The correct answer is that the bank transforms the risk profile of the loan, absorbing the potential credit default risk from the individual depositors whose funds are being lent. This is a core function of financial intermediation. Banks pool funds from many depositors (who seek low-risk, liquid assets) and use their expertise to assess and manage the credit risk of lending to borrowers like the startup. By doing so, the bank stands between the depositors and the borrower, effectively transforming the risk. Depositors face the low credit risk of the bank itself, while the bank assumes the higher credit risk of the startup. The bank does not guarantee the profitability of the borrower’s projects; it assesses the risk but cannot eliminate it or guarantee success. While banks facilitate the flow of capital, they do not necessarily provide loans at a lower rate than all other potential sources, as their rates must cover costs, risk premium, and profit margin. Finally, the funds a bank lends are primarily sourced from depositors in the household and business sectors, not typically from the government sector for general commercial lending.

A steeply upward-sloping yield curve, often called a normal yield curve, indicates that long-term debt instruments have a higher yield than short-term debt instruments. The most common interpretation of this shape is that market participants expect future short-term interest rates to rise. This expectation is typically associated with periods of anticipated economic expansion and potentially rising inflation, where investors demand a higher premium for holding longer-term bonds to compensate for the risk of future rate hikes which would devalue their holdings. The correct answer is that the market anticipates economic growth and a corresponding increase in future interest rates. An expectation of an economic recession and falling interest rates would typically result in an inverted yield curve, where short-term yields are higher than long-term yields. A flat yield curve, where yields are similar across all maturities, usually signals market uncertainty about the future direction of the economy. The idea that investors are demanding higher compensation for short-term instruments than for long-term ones describes an inverted curve, not an upward-sloping one.

Statement I is correct because it accurately identifies a risk related to the physical infrastructure of a business (office servers) and its potential loss from a specific event (power surge). This type of risk, where the only outcomes are loss or no loss, is a classic example of a pure risk, which is appropriately managed with an insurance policy. Statement II is also correct. The potential for loss due to unfavourable movements in share prices (the Hang Seng Index) is a core example of financial risk. Such risks are managed by the firm’s internal financial risk management systems, which include controls and specific strategies like hedging. Statement III is incorrect. The risk of a client defaulting on a loan is credit risk, which is a sub-category of financial risk, not pure risk. Pure risks are not related to the financial activities of the business like lending. Statement IV is incorrect. While a mismatch between asset and liability prices is a source of financial risk, the most fundamental reason for the existence of risk in general is the uncertainty of the future. The statement describes a specific risk factor rather than the foundational concept of why risk exists. Therefore, statements I and II are correct.

The correct answer is that a Negotiable Certificate of Deposit (NCD) represents a direct deposit liability of the issuing bank, while a Bankers’ Acceptance (BA) is an obligation of a third party, typically a corporation, that has been guaranteed by a bank. An NCD is fundamentally a certificate proving a time deposit has been made with an authorized institution, and that institution is directly obligated to repay the principal and interest to the bearer at maturity. In contrast, a BA originates as a bill of exchange drawn by a corporation to finance its operations, often related to trade. A bank then ‘accepts’ this bill, which constitutes a guarantee that the bank will pay the face value to the holder at maturity, irrespective of whether the original corporation defaults. The bank’s creditworthiness thus underpins the BA’s value. Other options are incorrect. Confusing NCDs with instruments issued by the Hong Kong Monetary Authority (HKMA) is a mistake; the HKMA issues Exchange Fund Bills, not NCDs. Stating that BAs are exclusively used for working capital while NCDs are for interbank lending oversimplifies their functions; both are versatile money market tools. Finally, the claim that NCDs are bearer instruments while BAs are registered is an inaccurate distinction; both are typically negotiable bearer instruments in the Hong Kong market.

