HKSI Paper 7 Preview (ENG) Set Two Set Two

The effective annual interest rate (EAR) reflects the true return on an investment when the effects of compounding are taken into account. Statement I is correct because the EAR calculation considers the compounding frequency. Statement II is incorrect; the stated annual interest rate, also known as the nominal interest rate, does not account for compounding. Statement III is correct because the EAR will always be equal to or greater than the nominal interest rate when compounding occurs more than once a year. Statement IV is incorrect; the EAR is particularly useful when comparing investments with different compounding frequencies, as it provides a standardized measure of return. The Securities and Futures Commission (SFC) emphasizes the importance of disclosing the effective interest rate to investors, as it provides a more accurate representation of the actual return they can expect, aligning with the principles of fair dealing and investor protection outlined in the Code of Conduct for Persons Licensed or Registered with the SFC. This ensures investors can make informed decisions based on a clear understanding of the investment’s true yield.

Credit risk centers on the possibility of financial loss stemming from a counterparty’s inability to meet their contractual obligations. This risk is inherent in lending scenarios, where the lender faces the prospect of the borrower defaulting on repayments. It also extends to over-the-counter (OTC) derivative contracts, where each party is exposed to the risk that the other will fail to fulfill their obligations. Settlement risk, a subset of credit risk, arises during the settlement of financial transactions. It occurs when one party fulfills their obligation, but the other party fails to do so due to delays or errors in the settlement process. Market risk, on the other hand, is the potential for loss due to changes in market prices or values. It encompasses both traded market risk, which arises from trading in financial securities, and non-traded market risk, which relates to mismatches between the pricing of assets and liabilities. Operational risk refers to the potential for loss resulting from inadequate or failed internal processes, people, and systems, or from external events. It is distinct from credit and market risks, focusing instead on internal and external factors that can disrupt operations and lead to financial losses. Legal risk is the risk of loss resulting from unenforceable contracts, lawsuits or adverse judgments. It is distinct from credit and market risks, focusing instead on the legal factors that can disrupt operations and lead to financial losses.

Statements I and II are correct. Eurobonds are indeed debt instruments issued in a currency different from the issuer’s home currency, and they are typically issued internationally, often bypassing domestic regulations. This international issuance allows for a broader investor base and potentially more favorable terms. Statement III is incorrect because while supranational bonds issued by entities like the World Bank or Asian Development Bank can offer tax advantages in some jurisdictions (like Hong Kong), this is not a universal characteristic. Tax treatment depends on the specific regulations of each jurisdiction. Statement IV is incorrect. While high net worth individuals and corporations may invest in Eurobonds, the issuers are typically large corporations, governments, or international organizations seeking to raise capital on a global scale. The term ‘Euro’ refers to the external nature of the bond issuance, not necessarily the currency (though many are denominated in Euros or US dollars). The Hong Kong Capital Markets Association provides information on supranational bonds, highlighting their role in the debt market and potential tax benefits in Hong Kong, as per local regulations.

Statement I is correct. The WTO’s principle of non-discrimination mandates that members treat all trading partners equally under the Most Favored Nation (MFN) principle. This means that a tariff concession granted to one member must be extended to all other members. Statement II is also correct. The Agreement on Safeguards allows a member to take ‘safeguard’ action to protect a specific domestic industry from an increase in imports of any product which is causing, or which threatens to cause, serious injury to that industry. These actions are temporary and should be applied only to the extent necessary to prevent or remedy the injury. Statement III is incorrect. While export subsidies are generally prohibited under WTO rules, there are exceptions, particularly for developing countries. These exceptions are subject to specific conditions and limitations. Statement IV is incorrect. While the WTO aims to reduce trade barriers, it does not mandate the complete elimination of all tariffs. Members retain the right to impose tariffs, provided they are applied in a non-discriminatory manner and are consistent with their WTO commitments. Therefore, the correct combination is I & II only.

