HKSI Licensing Examination Paper 8 (Securities) — All Questions

The best-known benchmark index of the largest companies listed on the Stock Exchange of Hong Kong is:

• a.The S&P 500
• b.The Hang Seng Index✓
• c.The FTSE 100
• d.The Nikkei 225

The Hang Seng Index (HSI) is the principal benchmark tracking the largest and most liquid companies listed on SEHK. The S&P 500, Nikkei 225 and FTSE 100 are the US, Japanese and UK benchmark indices.

Which macroeconomic change would most directly tend to reduce equity valuations, all else being equal?

• a.A sharp rise in market interest rates✓
• b.A fall in market interest rates
• c.Lower inflation expectations
• d.Stronger corporate earnings

Rising interest rates increase the discount rate applied to future cash flows and raise the cost of capital, tending to lower equity valuations. Falling rates, lower inflation and stronger earnings are generally supportive. Interest rates, inflation and economic cycles are the key market drivers in Topic 1.

An ordinary share differs from a corporate bond in that the ordinary share:

• a.Pays a fixed coupon set at issue
• b.Represents an ownership interest with no fixed maturity or guaranteed income✓
• c.Ranks ahead of all of the company's creditors and lenders in the event of a winding up or liquidation
• d.Must be repaid by the company on a set date

An ordinary share is an equity interest conferring ownership, voting rights and variable dividends with no maturity date, and it ranks last on a winding up. A bond is debt with a fixed coupon and redemption date that ranks ahead of shareholders.

Which instrument would normally trade in the money market rather than the capital market?

• a.A 3-month certificate of deposit✓
• b.A 10-year government bond
• c.A 20-year corporate debenture
• d.An ordinary share

The money market deals in short-term instruments (typically maturing within one year), such as certificates of deposit, commercial paper and Exchange Fund Bills. Long-dated bonds and equities are capital-market instruments.

In Hong Kong, GEM (formerly the Growth Enterprise Market) is best described as:

• a.A derivatives clearing house that settles the futures and options traded on the Hong Kong Futures Exchange each day
• b.The bond-trading platform of HKEX
• c.A market board for smaller and emerging companies with lower entry requirements than the Main Board✓
• d.A regulator of listed companies

GEM is a board of SEHK designed for smaller or emerging companies that do not yet meet Main Board requirements; it applies lower entry thresholds and carries higher risk. It is a market segment, not a clearing house or regulator.

When a company raises new money by selling shares to the public for the first time, the transaction takes place in the:

• a.Secondary market
• b.Primary market✓
• c.Derivatives market
• d.Money market

A primary-market transaction is one in which the issuer itself receives the proceeds, such as an initial public offering (IPO). Once the shares subsequently trade between investors, that trading occurs in the secondary market.

In a Hong Kong IPO, the firm responsible for conducting due diligence and dealing with the Exchange on the listing application is the:

• a.Sponsor✓
• b.Share registrar
• c.External auditor only
• d.Custodian

The sponsor, a licensed Type 6 (corporate finance) firm, manages the listing, conducts due diligence and liaises with the Exchange and the SFC. Registrars, custodians and auditors have separate, narrower roles in the listing process.

The prospectus issued for a Hong Kong IPO principally serves to:

• a.Set the level of the Hang Seng Index
• b.Give investors the material information needed to make an informed investment decision✓
• c.Guarantee that the share price will rise once the company is admitted to trading on the Main Board
• d.Replace the need for audited accounts

A prospectus must disclose the material information investors need to make an informed decision and carries statutory liability for false or misleading statements. It does not guarantee performance or replace audited financial statements.

A listed company raising additional capital by offering existing shareholders the right to buy new shares in proportion to their holdings is conducting a:

• a.Rights issue✓
• b.Bonus issue
• c.Stock split
• d.Share buy-back

A rights issue offers new shares to existing shareholders pro rata, usually at a discount, raising fresh capital. A bonus issue and a stock split raise no new money, and a buy-back returns capital by repurchasing shares.

Trades in HK-listed shares are cleared and settled through:

• a.Physical delivery of paper certificates on the trade date
• b.The Investor Compensation Fund, which matches and settles every exchange trade on behalf of the two brokers
• c.CCASS, operated by Hong Kong Securities Clearing Company, on a T+2 basis✓
• d.The Market Misconduct Tribunal

The Central Clearing and Settlement System (CCASS), run by HKSCC, clears and settles exchange trades on a T+2 (two-business-day) cycle, largely by electronic book entry rather than physical certificates.

