Statement I is correct. The Trading Fee is set at 0.005% of the transaction consideration for each side of a trade and is payable to The Stock Exchange of Hong Kong Limited (SEHK). Statement II is incorrect. The Investor Compensation Levy of 0.002% has been suspended since 19 December 2005, as the net asset value of the Investor Compensation Fund exceeded the statutory threshold of HK$1.4 billion. It is not currently being collected. Statement III is correct. Stamp Duty is a statutory tax imposed by the HKSAR Government on stock transactions. As of the latest regulations, it is levied at a rate of 0.1% on the value of the transaction, payable by both the buyer and the seller. Statement IV is incorrect. The share registrar’s transfer fee of HK$2.50 per new share certificate is payable by the buyer, who is receiving the new certificate. The seller is responsible for the transfer deed stamp duty of HK$5.00. Therefore, statements I and III are correct.

A long put option gives the holder the right, but not the obligation, to sell an underlying asset at a predetermined strike price. The payoff depends on the relationship between the spot price of the underlying asset at expiration and the option’s strike price.

Statement I is correct. The net profit/loss is calculated as (Strike Price – Spot Price) – Premium. If the spot price is HK$40, the payoff is (HK$50 – HK$40) – HK$3 = HK$10 – HK$3 = HK$7 per share. The position is profitable.

Statement II is correct. When the spot price equals the strike price (at-the-money), the option expires worthless. The holder would not exercise the right to sell at HK$50 when the market price is also HK$50. Therefore, the loss is the full premium of HK$3 paid to acquire the option.

Statement III is correct. For any long option position (call or put), the maximum possible loss is the premium paid to purchase the option. This occurs if the option expires out-of-the-money (spot price is at or above the strike price for a put).

Statement IV is incorrect. The profit potential for a long put is substantial but not unlimited. The maximum profit is achieved if the underlying asset’s price falls to zero. In this scenario, the maximum profit would be (Strike Price – 0) – Premium = (HK$50 – 0) – HK$3 = HK$47 per share. Profit is capped because the stock price cannot fall below zero. Therefore, statements I, II and III are correct.

This question tests the application of several General Principles of the SFC’s Code of Conduct. Statement I is incorrect because simply executing an unsuitable order, even with documentation, violates the fundamental duty to act honestly, fairly, and in the best interests of the client (GP1: Honesty and Fairness) and with due skill, care, and diligence (GP2: Diligence). The suitability obligation is paramount. Statement II is a correct and necessary action, aligning with the principle of providing adequate ‘Information for clients’ (GP5) by ensuring the client understands the material risks involved. Statement III is also correct, as it addresses the ‘Conflicts of interest’ (GP6) principle by transparently disclosing the commission that could influence the representative’s advice. Statement IV represents the ultimate fulfillment of the representative’s duty. When a product is clearly unsuitable based on the ‘Information about clients’ (GP4), refusing the transaction is the most appropriate way to act in the client’s best interest and uphold market integrity. Therefore, statements II, III and IV are correct.

This question assesses the candidate’s understanding of common technical indicators used in financial market analysis. Statement I is correct; a ‘golden cross’ is a bullish technical pattern where a shorter-term moving average (e.g., 50-day) crosses above a longer-term moving average (e.g., 200-day), often interpreted as a signal of a potential major rally. Statement II is also correct; the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. A reading above 70, such as 85, is typically considered to indicate that a security is overbought and may be primed for a trend reversal or corrective price pullback. Statement III is correct as well; the Moving Average Convergence-Divergence (MACD) indicator is used to spot changes in the strength, direction, momentum, and duration of a trend. A bearish crossover occurs when the MACD line crosses below the signal line, suggesting that downward momentum is increasing. Statement IV is incorrect; an exponential moving average (EMA) gives more weight to recent prices, making it more responsive to new information than a simple moving average (SMA), which gives equal weight to all prices in the period. Therefore, statements I, II and III are correct.