Corporate governance, as it relates to risk management within financial institutions in Hong Kong, is primarily concerned with the oversight and control mechanisms implemented by the board of directors. The board’s role is to supervise management on behalf of the shareholders, ensuring that the company’s operations align with established risk management policies and regulatory requirements. This includes establishing credit and investment limits, documenting risk management procedures, and adhering to Listing Rules. Payment systems, such as the Real Time Gross Settlement (RTGS) system, are crucial for mitigating settlement risk in interbank transactions. RTGS ensures that banks’ net positions are settled intra-day, reducing the potential for systemic failures. The “payment versus payment” system further reduces foreign exchange settlement risk by linking different currency payment systems. Credit ratings, while important for assessing creditworthiness, are not the primary focus of corporate governance processes aimed at managing financial risks within a company. Instead, internal controls and risk management frameworks are the direct tools employed by the board and management to oversee and mitigate these risks. The Companies Ordinance and Listing Rules provide the regulatory backdrop for these governance practices, emphasizing the importance of transparency, accountability, and effective risk management within Hong Kong’s financial institutions.

I & II only: Statement I is correct because commercial paper, being a short-term debt instrument, is indeed typically issued at a discount. The investor’s return comes from the difference between the purchase price and the face value at maturity. Statement II is also correct as money market funds are a common investment vehicle for short-term debt securities due to their focus on liquidity and capital preservation. They provide investors with access to a diversified portfolio of short-term instruments. Statement III is incorrect because while long-term debt securities can be used to finance ongoing operational expenses, they are more commonly used for long-term investments such as capital expenditures or acquisitions. Statement IV is incorrect because regulators, such as the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC), primarily focus on ensuring market integrity, investor protection, and systemic stability, rather than directly participating in the trading of debt securities. Their role is supervisory and regulatory, not transactional. The SFC’s regulatory framework, for instance, oversees the activities of intermediaries in the debt market to maintain fair and transparent trading practices, as outlined in the Securities and Futures Ordinance.

To determine the best return among different interest rate options, it’s crucial to compare their effective annual rates (EAR), not just their nominal rates. The EAR accounts for the effect of compounding, which significantly impacts the actual return earned over a year. The formula to calculate the effective annual rate is: EAR = (1 + (nominal rate / number of compounding periods))^number of compounding periods – 1.

Option (a) offers a nominal rate of 8.00% paid semi-annually. This means the interest is compounded twice a year. Using the EAR formula, the calculation is: EAR = (1 + (0.08 / 2))^2 – 1 = (1 + 0.04)^2 – 1 = 1.0816 – 1 = 0.0816 or 8.16%.

Option (b) presents a nominal rate of 7.90% paid quarterly. Here, the interest is compounded four times a year. The EAR calculation is: EAR = (1 + (0.079 / 4))^4 – 1 = (1 + 0.01975)^4 – 1 = 1.0814 – 1 = 0.0814 or 8.14%.

Option (c) provides a nominal rate of 8.10% paid annually. Since the interest is compounded only once a year, the EAR is simply the nominal rate, which is 8.10%.

Option (d) offers a nominal rate of 7.80% paid monthly. In this case, the interest is compounded twelve times a year. The EAR calculation is: EAR = (1 + (0.078 / 12))^12 – 1 = (1 + 0.0065)^12 – 1 = 1.0809 – 1 = 0.0809 or 8.09%.

Comparing the EARs, option (a) yields the highest effective annual rate of 8.16%, making it the most favorable investment option among the choices provided. This analysis aligns with the principles of investment management and the importance of considering compounding frequency when evaluating returns, as emphasized in guidelines issued by the Hong Kong Securities and Futures Commission (SFC) regarding fair and transparent investment practices.