This question assesses the understanding of the different objectives in the two primary phases of retail financial advising: wealth creation and wealth protection. For a client approaching retirement, the focus shifts from wealth creation (characterised by higher risk tolerance and aggressive growth) to wealth protection. In the wealth protection phase, the primary goals are to preserve the capital accumulated over the years and to generate a stable income stream. Statement II correctly identifies that the investment strategy must align with the client’s acceptable risk level, which is typically lower in this phase to protect capital. Statement III correctly highlights the need for liquidity to cover expenses without being forced to sell long-term investments, a key consideration for retirees who no longer have a regular salary. Conversely, Statement I is incorrect because maximising returns by taking on ‘substantial’ risk is contrary to the goal of capital preservation. Statement IV is also incorrect as the focus is on preservation and income generation, not ‘aggressive asset growth’, which is characteristic of the earlier wealth creation phase. Therefore, statements II and III are correct.

Statement I is correct. The Enron case is a classic example of concentration risk. Many employees held a large portion of their retirement funds in Enron stock, and its collapse led to devastating losses. This highlights the fundamental risk management principle of diversification, which is crucial for mitigating firm-specific, unsystematic risk.

Statement II is correct. The Metallgesellschaft case demonstrates a key risk in hedging. The firm used short-term futures contracts to hedge long-term fixed-price supply contracts. When oil prices fell, the firm faced massive and continuous margin calls on its futures positions, creating a severe funding liquidity crisis. This shows that a hedging strategy, while mitigating price risk, can introduce other significant risks like liquidity risk if not structured properly.

Statement III is correct. The Enron scandal was fundamentally a failure of corporate governance, characterized by a lack of transparency, conflicts of interest involving its auditor, and a board that did not provide effective oversight. For licensed corporations in Hong Kong, such as asset managers, the SFC’s Fund Manager Code of Conduct and the Code of Conduct for Persons Licensed by or Registered with the SFC emphasize the importance of conducting thorough due diligence on investments, which includes scrutinizing the governance and integrity of the investee company.

Statement IV is incorrect. This is an oversimplified and inaccurate conclusion. Derivatives are essential tools for risk management. The failure at Metallgesellschaft was not due to the use of derivatives per se, but rather the flawed hedging strategy (a maturity mismatch between the hedge and the underlying exposure) and the inadequate management of the resulting liquidity risk. The appropriate lesson is to ensure hedging strategies are well-designed and that all associated risks, including basis and funding risks, are managed. Therefore, statements I, II and III are correct.

The correct answer is that the firm will face a severe liquidity strain due to the need to fund substantial margin calls on its futures positions. This scenario mirrors the classic Metallgesellschaft case. The firm has a long-term commitment (a long physical position) and is hedging it by selling short-term futures (a short financial position). When the price of oil drops sharply, the short futures positions incur significant mark-to-market losses. The futures exchange will demand immediate cash payments (margin calls) to cover these losses. While the firm’s long-term physical supply contract becomes more profitable, this profit is unrealized and will only be received in the future. The immediate, massive cash outflow required for margin calls creates a severe liquidity crisis that can threaten the firm’s solvency, even if the hedge is theoretically sound over its full term. The other options describe valid but less critical risks in this specific context. The basis risk that futures and spot prices do not move in perfect alignment is a genuine concern that affects the hedge’s effectiveness over time, but it is not the immediate, critical threat posed by a large, adverse price move. The counterparty risk of the airline defaulting is a separate business risk related to the underlying contract, not a direct consequence of the hedging strategy’s mechanics in a falling market. Finally, operational risk in executing the rollover is an ongoing risk, but the primary financial crisis here is triggered by the market price movement itself, not by an error in execution.

This question tests the understanding of the empirical rule for a normal distribution, a fundamental concept in statistics often applied in financial risk management. For a normally distributed set of data:

Statement I is correct: Approximately 68% of all observations fall within one standard deviation (plus or minus) of the mean.

Statement II is correct: Approximately 95% of all observations fall within two standard deviations (plus or minus) of the mean.