The correct answer is HKD 186,140. The theoretical fair value, or price, of a bond is calculated by finding the present value of all its expected future cash flows. These cash flows consist of the periodic coupon payments and the final repayment of the principal (par value) at maturity. The discount rate used for this calculation is the current market yield for comparable bonds, not the bond’s own coupon rate. The calculation is as follows:
– Par Value (FV) = HKD 200,000
– Annual Coupon Payment (C) = 4% of HKD 200,000 = HKD 8,000
– Years to Maturity (n) = 4
– Market Yield (r) = 6% or 0.06 The price is the sum of the present values of each cash flow:
Price = [C / (1+r)^1] + [C / (1+r)^2] + [C / (1+r)^3] + [C / (1+r)^4] + [FV / (1+r)^4]
Price = [8,000 / (1.06)^1] + [8,000 / (1.06)^2] + [8,000 / (1.06)^3] + [8,000 / (1.06)^4] + [200,000 / (1.06)^4]
Price = 7,547.17 + 7,119.97 + 6,716.95 + 6,336.75 + 158,418.71 = HKD 186,139.55, which rounds to HKD 186,140. An answer of HKD 200,000 is incorrect because it mistakenly assumes the bond trades at par. A bond’s price equals its par value only when its coupon rate is the same as the market yield. In this case, the market yield (6%) is higher than the coupon rate (4%), so the bond must trade at a discount to its par value. An answer of HKD 232,000 is incorrect. This figure is the simple, undiscounted sum of all future cash flows (4 coupon payments of HKD 8,000 plus the HKD 200,000 principal). This calculation completely ignores the time value of money, a fundamental concept in valuation. An answer of HKD 190,419 is incorrect. This value is derived from correctly discounting the final principal payment but failing to discount the interim annual coupon payments. All future cash flows, including coupons, must be discounted to their present value.

This question tests the understanding of order execution for Limit Orders and Enhanced Limit Orders (ELO) under the trading rules of the Hong Kong Stock Exchange. Let’s analyze the outcome of each order sequentially against the initial order book.

Initial Order Book:
– Bid: 150,000 @ $2.11, 100,000 @ $2.10, 300,000 @ $2.09
– Ask: 100,000 @ $2.12, 200,000 @ $2.13

1. Order 1: Buy 50,000 @ $2.12 (Limit Order)
– A limit buy order at $2.12 will match with the best available ask price if it is at or below $2.12.
– The best ask is 100,000 shares at $2.12.
– Execution: 50,000 shares are bought at $2.12. The ask queue at $2.12 now has 50,000 shares remaining.

2. Order 2: Buy 150,000 @ $2.13 (Enhanced Limit Order)
– An ELO can match with up to 10 price queues simultaneously, as long as the prices are at or better than the limit price ($2.13).
– It first matches the best ask: 50,000 shares @ $2.12.
– It then matches the next best ask: 100,000 shares @ $2.13 (out of the 200,000 available).
– Execution: The order is fully filled (50,000 + 100,000 = 150,000). The ask queue at $2.12 is now empty, and the ask queue at $2.13 has 100,000 shares remaining.

3. Order 3: Sell 100,000 @ $2.12 (Limit Order)
– A limit sell order at $2.12 will only match with a bid price at or above $2.12.
– The current best bid is $2.11.
– Execution: No match occurs. The order is placed in the book, creating a new ask queue of 100,000 shares at $2.12.

4. Order 4: Sell 300,000 @ $2.09 (Enhanced Limit Order)
– An ELO sell order at $2.09 will match with bid prices at or better (higher) than $2.09.
– It matches the best bid: 150,000 shares @ $2.11.
– It matches the next best bid: 100,000 shares @ $2.10.
– It needs to sell 50,000 more shares. It matches 50,000 shares from the bid queue at $2.09.
– Execution: The order is fully filled across three price levels ($2.11, $2.10, and $2.09).

Now let’s evaluate the statements:
– Statement I: Correct. The second order (ELO buy) was filled with 50,000 shares from the $2.12 queue and 100,000 shares from the $2.13 queue.
– Statement II: Correct. The third order (limit sell) could not match the best bid of $2.11 and was therefore placed in the order book.
– Statement III: Incorrect. The fourth order completely consumed the bid queues at $2.11 and $2.10. The new best bid price after all orders are processed is $2.09 (with 250,000 shares remaining).
– Statement IV: Correct. The fourth order (ELO sell) was executed against the bid queues at $2.11, $2.10, and $2.09. Therefore, statements I, II and IV are correct.