The Securities and Futures Ordinance (SFO) mandates that licensed corporations and registered institutions must diligently supervise their outsourced functions, ensuring compliance with regulatory requirements. This includes maintaining adequate systems and controls to mitigate risks associated with outsourcing. The SFO emphasizes the accountability of the regulated entity for the actions of its service providers. The entity must conduct thorough due diligence on potential service providers, including assessing their financial stability, operational capabilities, and compliance history. Ongoing monitoring of the service provider’s performance is crucial, with regular audits and reviews to identify and address any deficiencies. The outsourcing agreement should clearly define the roles, responsibilities, and liabilities of both parties, including provisions for data protection, confidentiality, and business continuity. The regulated entity must have the ability to terminate the agreement if the service provider fails to meet the required standards or comply with regulatory requirements. Furthermore, the regulated entity must ensure that it retains sufficient expertise and resources to effectively oversee the outsourced functions and manage any associated risks. The Hong Kong Monetary Authority (HKMA) also provides guidance on outsourcing for authorized institutions, emphasizing the importance of risk management and regulatory compliance. This framework ensures that outsourcing does not compromise the integrity and stability of the financial system in Hong Kong.

Statement I is correct because a decrease in profit tax rates generally incentivizes businesses to invest more, as it increases the after-tax return on investment. This aligns with standard economic principles and is a common expectation in fiscal policy. Statement II is correct because government subsidies in a specific industry can artificially boost the profitability of firms within that industry, at least in the short term. This is because subsidies reduce production costs or increase revenue, leading to higher profits. Statement III is correct because the introduction of exchange rate controls can indeed reduce foreign trade and investment. These controls often create inefficiencies and uncertainties, discouraging international transactions and potentially leading to economic contraction. Statement IV is correct because labor market reforms that lead to increased wages and productivity can significantly affect inflation and monetary policy. Higher wages, if not offset by increased productivity, can lead to inflationary pressures, prompting monetary authorities to adjust interest rates or other policy tools to manage inflation. Therefore, all the statements are correct and reflect potential impacts of regulatory and political factors on the economy, as discussed in the context of the HKSI exam’s focus on understanding economic influences on financial markets.

The privatisation of government-owned companies involves transferring ownership from the public sector to the private sector. Statement I is correct because one of the primary objectives of privatisation is to improve competitiveness and encourage economic efficiency by introducing market-driven practices. Statement II is also correct; governments often privatise to reduce public debt and increase public revenue through the sale of assets. Statement III is accurate as privatisation aims to broaden share ownership, thereby stimulating the stock market and encouraging private sector investment. Statement IV is also correct; privatisation can lead to enhanced economic competition, attract private sector savings, create new financing sources for companies, and allow the government to divest assets that can be more efficiently managed privately. The Securities and Futures Ordinance (SFO) in Hong Kong governs the regulatory framework for securities and futures contracts, including the issuance and trading of shares resulting from privatisation. The Listing Rules of the Hong Kong Stock Exchange also play a crucial role in regulating the listing and trading of newly privatised entities. These regulations ensure transparency, fair trading practices, and investor protection during and after the privatisation process.

The Hong Kong Interbank Offered Rate (HIBOR) serves as the official cash rate in Hong Kong, reflecting the average of quoted yields from a select group of authorized institutions. It is a crucial benchmark for pricing short-term securities. The 1-month and 3-month HIBOR rates are specifically used as benchmark interest rates. These rates are essential for determining the cost of borrowing and lending in the interbank market and influence the pricing of various financial instruments. The best lending rate, also known as the prime rate, is the rate at which authorized institutions lend to their customers, including corporations. This rate is influenced by HIBOR and reflects the overall cost of funds for the banks. Understanding the relationship between HIBOR, the prime rate, and the interbank money market is crucial for assessing the liquidity and stability of the financial system. The Hong Kong Monetary Authority (HKMA) plays a significant role in overseeing these rates and ensuring the smooth functioning of the interbank market. The daily setting of HIBOR at 11:00 am ensures transparency and provides a reliable reference point for market participants. The interbank money market allows authorized institutions to manage their liquidity positions and meet their settlement obligations with the HKMA. This market is a vital component of the overall financial infrastructure in Hong Kong.