Statement III is correct: Approximately 99.7% of observations fall within three standard deviations of the mean. This implies that the remaining 0.3% of observations lie outside this range. Due to the symmetrical nature of the normal distribution, half of this tail probability (0.15%) corresponds to outcomes more than three standard deviations above the mean, and the other half (0.15%) corresponds to outcomes more than three standard deviations below the mean.

Statement IV is incorrect: The median of a normal distribution is equal to the mean, meaning 50% of returns are above the mean and 50% are below. However, the range within 0.5 standard deviations of the mean contains approximately 38.3% of the observations, not 50%. Therefore, statements I, II and III are correct.

The correct answer is The Bank for International Settlements (BIS). The BIS is uniquely positioned to fulfill the dual roles described in the scenario. Its primary functions include serving as a forum for international monetary and financial cooperation, where central bankers can meet to discuss policy coordination, such as harmonizing standards. Concurrently, it acts as a ‘bank for central banks,’ providing a wide range of financial services, which would include facilitating the operational aspects of currency swap lines and other transactions between its member central banks. The International Monetary Fund (IMF) primarily focuses on ensuring the stability of the international monetary system, providing financial assistance to countries with balance of payments problems, and conducting macroeconomic surveillance, rather than acting as a direct operational bank and meeting forum for central banks. The World Bank’s mandate is centered on providing financial and technical assistance to developing countries for long-term development projects and poverty reduction, which is distinct from central bank cooperation on monetary stability. The Financial Stability Board (FSB) is an international body that monitors and makes recommendations about the global financial system; while it is hosted by the BIS and promotes financial stability, it does not have the operational banking functions to act as an agent for transactions between central banks.

The correct answer is that the central bank would purchase government securities in the open market. This action is a core component of expansionary monetary policy known as open market operations. When a central bank buys government securities (like Exchange Fund Bills and Notes in Hong Kong) from commercial banks, it pays for them by crediting the banks’ accounts. This injection of cash into the banking system increases the supply of funds available for interbank lending, thereby putting downward pressure on short-term interest rates. Selling government securities would have the opposite effect; it would drain liquidity from the system as banks pay the central bank, causing short-term rates to rise. Announcing an increase in government expenditure is an example of fiscal policy, which influences the economy and potentially long-term interest rates, but it is not the direct tool used for managing short-term interbank liquidity. Raising the reserve requirements for licensed banks is a contractionary monetary policy tool that would reduce the amount of money banks can lend, thereby tightening liquidity and increasing interest rates, which is contrary to the stated objective.

In the Hong Kong exchange-traded derivatives market, a central counterparty (CCP) clearing system is in place to mitigate counterparty risk. For trades executed on the exchange, a designated clearing house, which is a subsidiary of Hong Kong Exchanges and Clearing Limited (HKEX), interposes itself between the buyer and the seller through a process called novation. This means the clearing house becomes the buyer to every seller and the seller to every buyer. Consequently, the direct link between the original trading parties is severed, and their contractual obligations are with the clearing house. The correct answer is that the designated HKEX clearing house ensures the performance of the contract. If the original seller defaults, the clearing house is legally obligated to fulfill the seller’s obligations to the investor, thereby protecting the investor from the seller’s failure. The brokerage firm that executed the trade acts as an agent or intermediary for the client but does not guarantee the performance of the exchange-cleared contract itself. The Stock Exchange of Hong Kong (SEHK) provides the trading platform and marketplace but is distinct from the clearing house that guarantees settlement. The original seller’s brokerage firm is also an intermediary and does not assume the counterparty risk, which is transferred to the central clearing house.

This question tests the understanding of the automatic adjustment mechanism of Hong Kong’s Linked Exchange Rate System (LERS) under the Currency Board arrangement, specifically during a period of capital outflow.

Statement I is correct. When the Hong Kong dollar weakens to the weak-side convertibility undertaking (currently HK$7.85 to US$1), the Hong Kong Monetary Authority (HKMA) is committed to intervene. It will buy Hong Kong dollars from licensed banks and sell them US dollars at this guaranteed rate to prevent the currency from weakening further.