The correct answer is that the fund manager is employing a bottom-up analysis. This analytical approach begins with a micro-level focus on a specific company. The manager’s initial steps—examining financial statements, management quality, and product pipelines—are all company-specific fundamental factors. This method seeks to identify strong individual companies first, with the broader industry and macroeconomic conditions being secondary considerations. In contrast, a top-down analysis would have started with an assessment of macroeconomic trends, such as global economic growth or interest rate policies, before narrowing the focus to specific industries and then finally to individual companies. Technical analysis is incorrect as it involves studying market data like price charts and trading volumes, not the fundamental financial health of a business. While the process involves numbers, describing it merely as quantitative analysis is incomplete; it fails to capture the specific micro-to-macro sequence which is the defining characteristic of the bottom-up framework.

The interest coverage ratio is a key metric used to assess a company’s ability to meet its interest obligations on outstanding debt. It is calculated as Earnings Before Interest and Taxes (EBIT) divided by Interest Expense. Statement I is correct because a higher or increasing ratio indicates that a company is generating more earnings from its core operations relative to its interest expense, thus strengthening its capacity to service its debt. Statement III is also correct; it highlights a fundamental limitation of ratio analysis. Financial ratios are derived from historical financial statements, which are based on past performance and accrual accounting. They do not guarantee future performance or a company’s prospective cash-generating ability. Statement II is incorrect because the numerator in the interest coverage ratio is EBIT, not net profit after tax. Using net profit would be conceptually wrong as it is the profit remaining after both interest and tax have already been deducted. Statement IV is incorrect because a strong financial ratio is an indicator of financial health, not an absolute guarantee against default. A company could still face a sudden liquidity crisis or other operational issues that prevent it from making a payment, despite having strong historical profitability. Therefore, statements I and III are correct.

The Hang Seng Index (HSI) methodology includes a capping mechanism to prevent any single constituent stock from dominating the index. During regular quarterly rebalancing, if a stock’s natural weighting exceeds the prescribed cap (e.g., 15%), its Capping Factor (CF) is adjusted downwards to bring its effective weighting back to the cap limit. This makes statement I correct. To ensure that this technical adjustment of the CF does not create an artificial discontinuity (a jump or drop) in the index level from one day to the next, the aggregate market capitalization from the previous day (used as the divisor in the index calculation) is adjusted. This process maintains the continuity of the index. This makes statement II correct. Statement III is incorrect because the Freefloat-adjusted Factor (FAF) reflects the proportion of shares available for public trading and is determined separately from the capping mechanism; the CF is the specific tool used to enforce the weighting cap. Statement IV is incorrect as only the CF of the stock exceeding the cap is adjusted; other constituents’ CFs are not necessarily reset to 1, especially if they are also subject to capping. Therefore, statements I and II are correct.

Statement I is a correct interpretation. A quick ratio below 1.0, such as Company A’s 0.8, signifies that the company’s most liquid assets (current assets minus inventory) are insufficient to cover its current liabilities. This suggests a potential reliance on selling inventory to meet short-term obligations, which can be a liquidity risk. Statement III is also correct. The quick ratio, or acid-test ratio, is inherently a more stringent measure of a company’s liquidity than the current ratio. By excluding inventory—which can be illiquid and difficult to convert to cash at its book value, especially during an economic downturn—it provides a more conservative view of a firm’s ability to pay its immediate debts. Statement II is an incorrect generalization. The nature of the business heavily influences the ideal inventory turnover rate. For a luxury watchmaker like Company B, inventory consists of high-value, low-volume items that are expected to sell slowly. A low turnover rate is typical for this industry and not necessarily a sign of poor management. Statement IV is incorrect. While high inventory turnover often indicates operational efficiency, it does not guarantee superior profitability. Company A’s fast-fashion items likely have very slim profit margins, whereas Company B’s luxury watches could have substantial margins, potentially leading to higher overall profit despite slower sales. Therefore, statements I and III are correct.