Statement I is correct. Unlisted real estate investment trusts (REITs) are indeed considered the most illiquid form of investment among the options provided. Their shares are not traded on public exchanges, making it difficult to quickly convert them into cash. Finding a buyer for these shares can take a considerable amount of time, and the price may not always reflect the true underlying value of the assets. Statement II is also correct. Ordinary shares represent ownership in a company and are evidence of holding a portion of the company’s capital. Shareholders are entitled to a share of the company’s profits (dividends) and have voting rights in company matters. Statement III is incorrect. The description fits a bond, not an ordinary share. Bonds are debt instruments that represent a loan made by an investor to a borrower (typically a corporation or government). The bond issuer promises to repay the principal amount of the loan at a specified maturity date and to make periodic interest payments (coupon payments) to the bondholder. Statement IV is incorrect. While ordinary shares can be used as collateral, they are not primarily designed for that purpose. Their main function is to represent ownership and provide a return through dividends and capital appreciation. Therefore, only statements I and II are correct.

The availability of substitutes significantly impacts the elasticity of demand for a product. When numerous substitutes are available, consumers can easily switch to alternatives if the price of the original product increases, making demand more elastic. Statement I is correct because the presence of readily available alternatives empowers consumers to shift their preferences based on price fluctuations. Statement II is also correct; the more unique a product is, the fewer substitutes exist, leading to inelastic demand as consumers have limited options. Statement III is incorrect because a product with many substitutes will have a more elastic demand, not inelastic. Statement IV is correct; if a product is considered a necessity with few substitutes, consumers will continue to purchase it even if the price increases, indicating inelastic demand. Therefore, the correct combination is I, II, and IV.

Corporate finance is a critical area that focuses on maximizing shareholder value through strategic financial decisions. Statement I is correct because corporate finance indeed involves applying economic and financial principles to enhance a company’s overall value. This includes investment decisions, financing strategies, and dividend policies. Statement II is also correct; corporate finance plays a crucial role in addressing key strategic issues, such as mergers and acquisitions, capital budgeting, and restructuring. These decisions require a deep understanding of financial markets and their implications for the firm’s long-term success. Statement III is incorrect because the certification of financial statements falls under the purview of auditing, which is a separate function typically performed by external auditors to ensure the accuracy and reliability of financial reporting. Statement IV is incorrect as well; underwriting activities are typically conducted by investment banks, which assist companies in raising capital through the issuance of securities. While corporate finance professionals may interact with underwriters, they do not directly engage in underwriting activities themselves. Therefore, only statements I and II are correct.

The Exchange Fund’s primary objective, as outlined by the Hong Kong Monetary Authority (HKMA), is to maintain exchange rate stability, particularly within the linked exchange rate system with the US dollar. This is achieved through strategic management of the fund’s assets, predominantly foreign currency assets. Statement I is correct because the Exchange Fund’s investments are primarily in foreign currency assets, which form the bulk of Hong Kong’s foreign reserves. These assets are crucial for intervening in the foreign exchange market to maintain the HKD/USD exchange rate within its target band. Statement II is incorrect because while the Exchange Fund does hold government fiscal reserves from the General Revenue Account, this is not its sole component. The monetary base also forms a significant part of the Exchange Fund. Statement III is correct because the issuance of coins and banknotes in Hong Kong is backed by the Exchange Fund. Banks issuing banknotes are required to hold certificates of indebtedness, which are essentially claims on the Exchange Fund, ensuring that the currency in circulation is fully backed by assets held within the fund. This mechanism is a cornerstone of Hong Kong’s monetary stability. Statement IV is incorrect because the government’s fiscal reserves are not the sole determinant of the Exchange Fund’s total value. The fund’s performance, investment returns, and interventions in the foreign exchange market also significantly impact its overall value. Therefore, the correct combination is I & III only.