A company makes a one-for-one bonus issue. All else being equal, the immediate effect is that:

• a.The company raises new capital
• b.The number of shares doubles while each share's price roughly halves, leaving total value unchanged✓
• c.Each existing shareholder receives an equivalent cash dividend funded from the company's distributable reserves
• d.The company's total assets increase

A bonus (scrip) issue capitalises reserves into new shares given free to shareholders. The share count rises and the price adjusts down proportionately, so an investor's total holding value and the company's net assets are unchanged.

The role of a custodian in the securities market is to:

• a.Set monetary policy
• b.Underwrite new share issues and guarantee that any shares left unsold in an offering are taken up
• c.Provide investment advice to retail clients
• d.Hold and safeguard clients' securities and settle transactions on their behalf✓

A custodian holds securities in safekeeping and handles settlement, income collection and corporate actions for clients such as institutional investors. Underwriting, advice and monetary policy are functions of other participants.

Which two bodies are the principal statutory regulators overseeing Hong Kong's securities markets and banking respectively?

• a.The Financial Secretary and the Stock Exchange
• b.The Market Misconduct Tribunal and the JFIU
• c.The SFC and the HKMA✓
• d.HKEX and the Companies Registry

The Securities and Futures Commission (SFC) regulates the securities and futures markets, while the Hong Kong Monetary Authority (HKMA) regulates banks, including their registered-institution securities business. HKEX operates the market infrastructure rather than regulating it.

To protect investors, a sell-side research analyst publishing a stock recommendation must:

• a.Guarantee the accuracy of the price forecast
• b.Disclose the firm's and the analyst's relevant interests and avoid misleading the market✓
• c.Share the report only with the issuer before publication
• d.Trade ahead of the published report in order to confirm the accuracy of the recommendation being made

Analysts must disclose conflicts of interest (such as the firm's holdings or banking relationships) and present balanced, non-misleading research. Trading ahead of a report (front running) and selective pre-disclosure to the issuer are prohibited.

Which of the following is an institutional investor?

• a.A first-time IPO subscriber buying for himself
• b.A retail investor using an online broker
• c.An individual day-trader
• d.A pension fund investing on behalf of its members✓

Institutional investors are organisations that invest large pooled sums, such as pension funds, insurance companies, mutual funds and asset managers. The other options describe retail investors trading their own money.

A preference share typically differs from an ordinary share in that a preference share:

• a.Always carries full voting rights at company meetings, ranking equally with ordinary shares in every respect
• b.Usually pays a fixed dividend and ranks ahead of ordinary shares for dividends and on winding up✓
• c.Ranks behind ordinary shares for dividends
• d.Gives its holder an unlimited share of residual profits

Preference shares usually carry a fixed dividend and rank ahead of ordinary shares for dividends and for capital on a winding up, but they generally have limited or no voting rights and no share in surplus profits.

An equity warrant gives the holder:

• a.Direct ownership of the company's assets
• b.A fixed interest coupon
• c.An obligation to buy the underlying shares at a fixed price on the maturity date, whatever the market price
• d.The right, but not the obligation, to buy shares at a set price before expiry✓

A warrant confers the right, not the obligation, to subscribe for shares at a specified exercise price within a set period. It is not a debt instrument and confers no ownership until it is exercised.

An exchange-traded fund (ETF) is best described as:

• a.A single company's ordinary shares that happen to be included within a widely followed stock-market index and benchmark
• b.A bilateral forward contract
• c.A short-term bank deposit
• d.A pooled fund, traded on an exchange like a share, that typically tracks an index or basket of assets✓

An ETF is a pooled investment fund listed and traded on an exchange, usually designed to track the performance of an index, commodity or basket of securities, combining diversification with intraday tradability.

A Real Estate Investment Trust (REIT) listed on SEHK primarily:

• a.Holds income-producing real estate and distributes most of its rental income to unit holders✓
• b.Trades foreign currencies
• c.Provides mortgage insurance
• d.Lends money to property developers and construction firms at fixed rates of interest secured on the land

A REIT is a listed collective investment scheme that invests in income-generating property and must distribute the bulk of its net income to unit holders, giving investors exposure to real-estate returns without owning property directly.

If market interest rates rise, the price of an existing fixed-coupon bond will generally:

• a.Fall, because its fixed coupon is now less attractive than new issues✓
• b.Rise to par immediately
• c.Rise, because the bond's fixed coupon becomes relatively more attractive than the coupons on newer issues
• d.Stay exactly the same

Bond prices move inversely to yields: when market rates rise, an existing bond's fixed coupon is worth less than newer higher-yielding issues, so its price falls. Longer-duration bonds are more sensitive to this effect.