Statement II is correct. The HKMA’s purchase of Hong Kong dollars is settled by debiting the clearing accounts that licensed banks maintain with the HKMA. This action directly reduces the sum of these balances, which is known as the Aggregate Balance. A contraction in the Aggregate Balance signifies a reduction in interbank liquidity.

Statement III is correct. A smaller Aggregate Balance means there is less money available in the interbank system. This tightening of liquidity leads to an increase in the cost of borrowing between banks, causing Hong Kong dollar interbank interest rates (such as HIBOR) to rise. This rise in interest rates is the core of the automatic adjustment mechanism, as it increases the attractiveness of holding HKD assets, thereby discouraging capital outflows and attracting inflows to stabilise the exchange rate.

Statement IV is incorrect. The Base Rate is the rate at which the HKMA provides overnight liquidity to banks. In a scenario of capital outflows and rising interbank rates, the Base Rate would be expected to rise, not fall. Lowering the Base Rate would inject liquidity and reduce borrowing costs, which would counteract the automatic adjustment mechanism and potentially exacerbate capital outflows. Therefore, statements I, II and III are correct.

The correct answer identifies that the most critical failure is the combination of inadequate segregation of duties and a remuneration system that encourages excessive short-term risk-taking. This scenario directly mirrors the key lessons from the Barings Bank collapse, where a single individual controlled both the trading and settlement functions, enabling the concealment of massive losses. It also reflects a central theme from the Enron case, where executive compensation schemes created powerful incentives to manipulate earnings for short-term personal gain. A sound internal control framework, as expected under the SFC’s Code of Conduct, mandates the separation of front-office (trading) and back-office (settlement, reporting) functions to prevent such conflicts and unauthorized activities. When this fundamental control is absent, and coupled with a high-pressure incentive structure, it creates a perfect environment for misconduct and catastrophic financial failure. While over-reliance on a single trader is a concentration risk, it is a business risk that can be managed with proper controls; the core issue here is the absence of those controls. Similarly, while compliance pre-approval and shareholder disclosure are important, they do not address the fundamental, post-trade structural weakness that allows for the potential manipulation of records and concealment of losses.

This question tests the fundamental economic functions of money. Statement I correctly describes money’s role as a ‘medium of exchange,’ which eliminates the need for a double coincidence of wants found in barter systems. Statement II accurately defines the ‘unit of account’ function, where money serves as a common denominator to measure and compare the value of goods, services, and assets. Statement III correctly identifies the ‘store of value’ function, meaning money can be held and retrieved later to be used for consumption, although its value can be eroded by inflation. Statement IV is incorrect; while people hope their savings will grow, money itself does not have an inherent function to generate a positive real return. In fact, inflation often causes cash to lose purchasing power over time. Generating a return is the primary objective of an investment, not a fundamental function of money. Therefore, statements I, II and III are correct.

The correct answer is that authorised capital represents the maximum amount of share capital the company is legally permitted to issue as per its constitutional documents. This figure, established during the company’s incorporation and specified in its prospectus, acts as a ceiling on the total nominal value of shares that can be created and offered to investors over time. It is distinct from the actual amount of capital raised in a specific offering. The amount of capital that will be raised immediately upon the completion of the IPO is known as the ‘issued’ or ‘subscribed’ capital, which is typically a portion of the total authorised capital. The total market value of the company’s shares after listing is its ‘market capitalisation’, a dynamic figure calculated by multiplying the share price by the number of issued shares. The nominal value of shares currently in circulation is a calculation based on the par value and the number of issued shares, but it does not represent the maximum limit for future issuance.