A risk-based supervisory framework, as adopted by the Hong Kong Monetary Authority (HKMA) following the Basel Committee’s guidelines, prioritizes the evaluation of an authorized institution’s risk management systems, processes, and procedures. This approach moves away from a one-size-fits-all model and focuses on the specific risks that each institution faces based on its activities, size, and complexity. The framework emphasizes forward-looking assessments to identify potential vulnerabilities before they materialize into significant problems. This includes evaluating the effectiveness of the institution’s internal controls, risk mitigation strategies, and overall governance structure in managing its risk profile. The goal is to ensure that institutions have adequate capital, liquidity, and risk management capabilities to withstand adverse economic conditions and maintain financial stability. Corporate governance plays a crucial role in supporting the risk management mechanism by providing oversight and accountability. Effective corporate governance ensures that risk management is integrated into the institution’s strategic decision-making process and that senior management is actively involved in identifying, assessing, and mitigating risks. It also promotes a strong risk culture throughout the organization, where employees are aware of their responsibilities in managing risks and are encouraged to escalate concerns. The documentation of risk management systems, processes, and procedures is an essential component of prudent corporate business practice, providing transparency and facilitating effective monitoring and control. This framework ultimately contributes to the stability of the financial system by promoting sound risk management practices and ensuring that institutions are resilient to shocks.

Equity-linked notes (ELNs) and HIBOR-linked deposits are structured products that combine features of debt instruments and options. Understanding their risk profiles is crucial for investors. ELNs expose investors to the credit risk of the issuer and the performance of the underlying equity. If the equity performs poorly, the investor may receive less than the principal amount. HIBOR-linked deposits are subject to interest rate risk, as fluctuations in HIBOR can affect the return. Both products may have limited liquidity compared to standard debt or equity instruments. Investors should carefully consider their risk tolerance and investment objectives before investing in these products. The Securities and Futures Commission (SFC) in Hong Kong emphasizes the importance of understanding the terms and conditions of structured products, including the embedded options and associated risks, as outlined in the Code of Conduct for Persons Licensed or Registered with the SFC. Distributors of these products must ensure that they are suitable for the investor, considering their knowledge, experience, and financial situation. The interbank market dynamics in Hong Kong, particularly concerning HIBOR, are influenced by factors such as liquidity conditions and regulatory policies, which can impact the returns on HIBOR-linked deposits. Investors should stay informed about these market dynamics to make informed investment decisions.

Convertible notes are debt instruments that can be converted into equity under certain conditions, offering investors a blend of debt and equity characteristics. They typically offer a fixed interest rate, providing a steady income stream, and the option to convert into ordinary shares at a predetermined conversion ratio. This conversion feature allows investors to benefit from potential equity upside.

Statement I is correct because convertible notes do indeed provide a fixed income stream through interest payments, similar to bonds, while also offering the potential for capital appreciation if the underlying equity performs well and the conversion option becomes valuable. This dual nature makes them attractive to investors seeking both stability and growth.

Statement II is incorrect. While convertible notes can be converted into ordinary shares, this conversion typically occurs at a predetermined ratio, not necessarily at the investor’s discretion at any time. The conversion terms are usually specified in the indenture agreement.

Statement III is correct because the conversion price is typically set at a premium to the market price of the underlying shares at the time of issuance. This premium reflects the investor’s willingness to accept a lower initial yield in exchange for the potential upside from equity conversion. It also protects existing shareholders from immediate dilution.

Statement IV is incorrect. While convertible notes can be complex, they are generally considered less complex than equity warrants. Equity warrants give the holder the right, but not the obligation, to purchase shares at a specific price within a certain timeframe, adding another layer of optionality and complexity. Convertible notes have a more straightforward conversion mechanism.

Therefore, the correct combination is I & III only.

Effective financial markets are characterized by several key attributes that contribute to their overall efficiency and stability. Liquidity refers to the ease with which assets can be bought or sold without causing significant price changes, ensuring that investors can readily enter or exit positions. Transparency implies that information about market conditions, prices, and trading volumes is readily available to all participants, fostering informed decision-making and reducing information asymmetry. Depth indicates the presence of numerous buyers and sellers at various price levels, allowing for large transactions to be executed without causing substantial price fluctuations. Breadth signifies the participation of a diverse range of market participants, including institutional investors, retail traders, and foreign entities, which enhances competition and reduces the potential for market manipulation. Resilience refers to the market’s ability to withstand shocks and disruptions, such as unexpected economic news or geopolitical events, without experiencing prolonged periods of instability. These characteristics collectively contribute to the efficient allocation of capital, the accurate pricing of assets, and the overall stability of the financial system, as highlighted in the introductory topic of the HKSI Paper 7 study manual. The absence of any of these characteristics can lead to market inefficiencies, increased volatility, and reduced investor confidence.