Statement I is correct because in an inflationary environment, households anticipate that prices, particularly for durable goods like cars and appliances, will be higher in the future. To preserve their purchasing power, they may accelerate these purchases, leading to a short-term increase in consumption. Statement II is also correct. Central banks typically combat inflation by raising nominal interest rates. Higher interest rates increase borrowing costs for companies, which can squeeze profit margins and reduce their incentive to invest in new projects. This can negatively affect stock market performance. Statement III is correct as well. Over the long term, equities are often considered a hedge against inflation because company revenues and earnings tend to grow with the general price level, which can protect the real value of an investment, unlike fixed-income instruments like bonds whose fixed payments are eroded by inflation. Statement IV is incorrect. A key characteristic of economic or business cycles is that their length and amplitude are irregular and vary, making them difficult to predict, regardless of the inflationary environment. Therefore, statements I, II and III are correct.

The correct course of action is to allow the option to expire worthless. A call option gives the holder the right, but not the obligation, to buy the underlying asset at a predetermined strike price. This right is only valuable if the market price of the asset is higher than the strike price. In this scenario, the strike price is HK$60, but the stock is only trading at HK$52. This is known as an ‘out-of-the-money’ option. Exercising the option would mean paying HK$60 for a share that could be purchased on the open market for HK$52, resulting in an immediate loss of HK$8 per share. Therefore, a rational investor would not exercise the option. Since the option is about to expire and is significantly out-of-the-money, its time value is negligible, and it has no intrinsic value. The most financially sound decision is to do nothing and let the option contract expire, limiting the total loss to the premium that was originally paid for it. It is incorrect to exercise the option, as this would lock in a guaranteed loss greater than the premium paid. It is also incorrect to suggest exercising and then immediately selling the shares, as this action also crystallizes an HK$8 per share loss. Selling the underlying shares short is a separate bearish strategy and does not address the decision regarding the existing long call option position.

The correct answer is that a trader mistakenly entering an order to sell 1,000,000 shares instead of 100,000 is an example of operational risk. Operational risk, as defined by regulatory bodies like the SFC, is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events. This scenario directly involves a failure in an internal process (order entry) and human error, which are central components of operational risk. The ‘Management, Supervision and Internal Control Guidelines’ mandate that licensed corporations establish and maintain effective procedures to manage such risks. The other options describe different, distinct types of financial risk. A decline in a bond portfolio’s value due to interest rate changes is an example of market risk, which is the risk of losses arising from movements in market prices. A client defaulting on a payment obligation represents credit risk (or counterparty risk), which is the risk that a counterparty will be unable to meet its financial commitments. Facing difficulty in selling an illiquid asset to meet obligations is an example of liquidity risk, which is the risk that a firm cannot meet its short-term financial demands without incurring substantial losses.

The value of a European call option using the one-period binomial model is found by calculating the expected future payoff in a risk-neutral world and then discounting it back to the present value using the risk-free rate. The process involves several steps: 1. Identify Parameters: From the scenario, the current stock price (S) is HK$80, the strike price (X) is HK$85, and the risk-free rate (r) is 3% or 0.03. The future possible stock prices are HK$100 (up-state, Su) and HK$70 (down-state, Sd). 2. Calculate Option Payoffs: Determine the option’s intrinsic value at expiration for each state. Up-state payoff (Cu) = max(Su – X, 0) = max(100 – 85, 0) = HK$15. Down-state payoff (Cd) = max(Sd – X, 0) = max(70 – 85, 0) = HK$0. 3. Calculate Risk-Neutral Probability (p): This is the probability of an upward movement in a world where all assets are expected to grow at the risk-free rate. First, determine the movement factors: u = Su/S = 100/80 = 1.25 and d = Sd/S = 70/80 = 0.875. Then, use the formula: p = ( (1 + r) – d ) / ( u – d ) = ( (1 + 0.03) – 0.875 ) / ( 1.25 – 0.875 ) = (1.03 – 0.875) / 0.375 = 0.155 / 0.375 ≈ 0.4133. 4. Calculate Option Value: The option’s current value (C) is the discounted expected payoff: C = [ p Cu + (1 – p) Cd ] / ( 1 + r ) = [ 0.4133 15 + (1 – 0.4133) 0 ] / 1.03 = (6.20) / 1.03 ≈ HK$6.02. The correct answer is therefore approximately HK$6.02. An answer of HK$6.20 incorrectly omits the final step of discounting the expected future payoff to its present value. An answer of HK$7.28 is derived from incorrectly assuming a simple 50% probability for the up and down movements instead of calculating the specific risk-neutral probability. An answer of HK$8.54 represents the value of a European put option with the same terms, not a call option, as it is calculated using the put payoff formula.