This question assesses the understanding of the distinct roles of the key subsidiaries under Hong Kong Exchanges and Clearing Ltd (HKEx). Statement I is correct as the Stock Exchange of Hong Kong (SEHK) is the primary operator of the securities market in Hong Kong, covering both initial public offerings (primary market) and subsequent trading (secondary market). Statement II is also correct; the Hong Kong Futures Exchange (HKFE) is the designated entity for trading futures and options contracts on various underlyings like indices and stocks. Statement III accurately describes the function of the Hong Kong Securities Clearing Company Limited (HKSCC), which acts as the central counterparty (CCP) and provides clearing, settlement, and depository services for securities traded on the SEHK, operating under the Central Clearing and Settlement System (CCASS). Statement IV is incorrect. While HKSCC is a crucial part of the market infrastructure, the responsibility for vetting listing applications and enforcing listing rules falls under the purview of the Listing Division of HKEx, which acts on behalf of the SEHK. Therefore, statements I, II and III are correct.

The correct answer is that a banker’s acceptance involves a bank guaranteeing payment, creating a three-party instrument, whereas commercial paper is a direct two-party promise between the issuer and the holder. The fundamental distinction lies in the credit enhancement provided by a financial institution. A banker’s acceptance (BA) originates as a time draft issued by a corporation, which is then ‘accepted’ by a bank. This acceptance signifies the bank’s unconditional promise to pay the face value at maturity, substituting the bank’s creditworthiness for the issuer’s. This creates a three-party relationship: the issuer (drawer), the accepting bank, and the holder. In contrast, commercial paper, also known as a promissory note, is a simple two-party instrument. It is a direct, and typically unsecured, promise from the issuing corporation (the borrower) to pay the holder (the lender) a specific sum on a future date. The credit risk is entirely dependent on the financial health of the issuing corporation without any third-party guarantee. One of the other statements is incorrect because it confuses the risk profiles; the bank guarantee makes a BA lower risk and thus trade at a lower yield than commercial paper. Another statement incorrectly describes the issuer; BAs are issued by corporations and accepted by banks, whereas Negotiable Certificates of Deposit (NCDs) are issued directly by banks to raise their own funds. Finally, the statement regarding purpose is inaccurate; commercial paper is used for short-term working capital needs, not long-term projects, and BAs are primarily for trade finance, not exclusively for interbank lending.

The correct answer is that a favorable credit rating can lead to lower borrowing costs and attract a broader range of institutional investors. For an issuer, a credit rating from a reputable agency serves as an independent assessment of its creditworthiness. A strong rating signals a lower probability of default, which increases investor confidence. This heightened confidence allows the issuer to offer the bond with a lower coupon rate (interest payment), thereby reducing its overall cost of borrowing. Furthermore, many institutional investors, such as pension funds and insurance companies, have investment mandates that restrict them to holding securities with a certain minimum credit rating. Therefore, obtaining a rating can significantly broaden the potential investor base, improving the liquidity and successful placement of the bond issue. It is incorrect to state that a rating serves as a formal guarantee of repayment. Credit ratings are opinions on relative credit risk and are not an insurance policy or a guarantee against default. Investors still bear the credit risk of the issuer. While a rating certainly assists the underwriting syndicate in their pricing and marketing efforts, this is a secondary effect. The primary financial advantage is for the issuer, who benefits directly from the improved market perception and resulting better financing terms. Finally, it is not a universal mandatory requirement from the Securities and Futures Commission (SFC) for all first-time corporate bond issuers to obtain a credit rating. While it is a standard market practice and often a practical necessity for a successful issuance, it is not a blanket regulatory obligation for every type of corporate debt offering.

A sound risk management process follows a logical sequence: 1) Identifying risk, 2) Measuring risk, 3) Managing risk, and 4) Monitoring risk. The foundational step, as outlined in the SFC’s Fund Manager Code of Conduct and general risk management principles, is to first gain a complete understanding of the business operations to accurately identify all relevant risks. In the given scenario, the firm’s business model has fundamentally changed, introducing new and potentially more significant risks beyond market risk, such as operational risk (e.g., errors in handling client instructions), legal risk (e.g., breach of fiduciary duty), and reputational risk (e.g., client complaints). Therefore, the correct initial action is to conduct a thorough analysis of the new business to identify this full spectrum of risks. The other options represent later stages of the process. Commissioning advanced models is part of ‘Measuring’ risk, which is ineffective if the correct risks have not been identified first. Implementing internal controls is a ‘Managing’ or mitigation strategy, which should be designed based on the identified and measured risks. Establishing a monitoring dashboard is part of the ‘Monitoring’ step, which occurs after risks have been identified, measured, and managed.

