits of not less than HKD100,000, with an original term to maturity of not less than three months.

Question 9 The particular arrangement operated by the HKMA involves entering into repurchase agreements with local banks and is called the “discount window”. “Intra-day short coverage”, “Liquidity insurance” and “Foreign exchange relief” are made-up terms.

Question 10 Imposing controls on interest rates for loans is one of the direct methods that a government could use to affect the level of money supply.

Question 11 The Hong Kong Exchanges and Clearing Limited (HKEx) is the result of a merger in March 2000 between the Stock Exchange of Hong Kong (SEHK), the Hong Kong Futures Exchange (HKFE) and the Hong Kong Securities Clearing Company Limited (HKSCC). HKEx became the holding company for these entities.

Question 12 According to the supply and demand theory, an increase in the supply of HKD to the market will drive the interest rates of HKD downwards.

Question 13 B is a made-up term.


ExplanationsQuestion 14 In May 2000, the HKEx entered into a Pilot Programme whereby a number of

securities listed on the National Association of Securities Dealers and Automatic Quotations (NASDAQ) and the American Stock Exchange (AMEX) were also listed on the SEHK. These securities do not constitute public offerings in Hong Kong. They are listed on the SEHK for trading purposes only and are regulated by the SEHK listing rules and Hong Kong laws. Securities included in the Pilot Programme comprise exchange-traded funds (mutual funds) as well as shares.

Question 15 Total number of shares before bonus issue: 800 shares Total value of shares issued before bonus issue: $1,600 = 800 × $2.00 Bonus share entitlement: 200 shares = 800 shares ÷ 4 Total number of shares after bonus issue: 1,000 shares = 800 + 200 Price per share after bonus issue: $1.60 = $1,600 ÷ 1,000

Question 16 The par value is an arbitrary amount per share determined at the time that a company is incorporated.

Question 17 The GEM was established in 1999 by the SEHK to encourage the development of companies in emerging and growth industries. The GEM enables listed companies, which do not have established profitability records – a prerequisite for listing on the Main Board – to raise funds publicly.

Question 18 In order to dispose of the shares acquired during the Asian financial crisis in 1998 in an orderly manner, the Hong Kong government decided to set up the Tracker Fund to sell off its shares gradually in 1999.

Question 19 Let S be the sum of principal and interest after 2 years:

S = 8,000 × (1 +4

7%) 8 = 9,191.05

Question 20 In 1997, the HKMA listed 57 EFN issues on the SEHK in order to encourage retail investment and to develop a liquid and active debt market in Hong Kong.

Question 21 Unlike government debt (i.e. EFBs and EFNs), quasi-government debt (i.e. HKMC Notes) and corporate paper (i.e. commercial bills and corporate bonds), Forward Rate Agreements (FRA) are OTC products and are not settled and cleared through the Central Money Markets Unit (CMU).

Question 22 III) is usually performed by asset managers. IV) is usually performed by dealers or stockbrokers.


Paper 7 - Sample Questions Question 23 I) There is no law regulating the minimum number of investors in a managed fund.

II) According to the Code on Unit Trusts and Mutual Funds, a fund cannot hold more than 10% of its net asset value in securities issued by a single issuer.

III) The risks of a managed fund vary according to its investment objectives and strategies.

IV) According to the Code on Unit Trusts and Mutual Funds, a fund cannot hold more than 10% of the ordinary shares issued by a single issuer.

Question 24 A: A corporate financier provides financial advice, for example relating to mergers and acquisitions and corporate restructuring, mainly to corporations.

B: A fund manager manages investment portfolios according to predetermined investment objectives and strategies.

C: A stockbroker executes orders for clients and provide incidental investment advice.

D: A retail financial planner assists individuals in constructing financial plans that meet their long-term goals.

Question 25 Retail financial planners do not act as financiers to their clients.

Question 26 Managed funds are so called because they are funds managed by professional investment managers who manage the assets on a discretionary basis. Individuals delegate the investment management of their money to professionals, who exercise discretion as to how it should be invested.

Question 27 D: Managed funds are managed on a discretionary basis. The fund managers have the discretion to change the asset allocation of funds according to predetermined investment objectives set out in the investment prospectus.

Question 28 III) Managing receivables and inventory does not involve risk management while the other 3 options focus on risk transfer, risk avoidance and risk retention.

Question 29 D: If there is an increase in interest rates, returns from equities will be reduced while returns from fixed-rate debt securities are fixed and are unable to capture upside opportunities. However, returns on floating-rate debt securities are able to reflect market changes.

Question 30 A: The HKMC was established in order to encourage the development of the secondary mortgage market in Hong Kong.

Question 31 Securities margin financing facilitates securities trading based on the transfer of securities as collateral.

Question 32 A is the definition of Mark-to-Market. B is the definition of Netting. C is the definition of Delivery vs. Payment (DvP), the correct answer. D refers to the process of Novation.


ExplanationsQuestion 33 Questionable derivatives practices and hedging strategies were the core reasons

behind Metallgesellschaft’s failure. IV) concerns spreading risk by diversification of business, which is not of importance to this particular case.