This question assesses the understanding of conflicts of interest related to research analyst independence, a key concern for regulators like the SFC. Statement I correctly identifies the fundamental conflict: the analyst’s duty to provide objective research for investors can be at odds with the firm’s desire to maintain a profitable corporate finance relationship with the subject company. Statement II is also correct; pressuring an analyst to change a report to favour a corporate client is a failure to act honestly, fairly, and in the best interests of the investing clients who rely on that research, which contravenes General Principle 1 of the SFC’s Code of Conduct. Statement IV accurately points out a primary regulatory expectation. The SFC requires licensed corporations to establish and maintain effective internal controls, commonly known as ‘Chinese Walls’, to insulate research departments from the influence of corporate finance and other business lines to ensure objectivity. Statement III is incorrect. While disclosure of a conflict of interest is mandatory, it is not sufficient on its own to resolve or eliminate the conflict. The firm must have robust policies and procedures in place to actively manage the conflict, with disclosure being just one component of the overall control framework. Therefore, statements I, II and IV are correct.

Statement I is correct. The Hong Kong stock market is consistently ranked among the top exchanges globally by market capitalization, establishing it as a premier international financial centre. Statement II is correct. The market is diversified across multiple sectors as classified by Hang Seng Indexes Company Limited, including financials, properties & construction, energy, and information technology, among others. This diversification prevents over-concentration in any single industry. Statement III is correct. A key feature of the Hong Kong market, particularly for blue-chip stocks, is its high liquidity, which is evidenced by substantial daily turnover and narrow bid-ask spreads, allowing investors to execute large trades efficiently. Statement IV is incorrect. While Hong Kong has notable local conglomerates, a significant and dominant portion of the market’s capitalization and trading activity is derived from Mainland Chinese enterprises, including H-shares and Red Chip companies. Therefore, statements I, II and III are correct.

The correct answer is that the notice must include a statement that it appears for information purposes only and does not constitute an invitation or offer to acquire, purchase, or subscribe for the debt securities. According to Chapter 25 of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (SEHK), this disclaimer is a mandatory component of a formal notice for debt securities. Its purpose is to clearly distinguish the notice from a formal offer document (like a prospectus or listing document) and to manage legal and regulatory risks associated with public announcements. While other pieces of information are important to investors, they are not all required in the formal notice itself. A detailed risk factor analysis, the issuer’s historical financial statements, and the specific interest payment schedule are all critical disclosures found within the main listing document, but the Listing Rules do not mandate their inclusion in the summary formal notice.

The standard formula for a market capitalization-weighted index is designed to reflect the percentage change in the total market value of its constituent stocks from one day to the next. Statement I is correct because the ratio (Today’s Market Cap / Yesterday’s Market Cap) represents the daily market movement as a factor. Multiplying this factor by ‘Yesterday’s Closing Index’ applies this daily change to the existing index level, effectively using it as the base for the day’s calculation. Statement II is also correct; this linking mechanism ensures the index is a continuous series, reflecting cumulative performance over its history rather than being a standalone daily figure. This allows for meaningful long-term trend analysis. Statement III is incorrect. Corporate actions like stock splits or rights issues are typically handled by adjusting the market capitalization figure or a separate index divisor, not by the ‘Yesterday’s Closing Index’ component. The purpose of such adjustments is to ensure these non-market events do not artificially skew the index value. Statement IV is incorrect. The transition from a full market capitalization to a freefloat-adjusted methodology changes how the market capitalization of each constituent is calculated, but it does not alter the fundamental principle of applying the daily percentage change to the previous day’s closing index. This core structure remains the same. Therefore, statements I and II are correct.