The correct answer is that Hong Kong’s most compelling strategic attributes for a global asset manager are its common law legal system and its role as a key conduit to Mainland China. The common law system, which is familiar to international institutions, provides a robust and predictable legal framework that fosters investor confidence, making it easier to attract global capital. Simultaneously, Hong Kong’s unique position and various cross-boundary schemes (like the Connect programmes) establish it as the principal gateway for international funds to access the vast and growing market in Mainland China, and for Chinese capital to be invested globally. This dual role directly addresses the strategic objectives of attracting international investment while tapping into the PRC market. While a favorable tax regime is an important benefit, it is more of an operational and cost consideration rather than the primary strategic driver for market access and investor confidence. Similarly, the availability of skilled professionals and administrative support is a crucial operational advantage, but it does not represent the core strategic value proposition related to capital flows and legal certainty. Focusing solely on the local high-net-worth market understates Hong Kong’s far more significant and unique role as an international financial centre that bridges global capital with opportunities in Mainland China.

The question tests the understanding of the clearing and settlement process for futures contracts in Hong Kong. Statement I is correct because the Hong Kong Futures Clearing Corporation Limited (HKCC) acts as the central counterparty for all trades executed on the Hong Kong Futures Exchange (HKFE), mitigating counterparty risk. Statement II is also correct as it accurately describes the process of novation, where the original bilateral contract is extinguished and replaced by two new contracts with the HKCC as the counterparty to both the original buyer and seller. Statement III is incorrect; while the HKFE is the exchange where trading occurs, it is the HKCC, the clearing house, that guarantees the settlement of all registered contracts, not the exchange itself. Statement IV is incorrect because the settlement of derivatives is highly automated through the Derivatives Clearing and Settlement System (DCASS), not handled manually. Furthermore, the Securities and Futures Commission (SFC) is the overall prudential regulator and does not manage the operational aspects of trade settlement. Therefore, statements I and II are correct.

Financial intermediaries play a crucial role in the effective functioning of financial markets. Statement I is correct because a primary function of intermediaries like asset managers is to pool investor funds and use their specialized expertise to measure, manage, and monitor investment risks. This effectively transfers the burden of complex risk management from individual investors to the specialist firm. Statement II is also correct as intermediaries benefit from economies of scale. By aggregating large volumes of transactions, they can negotiate lower brokerage fees and access more efficient trading infrastructure, spreading these costs and benefits across their client base. Statement IV is correct because large institutional intermediaries, through their frequent and high-volume trading, act as significant sources of liquidity. Their activities contribute to market depth, ensuring that there are consistently buyers and sellers available, which helps stabilize prices and allows for efficient execution of trades. Statement III is incorrect. A characteristic of an effective financial market is the free availability of information, often referred to as information symmetry. While intermediaries conduct proprietary research to gain an edge, their fundamental role is not to create or perpetuate information asymmetry in the market structure. An effective regulatory framework, such as that overseen by the SFC, promotes transparency and fair disclosure to ensure market integrity and investor confidence. Therefore, statements I, II and IV are correct.

