HKSI Paper 9 (Derivatives) English Free Trial

In the LME, copper futures contracts offer flexibility in terms of settlement options. Participants have the choice between physical delivery and cash settlement based on their preferences and requirements. This flexibility allows market participants to tailor their trading strategies according to their specific needs.

Option (a) is incorrect because settlement through physical delivery is not the only method available on the LME.

Option (b) is incorrect because settlement is not exclusively cash-settled; physical delivery is also a valid option.

Option (d) is incorrect because settlement terms are determined by the parties involved, with the LME providing the framework and regulations for these transactions.

To close a long position in copper futures contracts before the expiration date, the trader should execute a trade to sell the same number of contracts they hold. This action effectively offsets their existing position, allowing them to exit the market.

Option (a) is incorrect because physical delivery is not necessary for closing a futures position before expiration.

Option (c) is incorrect because cancelling the contract unilaterally without fulfilling obligations is not a valid procedure.

Option (d) is incorrect because waiting until expiration may subject the trader to market risks and uncertainties, which may not align with their trading strategy.

Speculators play a crucial role in the copper futures market on the LME by providing liquidity. They participate in trading activities with the intention of profiting from price movements, thus increasing market efficiency and reducing price volatility.

Option (b) is incorrect because speculators are allowed to participate in copper futures trading on the LME.

Option (c) is incorrect because while speculation involves seeking profits from price movements, it does not necessarily imply manipulation.

Option (d) is incorrect because official copper futures prices on the LME are determined based on market dynamics and not solely by speculators.

Given the potential supply disruption and its impact on copper prices, Mr. X should take proactive measures to manage his risk. Purchasing put options allows him to hedge against a possible decline in prices, thereby protecting his long position from losses. This strategy provides a level of insurance against adverse market movements while allowing him to maintain his exposure to potential price gains.

Option (a) is incorrect because holding onto his long position without protection exposes Mr. X to the risk of significant losses if copper prices decline due to the supply disruption.

Option (b) is incorrect because closing his long position immediately may not be the most strategic move, especially if prices subsequently rebound after the initial disruption.

Option (d) is incorrect because increasing his long position without risk management measures could exacerbate potential losses if prices do not rise as expected or if the impact of the supply disruption is less severe than anticipated.

Market makers play a vital role in derivatives markets by providing liquidity and facilitating trading activities. They continuously quote both buy and sell prices for derivatives contracts, thereby enabling other participants to execute trades efficiently. By matching buy and sell orders, market makers ensure that there is a smooth flow of transactions in the market.

Option (b) is incorrect because market makers are not regulatory authorities; they are private entities or firms operating within the market.

Option (c) is incorrect because market makers do not exclusively trade for their own accounts; their primary function is to provide liquidity and facilitate trading for all participants.

Option (a) is incorrect because while education and guidance may be provided by various entities in the market, it is not the primary role of market makers.

In a short hedge, the hedger takes a short position in futures contracts to offset potential losses from an adverse price movement in the underlying asset. In the case of Mr. Y, who wants to hedge against an increase in interest rates, taking a short position in interest rate futures contracts would provide protection. As interest rates rise, the value of the futures contracts would increase, offsetting losses incurred on the underlying assets.

Option (a) is incorrect because a long hedge is used to hedge against a decrease in the price of the underlying asset, not an increase.

Option (c) is incorrect because a calendar spread involves simultaneous purchase and sale of futures contracts with different expiration dates, rather than hedging against interest rate fluctuations.

Option (d) is incorrect because a straddle involves simultaneous purchase of both call and put options on the same underlying asset, which is not relevant to hedging interest rate exposure.

A long call option gives the holder the right to buy the underlying asset at a predetermined price (strike price) within a specified period (expiration date). If Ms. Z expects the price of the stock index to increase, she can profit by purchasing long call options. If the price indeed rises, she can exercise her right to buy the stock index at the lower strike price and then sell it at the higher market price, thereby realizing a profit.

Option (b) is incorrect because a short call option would expose Ms. Z to potentially unlimited losses if the price of the stock index rises.

Option (a) is incorrect because a long put option is used to profit from a decrease in the price of the underlying asset, which contradicts Ms. Z’s bullish outlook.