This question assesses the understanding of key option Greeks (Gamma, Vega, and Theta) in a portfolio management context.
Statement I is correct. Gamma measures the rate of change of an option’s delta in response to a one-unit change in the underlying asset’s price. A large positive gamma signifies that the portfolio’s delta is very sensitive to price movements, requiring the manager to adjust the hedge frequently to maintain a desired delta level (e.g., delta-neutral).
Statement II is correct. Vega measures an option’s sensitivity to changes in the implied volatility of the underlying asset. A portfolio with a positive vega will gain value if implied volatility increases, holding all other factors constant. Therefore, anticipating an event that will increase volatility makes a positive vega position desirable.
Statement III is correct. Theta, often called time decay, measures the rate at which an option’s value declines as time passes. A negative theta indicates the amount of value an option position will lose each day, assuming the underlying’s price and volatility do not change. This is a key risk for holders of long option positions.
Statement IV is incorrect. A small gamma value implies that the portfolio’s delta is stable and changes slowly with the underlying price. However, it does not mean the portfolio’s value is insensitive to the underlying’s price. The portfolio’s value sensitivity to the underlying’s price is measured by delta, not gamma. A portfolio can have a small gamma but a large delta, making its value very sensitive to price changes. Therefore, statements I, II and III are correct.

The correct answer is the price calculated by applying the percentage change derived from the modified duration. Modified duration measures the approximate percentage change in a bond’s price for a 1% change in its yield. The relationship between bond price and yield is inverse. First, calculate the expected percentage price change: Approximate % Price Change = – (Modified Duration) × (Change in Yield). The change in yield is an increase of 50 basis points, which is +0.50% or +0.005. Therefore, the approximate percentage price change is -8.0 × 0.005 = -0.04, or a 4% decrease. Next, apply this percentage change to the current bond price: $10,500 × (-0.04) = -$420. The new approximate price is the original price minus this change: $10,500 – $420 = $10,080. An answer of $10,920 incorrectly adds the price change, failing to recognize the inverse relationship between price and yield. An answer of $6,300 results from a significant calculation error, likely misinterpreting 50 basis points as 5% instead of 0.5%. An answer of $10,496 results from an incorrect calculation method, perhaps by subtracting the product of duration and basis points directly from the price without converting it to a percentage of the price.

This question tests the understanding of the key determinants of a European call option’s price, as described by models like the Black-Scholes-Merton model. Each factor has a distinct impact on the option’s value.

I: An increase in the expected volatility of the underlying equity’s price will increase the value of a call option. Higher volatility means a greater probability of large price swings. Since a call option holder has unlimited upside potential but limited downside (the premium paid), greater volatility increases the chance of the option finishing deep in-the-money, thus making it more valuable. This statement is correct.

II: A reduction in the risk-free interest rate will decrease the value of a call option. The strike price is a future payment. A lower interest rate increases the present value of this future payment, making the right to buy the stock less attractive. Therefore, a lower risk-free rate reduces the call option’s premium. This statement is incorrect.

III: An increase in the time remaining until the option’s expiry will increase the value of a call option. More time provides a greater opportunity for the underlying stock’s price to rise above the strike price. This additional time value makes the option more valuable. This statement is correct.

IV: An increase in the option’s exercise (strike) price will decrease the value of a call option. A higher strike price makes it more difficult for the stock price to exceed it, reducing the probability that the option will be exercised profitably (in-the-money). This makes the option less valuable. This statement is incorrect. Therefore, statements I and III are correct.

The explanation addresses the core concepts of nominal versus real interest rates. Statement I is correct because the coupon rate on a bond is its nominal interest rate, which is the stated rate before any adjustment for inflation. Statement II is correct as it correctly applies the approximation formula for the real interest rate: Real Interest Rate ≈ Nominal Interest Rate – Inflation Rate (4% – 2.5% = 1.5%). Statement III is also correct; if inflation (e.g., 5%) exceeds the nominal rate (4%), the real rate of return becomes negative (-1%), signifying that the investment’s return is not keeping pace with the rising cost of living, resulting in a loss of purchasing power. Statement IV is incorrect because yield curves are standardly constructed by plotting the nominal yields of bonds of the same credit quality against their respective maturities, not their real interest rates. Therefore, statements I, II and III are correct.