The Hong Kong Monetary Authority (HKMA) indeed has the primary objectives of maintaining a stable financial system, ensuring a sound and transparent banking system, and supervising authorized institutions. This is a cornerstone of Hong Kong’s financial regulatory framework, as outlined in the HKMA’s establishment ordinance and subsequent regulatory guidelines. Exchange rate stability in Hong Kong is maintained through the currency board system, which links the Hong Kong dollar to the US dollar within a narrow band. This mechanism is crucial for maintaining confidence in the Hong Kong dollar and attracting foreign investment. Liquidity management is achieved by the HKMA through various tools, including repurchase agreements with fully licensed and restricted licensed banks at discount rates. These agreements allow the HKMA to inject or withdraw liquidity from the market as needed to maintain stability. The General Revenue Account serves as the primary fund account for government revenue and expenditure, facilitating the financing of public services and infrastructure projects. Therefore, statements I, II, III, and IV are all correct.

The Exchange Fund Bills Programme, established in 1990, and the subsequent introduction of Exchange Fund Notes (EFNs) in 1993 by the Hong Kong Monetary Authority (HKMA), were pivotal in developing Hong Kong’s debt market. Exchange Fund Bills (EFBs) are short-term Hong Kong government debt securities, while EFNs are medium to long-term. Statement I is correct because the HKMA listed EFNs on the SEHK in 1997 to encourage retail investment and foster a more liquid debt market, aligning with the broader goal of market development. Statement II is incorrect because while EFBs were initially issued with maturities including 28-day bills to aid banks in managing liquidity within the Real Time Gross Settlement System, the demand decreased, leading the HKMA to reduce tap issues and shift towards longer-term EFNs. Statement III is correct because the introduction of EFBs and EFNs with varying maturities, ranging from short-term bills to longer-term notes (up to 10 years), aimed to diversify the available debt securities and establish a benchmark yield curve, enhancing liquidity. Statement IV is incorrect because the primary purpose of the Exchange Fund Bills Programme was to develop Hong Kong’s debt market and finance structured government debt securities, not specifically to fund infrastructure projects directly. Therefore, the correct combination is I & III only.

I, II, and IV are correct.

I. Short-term debt securities, such as commercial paper and treasury bills, are indeed characterized by their maturity periods typically lasting one year or less. This short-term nature makes them attractive for managing immediate liquidity needs.

II. Long-term debt securities, like bonds, generally have maturities exceeding one year. These securities are often used for long-term capital investments and strategic financial planning.

III. This statement is incorrect because regulators, such as the Securities and Futures Commission (SFC) in Hong Kong, play a crucial role in overseeing the debt market to ensure fair practices, investor protection, and market stability. They establish and enforce rules and guidelines that participants must adhere to.

IV. Industry associations and professional bodies, such as the Hong Kong Securities and Investment Institute (HKSII), contribute to the debt market by providing education, training, and professional development opportunities. They also promote ethical standards and best practices among market participants, enhancing the overall integrity and competence of the industry. These bodies often collaborate with regulators to improve market standards and investor confidence, as outlined in the Securities and Futures Ordinance (SFO).

The Metallgesellschaft (MG) case highlights critical lessons in financial risk management, particularly concerning derivatives and hedging strategies. MG’s downfall stemmed from hedging long-term exposures with short-term instruments, a mismatch that proved disastrous when market conditions shifted. The core issue was the ‘cost-of-carry’ relation, where rolling over short-term futures contracts inflicted substantial losses. This situation was exacerbated by a lack of understanding at the top management level regarding the hedging strategy’s true nature and associated risks. Quantifying the cash needs for the hedging program was also overlooked, leading to severe strain on MG’s cash reserves when oil prices moved unfavorably. Derivative dealers demanded additional collateral or terminated contracts, further compounding the problem. The Hong Kong government emphasizes financial risk management best practices through initiatives like the Steering Committee on the Enhancement of the Financial Infrastructure, aiming to prevent similar failures by promoting robust risk assessment and governance. These initiatives underscore the importance of aligning hedging strategies with organizational capabilities, maintaining adequate cash reserves, and ensuring management’s thorough understanding of complex financial instruments. The MG case serves as a cautionary tale, highlighting the potential for significant losses when these principles are disregarded, and the need for regulatory frameworks that promote sound risk management practices.