Option (d) is incorrect because a short put option involves obligations to buy the underlying asset at the strike price, which is not aligned with Ms. Z’s expectation of price increase.

In a forward contract, the counterparty is the party that enters into the agreement with the other party (the counterpart). The counterparty agrees to either buy or sell the underlying asset at a specified future date and price, depending on the terms of the contract.

Option (a) is incorrect because the counterparty is not a regulatory body; it is a party to the contract.

Option (b) is incorrect because while financial institutions may facilitate forward contracts, they are not necessarily the counterparty.

Option (d) is incorrect because while third-party entities such as clearinghouses may be involved in certain types of forward contracts, they are not typically referred to as counterparties.

In a forward contract, the buyer (long position) benefits from a rise in the market price of the underlying asset. Since the market price of crude oil has increased to $70 per barrel, Mr. A can purchase the oil at the lower agreed-upon price of $60 per barrel, resulting in a gain.

Option (a) is incorrect because Mr. A benefits from the increase in the market price, rather than incurring a loss.

Option (c) is incorrect because Mr. A’s position is affected by changes in the market price of crude oil before the expiration date of the forward contract.

Option (d) is incorrect because the status of Mr. A’s position is determined by market conditions and the terms of the forward contract, rather than the actions of the counterparty.

In a forward contract, the seller (short position) is obligated to deliver the agreed-upon quantity of the underlying asset at the specified price, regardless of changes in market conditions. If Ms. B’s wheat yield is lower than expected and the market price of wheat decreases below the fixed price specified in the forward contract, she may incur financial losses compared to what she could have received by selling her wheat at the prevailing market price.

Option (b) is incorrect because defaulting on contractual obligations could have legal and financial consequences for Ms. B but is not directly related to the market price of wheat.

Option (c) is incorrect because finding a counterparty for a reduced quantity of wheat may pose challenges but does not directly address the financial risk associated with price fluctuations.

Option (a) is incorrect because while Ms. B may be required to deliver the agreed-upon quantity of wheat, the situation described in the question pertains to price risk rather than quantity risk.

In this scenario, where unexpected market conditions have led to a significant drop in copper prices, Mr. Smith should take action to limit his losses. Closing his futures contract allows him to lock in the current market price, thereby avoiding further potential losses if copper prices continue to decline. This action effectively fulfills the purpose of hedging, which is to mitigate risk exposure to adverse price movements.

Option (b) is incorrect because holding onto the futures contract without risk management could result in further losses if copper prices do not rebound as anticipated.

Option (c) is incorrect because increasing his position in the futures market without assessing market conditions may exacerbate losses if copper prices continue to decline.

Option (d) is incorrect because futures contracts are binding agreements with predetermined terms, and renegotiation is generally not feasible based on market developments after entering into the contract.

According to the put-call parity rule, the net profit from exercising a put option on a futures contract is equal to the difference between the strike price and the current market price of the underlying asset. In this case, the strike price is $50 and the current market price is $45. Therefore, the net profit from exercising the put option would be $50 – $45 = $5. However, since Mr. Wong holds the put option, he has the right to sell the underlying asset at the strike price of $50. Since the market price is lower at $45, he would exercise his right to sell, but he would not make any profit from exercising the option itself as the market price is below the strike price. Thus, his net profit would be $0.

Option A) $5: This is incorrect because it represents the difference between the strike price and the current market price of the underlying asset, but it does not take into account the fact that Mr. Wong would exercise the put option to sell at the higher strike price, resulting in a net profit of $0.
Option C) $45: This is incorrect as it represents the difference between the current market price and the strike price, but it does not consider the exercise of the put option.
Option D) $50: This is incorrect because it does not consider the actual net profit from exercising the put option, which is $0 as explained above.

A warrant is a financial instrument that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific time frame. The correct answer is B) Exchanged on secondary markets because warrants are typically traded on secondary markets such as stock exchanges after their initial issuance by the company. This allows investors to buy and sell warrants freely, even after their initial issuance.