Return on Equity (ROE) is a fundamental profitability ratio that measures how much profit a company generates with the money shareholders have invested. Statement I is correct as ROE directly assesses management’s efficiency in using equity financing to generate earnings. Statement II is also correct because ROE can be artificially inflated by high financial leverage (i.e., a high debt-to-equity ratio). While a high ROE seems positive, if it is driven by excessive debt rather than operational efficiency, it indicates higher financial risk. Statement III is correct because financial ratios are most meaningful when used for comparison. Benchmarking a company’s ROE against its direct competitors and the industry average provides crucial context for evaluating its performance. Statement IV is incorrect; ROE is a measure of profitability, not liquidity. A company’s ability to meet short-term obligations is measured by liquidity ratios, such as the current ratio or quick ratio. A profitable company can still face a liquidity crisis. Therefore, statements I, II and III are correct.

Statement I is correct. The Macaulay duration of a zero-coupon bond is equal to its time to maturity, as there is only one cash flow at the end. For a coupon-paying bond, the interim coupon payments mean that the weighted-average time to receive cash flows is always less than its time to maturity. Therefore, given the same maturity, the zero-coupon bond will have a longer Macaulay duration. Statement II is correct. A higher coupon rate means that a larger portion of the bond’s total cash flows is received earlier in the bond’s life. This shifts the weight of the cash flows towards the present, resulting in a shorter weighted-average maturity, and thus a shorter Macaulay duration. Statement III is incorrect. An increase in a bond’s yield-to-maturity (YTM) means future cash flows are discounted at a higher rate. This reduces the present value of distant cash flows more than it reduces the present value of nearer cash flows, effectively giving more weight to the earlier payments. Consequently, the Macaulay duration decreases. Statement IV is incorrect. This statement describes modified duration, which is a measure of price sensitivity. Macaulay duration is the weighted-average time (in years) until a bond’s cash flows are received and is a key input for calculating modified duration, but it is not itself a measure of percentage price change. Therefore, statements I and II are correct.

The Capital Asset Pricing Model (CAPM) is a fundamental concept in finance used to determine the required rate of return for an asset. The formula is R = Rf + β(Rm – Rf).

Statement I is correct. Beta (β) measures the systematic risk of a security in relation to the overall market. A beta greater than 1, such as 1.3, indicates that the stock is more volatile than the market and is expected to have a higher return (or loss) for a given market movement. Therefore, it carries a higher level of systematic risk.

Statement II is incorrect. The risk-free rate (Rf) represents the return on an investment with zero risk. In practice, this is typically proxied by the yield on government securities (e.g., Hong Kong Exchange Fund Bills or US Treasury bills), not high-risk corporate bonds, which carry credit risk.

Statement III is incorrect. The primary output of the CAPM is the required or expected rate of return on an asset (R). This rate is then often used as the discount rate in other valuation models, such as the Dividend Discount Model (DDM), to calculate a stock’s intrinsic value. CAPM itself does not directly calculate the value.

Statement IV is correct. According to the CAPM formula, the required return (R) is positively related to the expected market return (Rm). If Rm increases while the risk-free rate (Rf) and beta (β) remain constant, the market risk premium (Rm – Rf) will increase, leading to a higher calculated required rate of return for the stock. Therefore, statements I and IV are correct.

An inverted or negative yield curve occurs when short-term interest rates are higher than long-term interest rates. This directly validates statement I. This market condition is often interpreted as a leading indicator of a potential economic slowdown or recession, as it suggests that market participants expect interest rates and inflation to fall in the future. Therefore, statement II, which suggests expectations of economic expansion and rising inflation, is incorrect. The expectation of falling future rates often implies that the central bank may cut interest rates to stimulate a sluggish economy, making statement III a correct interpretation. For investors, an inverted yield curve presents an opportunity to lock in relatively higher long-term yields before they decline. A common strategy is to lengthen the maturity (or duration) of their bond portfolios, which aligns with the advice in statement IV. Therefore, statements I, III and IV are correct.