Statement I is correct because increased access to real-time information allows for quicker identification and management of economic imbalances. This aligns with the concept that economies are more readily contained due to better information flow. Statement II is correct as deregulation and innovation in financial and product markets enhance the efficiency of resource allocation and market responsiveness, contributing to economic resilience. This reduces the severity of cyclical episodes. Statement III is correct because globalization facilitates trade, borrowing, and lending across borders, fostering economic interdependence and stability. The efficient mobilization of funds, as mentioned, supports resource allocation. Statement IV is correct because sophisticated modern technology enables the efficient and fast mobilization of funds across borders and access to information and markets. This facilitates efficient resource allocation, contributing to economic resilience. Therefore, all statements are correct, reflecting factors that contribute to the increased resilience of modern economies. These factors help in containing economic imbalances and reducing the severity of cyclical episodes, as highlighted in the provided context. The mobility of funds, facilitated by globalization and technology, allows for efficient resource allocation but also poses risks of speculative capital flows, which need to be managed effectively.

Liquidity risk in fund management refers to the potential difficulty in selling an investment quickly at or near its fair market value. This risk is particularly pertinent in scenarios involving large redemptions or market downturns where selling assets might be necessary to meet investor demands or maintain fund stability. Option (a) directly addresses this core concern by focusing on the ability to meet redemption requests without significantly impacting the fund’s asset values. This is a primary measure of liquidity risk management. Options (b), (c), and (d) touch upon related aspects of fund management but do not directly encapsulate the essence of liquidity risk. While regulatory compliance, operational efficiency, and investment strategy are crucial, they are not the defining factors in assessing a fund’s ability to handle liquidity demands. A fund might have excellent compliance and strategy but still face liquidity issues if its assets are difficult to sell quickly. Therefore, the capacity to satisfy redemption requests without causing substantial losses is the most accurate indicator of effective liquidity risk management. This is especially important in Hong Kong’s financial market, where regulatory bodies like the Securities and Futures Commission (SFC) emphasize the importance of liquidity management to protect investors and maintain market stability, as outlined in the Fund Manager Code of Conduct.

The Code on Unit Trusts and Mutual Funds, as stipulated by the SFC, sets diversification standards to mitigate risk. Statement I is correct because the Code explicitly states that a fund cannot hold more than 10% of its net asset value in securities issued by a single issuer. This rule prevents over-exposure to any single company, thus reducing the impact of adverse events affecting that company. Statement II is also correct; the Code specifies that a fund cannot hold more than 10% of the ordinary shares issued by a single issuer. This prevents the fund from exerting undue influence over a company and ensures that the fund’s performance is not overly reliant on the performance of a single entity’s shares. Statement III is incorrect because while managed funds do offer access to a wide scope of securities with relatively low minimum investments, the typical exposure to 40 to 50 stocks is not a specific requirement outlined in the Code on Unit Trusts and Mutual Funds. This is more of a general benefit of investing in managed funds. Statement IV is incorrect because while fund managers may benefit from volume discounts, this is not a diversification requirement set by the SFC. The diversification requirements are primarily focused on limiting exposure to single issuers, not on cost benefits. Therefore, only statements I and II reflect the diversification requirements set by the SFC in the Code on Unit Trusts and Mutual Funds.