An investor buys shares using securities margin financing. The main additional risk compared with an unleveraged purchase is that:

• a.Dividends are forfeited to the lender
• b.The shares cannot be sold until the loan matures
• c.Losses (and gains) are magnified, and a margin call may force the sale of collateral✓
• d.The investor loses all of the voting rights attached to the shares while the margin loan remains outstanding

Margin financing leverages the position, so both gains and losses are amplified. If the collateral value falls, the broker can issue a margin call and, if it is unmet, sell the pledged securities, potentially crystallising losses.

Commercial paper is best described as:

• a.A short-term unsecured debt instrument issued by a company to raise working capital✓
• b.A long-dated government bond issued to finance public spending over a period of many years
• c.An equity security
• d.A type of exchange-traded fund

Commercial paper is a short-term (typically up to one year) unsecured promissory note issued by companies at a discount to raise working capital. It is a money-market instrument, not equity or a fund.

The buyer of a call option on a share profits when:

• a.Interest rates fall to zero
• b.The option expires unexercised
• c.The share price rises sufficiently above the strike price plus the premium paid✓
• d.The share price falls well below the strike price before the option reaches its expiry date

A call option gives the right to buy at the strike price; the holder profits once the share rises above the strike by more than the premium paid. If the price stays below the strike, the option expires worthless and the loss is limited to the premium.

Orders entered into the Stock Exchange of Hong Kong's automatic order-matching system are generally executed on the basis of:

• a.Price and then time priority✓
• b.The broker offering the highest commission first
• c.The largest order first, regardless of price
• d.Random allocation among all orders

The Exchange's automatic order-matching and execution system matches orders on a price-then-time priority basis: better-priced orders execute first, and among equally priced orders the earliest entered is filled first.

Which of the following is a government-imposed cost on a typical Hong Kong share transaction?

• a.The custodian's safekeeping fee
• b.The broker's commission
• c.The fund manager's performance fee
• d.Stamp duty on the transfer of shares✓

Stamp duty is a government levy charged on transfers of Hong Kong stock. Brokerage commission, custody fees and management fees are charged by market participants; the SEHK and SFC also levy small trading and transaction fees.

A brokerage's requirement that the staff who execute trades are kept separate from those who settle and record them is an example of:

• a.A breach of the Code of Conduct
• b.A tax-avoidance technique
• c.A marketing strategy intended to reassure clients that their orders are handled by separate teams
• d.Segregation of duties, an internal control to reduce error and fraud✓

Segregation of duties separates incompatible functions (dealing, settlement, record-keeping) so no single person controls a whole transaction, reducing the risk of error and fraud. It is a core internal-control principle in a firm's operations.

Most HK-listed shares today are held and transferred:

• a.By the SFC on investors' behalf, which holds all listed shares centrally in a single government register
• b.In book-entry (electronic) form within CCASS rather than by moving paper certificates✓
• c.Exclusively through overseas custodians
• d.Only as physical paper certificates delivered by hand

Modern settlement is largely dematerialised: securities are immobilised in CCASS and transferred by electronic book entry, which is faster and safer than physically delivering paper certificates.

The price-to-earnings (P/E) ratio, used in fundamental analysis, measures:

• a.A company's total outstanding debt divided by its shareholders' equity, showing its overall financial gearing and leverage
• b.The dividend paid per share
• c.A bond's yield to maturity
• d.The share price relative to earnings per share, indicating how much investors pay per unit of earnings✓

The P/E ratio divides the share price by earnings per share, showing how much the market will pay for each unit of a company's earnings. It is a core valuation metric in fundamental analysis, distinct from gearing or dividend measures.

Technical analysis of a share differs from fundamental analysis in that it primarily studies:

• a.Macroeconomic GDP forecasts
• b.The company's audited balance sheet and profit-and-loss statements over recent financial years
• c.Past price and volume patterns to forecast future price movements✓
• d.The quality of the firm's management

Technical analysis examines historical price and trading-volume data, using charts, trends and indicators to anticipate future movements, whereas fundamental analysis assesses intrinsic value from financial statements and the wider economy.

Spreading a portfolio across different, imperfectly correlated securities primarily aims to:

• a.Guarantee a fixed positive return regardless of overall market conditions in any given year
• b.Increase transaction costs
• c.Reduce unsystematic (specific) risk through diversification✓
• d.Eliminate all possible risk

Diversification reduces unsystematic (company- or sector-specific) risk because losses in one holding may be offset by gains in others. It cannot remove systematic (market-wide) risk or guarantee a return.