Option A) Exercisable at any time before expiry: This is incorrect as warrants have specific expiration dates, and they can only be exercised before their expiry date.
Option B) Provides the holder with voting rights: This is incorrect because warrants do not usually provide the holder with any voting rights in the issuing company.
Option D) Typically issued by the government: This is incorrect as warrants are usually issued by corporations as a way to raise capital or as part of a financial transaction, rather than by the government.

A short straddle involves selling both a call option and a put option with the same strike price and expiration date. By selling both options, the investor collects premiums from both options, hoping that the underlying asset’s price remains stable and both options expire worthless, allowing the investor to keep the premiums as profit.

Option A) Long straddle: This is incorrect as a long straddle involves buying both a call option and a put option with the same strike price and expiration date, anticipating significant price movement in either direction.
Option C) Bull call spread: This is incorrect as a bull call spread involves buying a call option and simultaneously selling another call option with a higher strike price, expecting the underlying asset’s price to rise moderately.
Option B) Bear put spread: This is incorrect as a bear put spread involves buying a put option and simultaneously selling another put option with a lower strike price, expecting the underlying asset’s price to decline moderately.

In an exchange-traded equity derivatives market, the clearing house acts as a central counterparty and guarantees the performance of futures and options contracts. It ensures that both parties fulfill their obligations by facilitating the clearing and settlement process. This reduces counterparty risk and enhances market integrity.

Option B) Investment bank: This is incorrect as investment banks are not responsible for guaranteeing the performance of futures and options contracts in an exchange-traded market.
Option C) Securities regulator: This is incorrect as securities regulators oversee the operation of the market and ensure compliance with regulations but do not guarantee contract performance.
Option D) Central bank: This is incorrect as central banks are responsible for monetary policy and do not typically guarantee the performance of derivatives contracts.

To maximize his profit, Mr. Chen should exercise the warrant, allowing him to purchase shares of Company X at the predetermined price of $50 per share. By doing so, he can then sell the shares at the current market price of $60 per share, resulting in a profit of $10 per share.

Option B) Sell the warrant: This is incorrect because selling the warrant would not allow Mr. Chen to realize the potential profit from the difference between the warrant’s exercise price and the current market price of the shares.
Option C) Hold the warrant until expiration: This is incorrect because holding the warrant until expiration without exercising it would mean missing out on the opportunity to profit from the favorable difference between the exercise price and the market price of the shares.
Option D) Convert the warrant into shares: This is incorrect because converting the warrant into shares would not generate profit unless Mr. Chen sells the shares at a price higher than the exercise price.

In this situation, Mr. Lee may consider holding the call option until expiration. Holding the option allows him to potentially benefit from any further increase in the market price of Company Y’s shares without the obligation to exercise the option immediately. If the market price continues to rise, Mr. Lee can exercise the option before expiration to buy shares at the lower strike price. If the market price decreases or remains stable, he can simply let the option expire without exercising it, limiting his losses to the premium paid for the option.

Option A) Exercise the call option: This may not be the best choice because exercising the call option would require Mr. Lee to buy shares at the strike price, which may not be optimal if the market price continues to rise.
Option C) Sell the call option: While selling the call option would allow Mr. Lee to lock in any profits, it may not be the most advantageous strategy if he believes there is still potential for further price appreciation in the shares.
Option D) Hedge the call option with a put option: While hedging with a put option could mitigate potential losses, it may not be necessary if Mr. Lee is willing to accept the risk associated with holding the call option until expiration.

In this scenario, Ms. Ng can consider using a protective put strategy to mitigate the short-term price risk while still benefiting from potential long-term gains. A protective put involves buying a put option on the same underlying asset as the futures contract to protect against downward price movements. If the price of gold decreases in the short term, the put option will increase in value, offsetting the losses on the futures contract. However, if the price of gold increases as expected over the long term, Ms. Ng can still profit from the futures contract.

Option A) Long straddle: This strategy involves buying both a call option and a put option with the same strike price and expiration date, which may not be suitable for Ms. Ng’s objective of mitigating short-term price risk.
Option B) Short straddle: This strategy involves selling both a call option and a put option with the same strike price and expiration date, which may expose Ms. Ng to unlimited risk if the price of gold moves significantly in either direction.
Option C) Bull call spread: This strategy involves buying a call option and simultaneously selling another call option with a higher strike price, which may not effectively mitigate short-term price risk.