The correct answer is the Freefloat Adjusted Factor (FAF). In calculating a freefloat-adjusted market capitalization-weighted index, the goal is to reflect the value of shares that are actually available for public trading, not the company’s total theoretical value. The total market capitalization is calculated by multiplying the total issued shares by the closing price. However, this figure includes shares held by strategic investors, governments, or company insiders, which are not readily available on the open market. To determine the ‘investable’ market capitalization, this total figure is multiplied by the Freefloat Adjusted Factor (FAF), which is a percentage representing the proportion of shares considered to be in public hands. This adjustment ensures that the weight of a constituent stock in the index is proportional to its actual influence and availability in the market. The total number of issued shares is a necessary component for calculating the full market capitalization, but on its own, it does not account for non-tradable blocks of shares and therefore doesn’t represent the investable portion. Daily trading volume is a measure of a stock’s liquidity, but it is not used as a direct multiplier to adjust the market capitalization for index weighting purposes. The par value of a stock is a nominal accounting value and has no relevance to the stock’s market price or its weighting in a modern market index.

Statement I is incorrect. The Macaulay duration of a coupon-paying bond is the weighted-average time to receive all its cash flows (coupons and principal). Because the investor receives coupon payments before the maturity date, this weighted-average time is always less than the bond’s final maturity. Statement II is correct. A zero-coupon bond has only one cash flow: the principal repayment at maturity. Therefore, its weighted-average time to receive cash flows (Macaulay duration) is exactly equal to its time to maturity. Statement III is correct. Duration is a measure of a bond’s price sensitivity to changes in interest rates. A bond with a longer duration will experience a larger price change for a given change in yield. Since Bond Z (the zero-coupon bond) has a longer Macaulay duration (10 years) than Bond X (the coupon bond, which is less than 10 years), its price will be more sensitive to interest rate movements. Thus, an increase in market yields will cause a larger percentage price decrease for Bond Z. Statement IV is incorrect. This statement describes Macaulay duration, not modified duration. Modified duration is a measure derived from Macaulay duration that estimates the percentage change in a bond’s price for a 1% change in its yield to maturity. Therefore, statements II and III are correct.

The correct answer is that investors likely have higher expectations for future earnings growth for Dynamic Power Corp, while Stable Grid Holdings is perceived more as an income-generating investment. The Price-to-Earnings (P/E) ratio reflects market sentiment about a company’s future growth prospects. A high P/E ratio, like Dynamic Power’s 25, indicates that investors are willing to pay a premium for each dollar of current earnings, anticipating significant earnings growth in the future. Conversely, a lower P/E, like Stable Grid’s 10, suggests more modest growth expectations. The dividend yield measures the annual dividend per share as a percentage of the stock’s market price, representing the income return. A high dividend yield, like Stable Grid’s 5.0%, is attractive to investors seeking regular income. A low yield, like Dynamic Power’s 1.5%, often implies that the company is reinvesting a larger portion of its profits back into the business to fuel the expected future growth, rather than distributing it to shareholders. One incorrect option suggests that a lower P/E ratio means a company is fundamentally more profitable, which is a misunderstanding; P/E is a valuation multiple, not a direct measure of profitability. Another incorrect option incorrectly assumes that a low dividend yield signifies financial distress; for a growth company, it typically indicates a strategy of reinvesting earnings. The final incorrect option wrongly equates a high P/E ratio with lower risk; in fact, high-growth stocks with high P/E ratios are often considered riskier because their valuation depends heavily on future expectations that may not be met.

The correct answer is that the key metric is the freefloat-adjusted market capitalisation. In a freefloat-adjusted market-capitalisation weighted index, a stock’s influence is not based on its total market value but on the value of shares that are readily available for public trading. This is calculated by multiplying the total issued shares by the closing price and then by the Freefloat-Adjusted Factor (FAF). For Alpha Corp, this would be 2,000m x HKD 50 x 0.60 = HKD 60,000 million. For Beta Tech, it is 800m x HKD 100 x 0.90 = HKD 72,000 million. This metric provides a more accurate representation of a company’s investable market size. Using the total market capitalisation before any adjustments is incorrect because it fails to exclude shares held by strategic investors, governments, or insiders, which are not available on the open market. This would overstate the stock’s actual influence on the index. Relying solely on the closing price per share would be characteristic of a price-weighted index, a different and less common methodology that does not account for the number of shares in circulation. Using the total number of issued shares is also incorrect as it ignores the share price, a critical component of a company’s overall value.