The Hong Kong Futures Exchange (HKFE) operates a fully automated trading system known as HKATS, which was implemented in June 2000. This system facilitates efficient and transparent trading of futures and options contracts. The Hong Kong Futures Clearing Corporation Limited (HKCC) plays a crucial role in clearing and settlement through the Derivatives Clearing and Settlement System (DCASS). A key function of the HKCC is to act as a central counterparty to all trades, guaranteeing settlement and mitigating counterparty risk. This is achieved through novation, where the original contract between the buyer and seller is replaced by two new contracts: one between the buyer and the HKCC, and another between the seller and the HKCC. This process ensures that the HKCC stands as the guarantor for both sides of the transaction, enhancing market stability and confidence. Statement I is correct as HKATS is indeed the automated trading system used by HKFE. Statement II is also correct as the HKCC does act as a central counterparty. Statement III is incorrect because the SFC provides overall prudential supervision, not direct operation of the HKATS. Statement IV is incorrect as the HKCC uses DCASS for clearing and settlement, not HKATS. Therefore, the correct combination is I & II only.

Statement I is correct because licensed banks, restricted licence banks, and deposit-taking companies represent the three distinct tiers of authorized institutions as defined under the Hong Kong regulatory framework. These institutions differ in their scope of permissible activities and the minimum asset requirements they must maintain, reflecting a tiered approach to banking regulation. Statement II is incorrect because fund houses, also known as fund managers, primarily focus on investing funds on behalf of investors, not on facilitating the trading of securities or futures. Brokerage houses are the entities that facilitate trading. Statement III is correct because the Hong Kong market is indeed influenced by a complex interplay of factors, including government monetary and fiscal policies, the economic conditions of major trading partners like the People’s Republic of China and the United States, regulatory and political trends, and technological advancements. These factors collectively shape market dynamics and investor sentiment. Statement IV is incorrect because technology, while fostering efficiency and transparency, also introduces globalization of risks. The ease of information flow and fund mobility can amplify the impact of adverse events originating in other markets, increasing systemic risk. Therefore, the correct combination is I & III only.

Statement I is correct because the Hong Kong foreign exchange market operates without strict exchange controls, allowing free conversion and transfer of funds, which facilitates international trade and investment. This is a key characteristic of a well-developed financial center like Hong Kong. Statement II is also correct. Arbitrage opportunities arise due to temporary price discrepancies of currencies across different markets. Participants exploit these differences to profit, contributing to market efficiency by quickly aligning prices. Statement III is incorrect. While derivatives can be used for hedging and speculation, their primary function is not solely for regulatory compliance. They serve a broader purpose in managing risk and expressing market views. Statement IV is incorrect. The Hong Kong derivatives market includes a wide array of instruments beyond just currency futures, such as interest rate swaps, options, and equity derivatives, catering to diverse risk management and investment needs. Therefore, the correct combination is I & II only.

The Asia-Pacific Economic Cooperation (APEC) is a regional economic forum established in 1989 to leverage the growing interdependence of the Asia-Pacific. APEC’s 21 members aim to create greater prosperity for the people of the region by promoting balanced, inclusive, sustainable, innovative, and secure growth and by accelerating regional economic integration. APEC works to reduce tariffs and other trade barriers across the Asia-Pacific region, creating efficient domestic economies and dramatically increasing international trade and investment. Decisions made within APEC are reached by consensus and commitments are undertaken on a voluntary basis. APEC’s structure is based on a non-binding, open dialogue and equal respect for the views of all participants. Unlike the World Trade Organization, APEC has no treaty obligations required of its participants. The commitment to open dialogue and voluntary cooperation allows APEC to be flexible and responsive to the evolving economic landscape of the Asia-Pacific region. The organization’s initiatives range from streamlining customs procedures and aligning regulatory standards to promoting sustainable development and addressing security challenges. APEC’s activities are primarily focused on trade facilitation, investment liberalization, and economic and technical cooperation. These efforts contribute to a more integrated and prosperous Asia-Pacific region, benefiting businesses and consumers alike. The voluntary nature of APEC agreements encourages member economies to implement reforms at their own pace, taking into account their specific circumstances and priorities. This approach fosters a sense of ownership and commitment, leading to more effective and sustainable outcomes. The APEC forum plays a crucial role in shaping the regional economic agenda and promoting cooperation among its diverse member economies.