Exchange-traded interest-rate derivatives, such as interest rate futures, are standardized contracts that are traded on organized exchanges, such as the Chicago Mercantile Exchange (CME) or Eurex. These exchanges act as intermediaries, providing a platform for buyers and sellers to trade these contracts. Standardization ensures liquidity and transparency in the market. Therefore, option (b) is the correct answer.

Option (a) is incorrect because exchange-traded derivatives are standardized contracts and not customized between parties. Option (c) is incorrect because exchange-traded derivatives are not bilateral contracts; they are traded on exchanges with multiple participants. Option (d) is incorrect because exchange-traded derivatives tend to be more liquid due to trading on organized exchanges with numerous market participants.

In exchange-traded derivatives, initial margin is the collateral required to be deposited by both parties to cover potential future losses. It acts as a security deposit to ensure that parties fulfill their obligations under the contract. This collateralization helps mitigate counterparty risk. Therefore, option (c) is the correct answer.

Option (a) is incorrect because initial margin does not represent the maximum loss; it serves as collateral. Option (b) is incorrect because initial margin is not a fee charged by the exchange but rather a deposit. Option (d) is incorrect because initial margin is not the profit earned but rather a collateral requirement.

In exchange-traded derivatives, central clearing is a key feature that mitigates counterparty risk. Through central clearing, a clearinghouse acts as an intermediary, becoming the counterparty to both buyer and seller. This process helps ensure the performance of contracts, reducing the risk of default. Therefore, option (a) is the correct answer.

Option (b) is incorrect because over-the-counter trading exacerbates counterparty risk due to direct bilateral agreements. Option (c) is incorrect because exchange-traded derivatives are standardized, not customized. Option (d) is incorrect because standardized terms enhance transparency and liquidity, reducing risk.

Interest rate futures are exchange-traded derivatives that allow investors to speculate on future interest rate movements. By buying or selling futures contracts, investors can profit from changes in interest rates. These contracts are standardized and traded on organized exchanges, providing liquidity and transparency. Therefore, option (c) is the correct answer.

Option (a) is incorrect because interest rate swaps are over-the-counter derivatives primarily used for hedging rather than speculation. Option (b) is incorrect because interest rate options provide the right but not the obligation to buy or sell at a specified rate, not ideal for pure speculation. Option (d) is incorrect because FRAs are also over-the-counter contracts used for hedging interest rate risk.

In a scenario where an investor anticipates a decrease in interest rates and wants to protect against potential losses in their bond portfolio, selling interest rate futures contracts would be most appropriate. By selling futures contracts, the investor can hedge against the risk of falling interest rates. If interest rates decrease, the value of the futures contracts would increase, offsetting losses in the bond portfolio. Therefore, option (a) is the correct answer.

Option (b) is incorrect because buying options would involve a premium and may not fully hedge against losses. Option (c) is incorrect because entering into an interest rate swap may not directly hedge against interest rate movements. Option (d) is incorrect because purchasing FRAs is an over-the-counter agreement and may not provide the desired hedge.

The correct answer is (c) Short call options on interest-rate futures. This strategy involves selling call options on interest-rate futures contracts, anticipating a decline in interest rates. If the interest rates decrease, the value of the futures contract would decline, resulting in profits for the seller of the call options.

Option (a) Long call options on interest-rate futures would not be suitable because it profits from an increase in interest rates, which contradicts Mr. Wong’s expectation. Option (b) Short put options on interest-rate swaps is incorrect as it would expose Mr. Wong to the risk of having to purchase the underlying asset at a potentially unfavorable price, which is not aligned with his objective. Option (d) Long put options on interest-rate swaps is also incorrect as it profits from a decrease in interest rates, but it involves the purchase of put options rather than the sale, which does not align with Mr. Wong’s objective of capitalizing on the anticipated decrease in interest rates.

The correct answer is (d) A hedge fund manager sells currency futures to capitalize on anticipated currency depreciation. This scenario represents speculative use as the hedge fund manager is taking a position to profit from the expected decline in currency value without having an underlying exposure.