Question 34 Market risk refers to the potential for losses or gains as a result of market price movements in financial securities. A loss has been incurred in John’s portfolio due to a market change.

Question 35 As part of the operation of the Hong Kong Currency Board mechanism, note-issuing banks deposit equivalent amounts of USD with the HKMA and obtain a certificate of indebtedness in return.

Question 36 I) Hedging activity with call options. II) Arbitrage activity with spot gold contracts and futures. III) Redeeming from a managed fund does not utilise any derivatives. IV) Leveraging activity with futures contracts.

Question 37 Futures contracts are exchange-traded contracts and therefore have standardised contract features.

Question 38 Forward contracts that fix interest rates of future investments are called Forward Rate Agreements (FRAs). The FRA will lock in the return of Yuletide’s planned investment at the current interest rate level.

Question 39 GBP/USD forward rate:

)36090

(3.95%1

)] 36090

(2.35%+[11.5123

×+

××= 1.5063

Question 40 In order for a fixed exchange rate system to operate effectively, the central bank’s levels of foreign currency reserves and local currency will fluctuate on a daily basis. Normally this creates difficulty in controlling domestic money supply and interest rates. The central bank must always cover the daily shortfall or surplus of currencies held by domestic banks.

Question 41 Let x be the nominal interest rate: 4)

4x

(1+ -1 = 3.546%

x = 3.50%



Question 42 Coupon payment: 1,250,000 2

2.5%0100,000,00 =×

Fair price of bond:

])

22.5%(1

0101,250,00[ ])

22.5%(1

1,250,000[ ])

22.5%(1

1,250,000[ ])

22.5%(1

1,250,000[ ])

22.5%(1

1,250,000[5432 +

++

++

++

++

=100,000,000

Question 43 Distractors C and D are made-up. The coupon payment on a floating rate coupon bond will vary against a predetermined benchmark rate.

Question 44 The statement in the question reflects the fact that the bond is very close to a risk-free security since the yield is just barely above that of the risk-free rate. The closer the bond is to being risk-free, the higher the credit rating of the issuer.

Question 45 In a “normal” situation, yields increase in line with the term to maturity. The longer the term to maturity, the greater the uncertainty and therefore the greater the risk. Yields on long term securities therefore increase to reflect the greater risk for investors. When short-term yields are higher than long-term yields on a yield curve, and yields decrease with an increase in the term to maturity, this is referred to as an inverse yield curve.

Normal positive yield curve Inverse yield curve

mat urit y

Question 46 Only II) and IV) are correct in relation to the scenario of securitisation.

Question 47 This is an example of a supranational bond and is very likely to enjoy an exemption from profits tax applicable in Hong Kong.

Question 48 The main difference between a rights issue and a bonus issue is that a bonus issue is a free offer of new shares to shareholders based on the number of existing shares held by each shareholder while a rights issue is normally subscribed by shareholders at a price lower than the prevailing market price. Shareholders who do not exercise their rights in a rights issue will have their holdings diluted.

yield

maturity

yield

maturity


ExplanationsQuestion 49 III) Option holders do not necessarily exercise their rights; such options are

therefore not a reliable source of equity finance. IV) US securities traded on the Hong Kong Stock Exchange in the Pilot Programme

are settled on a “T+3” basis.

Question 50 Reduced government spending and increased taxation usually stem from a contractionary fiscal policy. An economy in recession is likely to be worse off under such a policy.

Question 51 Convertible notes are hybrid securities. An investor can convert the notes into shares or simply redeem them at maturity in the same way as other debt securities.

Question 52 Only II) and III) about the Bretton Woods System’s main objective and breakdown are correct. I) The Maastricht Treaty was concerned with the development of a timetable for

the transition towards European Monetary Union and the single currency for its member states, the Euro.

IV) The Central Currency Backup Fund does not exist

Question 53 The buyer and the seller take two opposing views and only one side can be “right”, the other side must lose.

Question 54 Forward agreements, stock options and gold futures are all derivatives instruments but not stock splits.

Question 55 C is the choice of highest return and lowest standard deviation amongst the four choices.

Question 56 Since the contract carries clauses with no legal effect, the enforceability of the contract is in question, which constitutes a legal risk. Faulty also bears market risk if there is any movement in interest rates. The suspension from trading of Company B’s shares on the stock exchange will make it difficult for Faulty to convert Company A’s collateral into liquid assets (e.g. cash) in the event of Company A’s default, and this constitutes a liquidity risk for Faulty.

Question 57 Prudent corporate governance includes segregation of duties and functions and IV) violates such good practice in as much as traders are involved in activities which should be beyond their remit as in the case of Barings.

Question 58 Stress testing is the technique used to test performance under a “worst-case scenario”.


Paper 7 - Sample Questions Question 59 Eurobonds are debt securities issued by companies in the foreign capital markets as

opposed to domestic debt securities issued in local markets. The term “euro” in this context derives from the Latin term meaning external. Promissory notes, banker’s acceptances and negotiable certificates of deposit are short-term instruments traded in the money markets, usually carrying maturities of up to one year.

Question 60 A bull market refers to the expectation of investors that the stock market is going to rise and a bear market refers to the expectation of investors that the stock market is going to fall.

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