Arbitrage is a strategy that involves exploiting price differences of identical or similar financial instruments in different markets or in different forms. Statement I is correct as the core of an arbitrage strategy is the simultaneous or near-simultaneous execution of offsetting trades (e.g., buying in one market and selling in another) to lock in a profit. Statement II is also correct because the entire premise of arbitrage is to capitalize on temporary price inefficiencies or discrepancies between markets. Statement IV is correct as the actions of arbitrageurs—buying the underpriced asset and selling the overpriced one—drive prices towards convergence, thereby enhancing overall market efficiency. Statement III is incorrect; a pure arbitrage strategy is designed to be theoretically risk-free in terms of market price movements because the profit is locked in at the moment of execution. The primary risks are operational or related to execution (e.g., one leg of the trade failing), not market risk from adverse price changes, which is characteristic of speculation. Therefore, statements I, II and IV are correct.

This question assesses the understanding of the key economic vulnerabilities that led to the 1997 Asian Financial Crisis. Statement I is correct because when a local currency devalues against the US dollar, it takes more of the local currency to repay a debt denominated in US dollars. This dramatically increases the real cost of debt servicing for local corporations, potentially leading to defaults. Statement II is also correct. When a local currency is pegged to a strengthening US dollar, the local currency effectively appreciates along with it against other world currencies. This makes the country’s exports more expensive and less competitive in international markets, leading to a slowdown in export growth. Statement III is incorrect; while a currency peg can provide short-term stability, it creates significant risk if the underlying economic fundamentals cannot support the fixed exchange rate. It does not insulate the economy but rather creates a point of catastrophic failure if the peg breaks. Statement IV is incorrect because the currency peg does not eliminate foreign exchange risk; it only masks it. The risk materializes if the peg is abandoned or revalued, which is precisely what happened during the crisis, causing immense financial distress for borrowers. Therefore, statements I and II are correct.

This question assesses the understanding of essential components for an effective market risk management system within a licensed corporation, as expected by the SFC. Statement I is correct because establishing and regularly reviewing trading and exposure limits is a fundamental tool for controlling market risk. Statement II is correct as the segregation of duties between the trading function (front office) and risk control/settlement functions (middle/back office) is a critical internal control to prevent unauthorized trading and ensure independent verification. Statement IV is correct because senior management requires timely, accurate, and comprehensive risk reports to make informed decisions and oversee the firm’s risk profile effectively. Statement III is incorrect; while an independent risk function is crucial, there is no regulatory requirement to outsource it, let alone to a single vendor. Relying on a single external vendor could introduce concentration risk. The principle is the independence and competence of the risk function, which can be achieved internally or through a well-managed outsourcing arrangement. Therefore, statements I, II and IV are correct.

Statement I is correct. Open market operations are a key tool of monetary policy. When a central bank sells government securities, it removes liquidity from the interbank market. This reduction in the supply of money makes borrowing more expensive for commercial banks, leading to an increase in short-term interest rates. Statement II is correct. Fiscal policy involves government spending and taxation. When a government runs a large budget deficit and finances it by issuing new long-term bonds, it increases the supply of those bonds in the market. To attract sufficient capital to purchase this increased supply, the government typically has to offer higher yields, which puts upward pressure on long-term interest rates. Statement III is incorrect. If investors expect higher inflation, they will demand a higher nominal yield on long-term bonds to compensate for the expected erosion of their purchasing power. This ensures their ‘real’ rate of return remains positive. Therefore, higher inflationary expectations lead to higher, not lower, bond yields. Statement IV is incorrect. Inflation caused by an increase in the costs of production, such as widespread wage hikes not supported by productivity gains, is known as cost-push inflation. Demand-pull inflation occurs when aggregate demand outstrips an economy’s productive capacity. Therefore, statements I and II are correct.

Effective corporate governance is fundamental to robust risk management within a licensed corporation. Statement II is correct because a key function of the board and senior management, under the principles of good corporate governance, is to ensure that the firm’s risk management framework, including its systems, processes, and procedures, is clearly defined and documented. This provides clarity, consistency, and a basis for audit and regulatory review. Statement III is also correct as corporate governance extends beyond formal policies to encompass the firm’s operating culture. A strong ‘tone from the top’ set by the board is crucial for embedding a risk-aware culture throughout the organisation. Statement I is incorrect because while the board can delegate the implementation of risk management tasks, it retains ultimate responsibility and oversight. Statement IV is incorrect because the risk-based supervisory approach used by regulators like the SFC and HKMA places significant emphasis on evaluating the quality and effectiveness of an institution’s internal risk management systems and corporate governance, rather than diminishing their importance in favour of quantitative metrics. Therefore, statements II and III are correct.