Option (a) describes a hedging use of currency forwards, where the multinational corporation is mitigating its foreign exchange risk. Option (b) depicts a hedging strategy as the individual investor is using currency options to protect against adverse currency movements. Option (c) also represents hedging as the commercial bank is using a currency swap agreement to manage its foreign currency exposure.

The correct answer is (a) Buy USD/HKD call options. By purchasing call options on the USD/HKD currency pair, Ms. Lee can protect her business against the risk of HKD appreciation. If the HKD appreciates as she expects, she can exercise the call options to buy USD at the predetermined strike price, effectively locking in a favorable exchange rate.

Option (b) Sell USD/HKD call options would expose Ms. Lee to unlimited potential losses if the HKD appreciates, as she would be obligated to sell USD at the predetermined strike price. Option (c) Buy USD/HKD put options is incorrect as it would only be beneficial if Ms. Lee expected the USD to appreciate against the HKD, which contradicts her expectation. Option (d) Sell USD/HKD put options is also incorrect as it would expose Ms. Lee to the risk of having to buy USD at potentially unfavorable rates in the event of HKD appreciation.

The correct answer is (b) Short call options on interest-rate swaps. This strategy involves selling call options on interest-rate swaps, anticipating a rise in interest rates. If interest rates increase, the value of the swaps would rise, resulting in profits for the seller of the call options, thus providing a hedge against the risk of rising interest rates.

Option (a) Long put options on interest-rate futures would not be suitable because it profits from a decrease in interest rates, which does not align with Mr. Chan’s objective of hedging against rising interest rates. Option (c) Long call options on interest-rate swaps is incorrect as it profits from an increase in interest rates, which does not serve the purpose of hedging against the risk of rising rates. Option (d) Short put options on interest-rate futures is also incorrect as it profits from a decrease in interest rates, which contradicts Mr. Chan’s objective.

The correct answer is (c) Buying USD/HKD put options. By purchasing put options on the USD/HKD currency pair, Mr. Li can protect his business against the risk of HKD depreciation. If the HKD depreciates as he expects, he can exercise the put options to sell USD at the predetermined strike price, effectively locking in a favorable exchange rate for his imports.

Option (a) Selling EUR/HKD call options would not be suitable for Mr. Li as he primarily deals with suppliers from Europe and the United States, not the Eurozone. Option (b) Buying USD/HKD call options would expose Mr. Li to potential losses if the HKD depreciates, as he would be obligated to buy USD at the predetermined strike price. Option (d) Selling EUR/HKD put options is also incorrect as it does not align with Mr. Li’s objective of hedging against USD exchange rate risk.

The correct answer is (d) An individual investor buys currency options to profit from anticipated currency movements in a foreign investment. This scenario represents speculative use as the individual investor is taking a position to profit from anticipated currency movements without having an underlying exposure that needs to be hedged.

Option (a) describes a hedging use of currency forwards, where the multinational corporation is mitigating its foreign exchange risk. Option (c) also represents hedging as the commercial bank is using a currency swap agreement to manage its exposure to foreign currencies. Option (b) similarly depicts hedging as the small business owner is using currency futures to protect against currency fluctuations in international transactions.

This scenario presents an opportunity for covered interest rate arbitrage. According to the covered interest rate parity, the forward exchange rate should reflect the interest rate differential between the two currencies. In this case, the forward rate is higher than the spot rate, indicating that the HKD is trading at a forward premium against the USD. To exploit this, Mr. Wong should borrow USD at the lower interest rate, convert it to HKD, invest in HKD-denominated assets to earn interest, and simultaneously enter into a forward contract to buy USD in 6 months. This allows him to lock in a profit from the forward premium.

Option Analysis:

a) This option suggests borrowing HKD, converting to USD, and entering into a forward contract to sell USD. However, this would result in a loss as the USD is borrowed at a higher interest rate than the HKD, and the forward premium favors buying USD, not selling.

c) This option suggests borrowing USD, converting to HKD, and entering into a forward contract to sell USD. Similar to option (a), this would result in a loss due to the interest rate differentials and the direction of the forward premium.

d) This option suggests borrowing HKD, converting to USD, and entering into a forward contract to buy USD. While this aligns with the direction of the forward premium, it overlooks the interest rate differentials, leading to potential losses.