Statement I is correct. A primary effect of technology and globalisation is increased market efficiency. Real-time information systems and high-speed electronic trading allow price discrepancies between different markets or exchanges to be identified and exploited almost instantly. This rapid correction of prices significantly reduces or eliminates traditional arbitrage opportunities, which rely on exploiting these temporary price differences. Statement II is also correct. The shift to online trading and greater cross-border investment activity introduces new risks, such as cybersecurity threats, operational failures in electronic systems, and challenges in supervising activities across jurisdictions. Consequently, regulators like the Securities and Futures Commission (SFC) must evolve their regulatory frameworks, as seen in guidelines on electronic trading and internet-based activities, to ensure investor protection and market integrity. Statement III is incorrect. While international capital flows can bring benefits, they can also be destabilising. The provided study material explicitly cites the 1997-98 Asian Financial Crisis as an example where massive, short-term speculative capital flows led to severe currency devaluations and economic instability, directly contradicting the claim of exclusive stability. Statement IV is correct. As traditional, low-risk profit sources like arbitrage diminish due to market efficiency, financial institutions are compelled to innovate. They develop more complex, specialised, or niche products (e.g., structured products, sophisticated derivatives) to offer clients potential for higher returns and to maintain their own profitability and competitive advantage. Therefore, statements I, II and IV are correct.

This question tests the understanding of the difference between nominal interest rates and effective annual rates, particularly the impact of compounding frequency. The effective annual rate (EAR) reflects the true return on an investment when compounding occurs more than once a year. The formula for EAR is (1 + (i/n))^n – 1, where ‘i’ is the nominal annual rate and ‘n’ is the number of compounding periods per year.

For Option B, the certificate of deposit:
Nominal rate (i) = 8.00% or 0.08
Compounding periods (n) = 2 (semi-annually)

EAR = (1 + (0.08 / 2))^2 – 1
EAR = (1 + 0.04)^2 – 1
EAR = (1.04)^2 – 1
EAR = 1.0816 – 1
EAR = 0.0816 or 8.16%

Statement I is correct because the calculated effective annual rate for Option B is indeed 8.16%.

Statement II is correct because the effective return of Option B (8.16%) is higher than the simple annual return of Option A (8.10%). Therefore, Option B provides a superior yield over the one-year period.

Statement III is incorrect. It describes a simple interest scenario and completely ignores the principle of compounding, where interest is earned on previously paid interest, thus increasing the total return above the nominal rate.

Statement IV is incorrect. A direct comparison of a simple annual rate with a nominal rate that is subject to compounding is misleading. The compounding effect must be factored in to determine the true, or effective, return. Therefore, statements I and II are correct.

Statement I is correct as Hong Kong remains the premier offshore fundraising centre for Mainland Chinese companies seeking international capital through IPOs and debt issuance. It is also the world’s largest offshore Renminbi (RMB) hub, facilitating trade settlement, financing, and investment in the currency. Statement II is correct because Hong Kong’s economy is dominated by the services sector, particularly financial, legal, and professional services. These sectors provide crucial expertise and a mature regulatory framework that supports the international expansion and development of Mainland businesses. Statement III is correct. The various mutual market access schemes, including Stock Connect, Bond Connect, and Wealth Management Connect, are fundamental pillars of the financial integration between Hong Kong and the Mainland, enabling significant two-way investment flows. Statement IV is incorrect. While trade with the Mainland is substantial, Hong Kong’s economy has long transitioned from manufacturing-based to services-based. The export of locally manufactured goods is a very small component of its GDP compared to the contributions from financial services, trading, and logistics. Therefore, statements I, II and III are correct.