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

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

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

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

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.The bond-trading platform of HKEX
• b.A derivatives clearing house that settles the futures and options traded on the Hong Kong Futures Exchange each day
• 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.Derivatives market
• b.Money market
• c.Secondary market
• d.Primary 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.Custodian
• b.Sponsor✓
• c.External auditor only
• d.Share registrar

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

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

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

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

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

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

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.Trade ahead of the published report in order to confirm the accuracy of the recommendation being made
• 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.Guarantee the accuracy of the price forecast

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

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

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

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

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.Provides mortgage insurance
• c.Lends money to property developers and construction firms at fixed rates of interest secured on the land
• d.Trades foreign currencies

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

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.Losses (and gains) are magnified, and a margin call may force the sale of collateral✓
• b.The shares cannot be sold until the loan matures
• c.Dividends are forfeited to the lender
• 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 type of exchange-traded fund
• b.An equity security
• c.A long-dated government bond issued to finance public spending over a period of many years
• d.A short-term unsecured debt instrument issued by a company to raise working capital✓

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

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.The largest order first, regardless of price
• b.The broker offering the highest commission first
• c.Price and then time priority✓
• 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 broker's commission
• b.Stamp duty on the transfer of shares✓
• c.The custodian's safekeeping fee
• d.The fund manager's performance fee

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

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.Only as physical paper certificates delivered by hand
• c.In book-entry (electronic) form within CCASS rather than by moving paper certificates✓
• d.Exclusively through overseas custodians

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

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.The quality of the firm's management
• d.Past price and volume patterns to forecast future price movements✓

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

A distinctive feature of a cumulative preference share is that:

• a.It always carries more votes at a general meeting than an ordinary share
• b.It converts automatically into ordinary shares at maturity
• c.It always shares, without any cap, in the whole of the company's surplus profits after ordinary dividends have been paid
• d.Any dividend passed in a poor year accumulates and must be paid before ordinary dividends resume✓

On a cumulative preference share, a dividend that is missed (passed) in one year is carried forward and all such arrears must be cleared before ordinary shareholders can be paid. Preference shares usually carry limited voting rights and no share in surplus profits.

A convertible bond is best described as a bond that:

• a.Pays its coupon only in a foreign currency
• b.Must be repaid to the holder in a series of fixed equal instalments spread evenly across the whole of its life
• c.The holder can exchange for a preset number of the issuer's ordinary shares✓
• d.Is always secured on the company's property

A convertible bond gives the holder the option to exchange it for a fixed number of the issuer's shares on set terms, combining bond income with potential equity upside. The other features describe currency, security or amortisation, not convertibility.

A zero-coupon bond:

• a.Pays no periodic interest and is issued at a discount to its par value✓
• b.Guarantees the holder a fixed percentage of capital growth every year until the bond finally reaches maturity
• c.Pays a higher coupon than comparable bonds
• d.Pays a floating coupon linked to HIBOR

A zero-coupon bond makes no interest payments; instead it is sold below par and redeemed at par, so the investor's return is the difference between the discounted purchase price and the redemption value.

Comparing default (credit) risk, which statement is generally correct?

• a.A high-quality government bond usually carries lower default risk than a corporate bond✓
• b.Corporate bonds are entirely free of default risk
• c.Government bonds always pay higher coupons than corporate bonds
• d.Corporate bonds cannot be bought or sold in the secondary market at any time before their stated maturity date

A high-quality sovereign issuer is normally seen as more creditworthy than a company, so its bonds carry lower default risk and therefore typically a lower yield. No corporate bond is wholly free of default risk.

The par (face) value of a bond is:

• a.The total amount of interest the issuer will pay to the holder over the entire remaining life of the bond
• b.The brokerage commission charged on the trade
• c.The current market price of the bond
• d.The amount the issuer promises to repay the holder at maturity✓

Par (or face) value is the principal amount repaid at maturity and the base on which the coupon is calculated. It is distinct from the market price, which fluctuates with interest rates and credit conditions.

A bond's coupon rate refers to:

• a.The total annualised return the investor will earn if the bond is bought today and then held all the way to maturity
• b.The annual interest the issuer pays, expressed as a percentage of par value✓
• c.The discount to par at which it was issued
• d.The credit rating assigned to the bond

The coupon rate is the fixed annual interest, stated as a percentage of par. It is not the same as the yield to maturity, which also reflects the price paid and any capital gain or loss to redemption.

A bond with a 5% coupon on a HK$100 par value is trading at HK$125. Its current yield is approximately:

• a.6.25%
• b.5.0%
• c.4.0%✓
• d.3.0%

Current yield = annual coupon / market price = HK$5 / HK$125 = 4.0%. Because the bond trades above par, its current yield is below the coupon rate.

Yield to maturity (YTM) on a bond represents:

• a.The bond's fixed coupon rate on its own, taking no account of the price paid or any gain or loss to redemption
• b.The dividend yield of the issuer's shares
• c.The total annualised return earned if the bond is held to maturity, allowing for price, coupons and redemption✓
• d.The current yield alone

YTM is the single discount rate that equates the bond's price with the present value of all its coupons and its redemption at par. It captures coupon income plus any capital gain or loss to maturity, unlike the current yield.

A callable bond:

• a.Gives the holder, rather than the issuer, the right to demand that the bond be repaid early before its maturity
• b.Gives the issuer the right to redeem the bond before maturity✓
• c.Pays no coupon at all
• d.Can always be converted into ordinary shares

A call feature lets the issuer repay the bond early, typically when interest rates have fallen so it can refinance more cheaply. This works against the holder, who faces reinvestment risk, so callable bonds usually offer a higher yield.

A perpetual bond is one that:

• a.Has no fixed maturity date and may pay coupons indefinitely✓
• b.Must be converted into equity on a set date
• c.Matures in exactly one year
• d.Pays a coupon whose size varies each year directly in line with the level of profits the issuer happens to report

A perpetual (or undated) bond has no scheduled redemption; the issuer may pay coupons indefinitely. The investor relies on selling in the market or on an issuer call to recover capital, so price sensitivity to rates is high.

A floating-rate note (FRN):

• a.Pays a single fixed coupon rate that is set at the time of issue and then stays unchanged for the whole of its life
• b.Can never fall in price
• c.Pays no coupon at all
• d.Pays a coupon that is periodically reset in line with a reference rate such as HIBOR✓

An FRN's coupon is reset at intervals to a benchmark rate plus a margin, so its income rises and falls with market rates. Because the coupon adjusts, its price stays comparatively stable when rates move.

Accrued interest on a bond is:

• a.The stamp duty payable on a bond trade
• b.Interest the issuer has already defaulted on
• c.A financial penalty that the buyer is charged by the exchange whenever settlement of the trade is completed late
• d.Interest earned since the last coupon date, which the buyer pays to the seller✓

Between coupon dates interest builds up daily. A buyer compensates the seller for the interest accrued from the last coupon to the settlement date, since the buyer will receive the whole next coupon.

A credit rating on a bond is used because:

• a.Ratings are set officially by the SFC for every issue
• b.A higher credit rating on a bond automatically means the issuer must pay a correspondingly higher coupon to holders
• c.All rated bonds are risk-free
• d.A rating below investment grade signals higher default risk and usually a higher yield✓

Rating agencies assess an issuer's ability to pay. Bonds rated below investment grade ("high-yield" or "junk") carry greater default risk and must offer higher yields to attract buyers. Ratings are opinions, not guarantees.

A bond described as 'secured' means that:

• a.Its coupon is fixed for life
• b.It is guaranteed by the SFC
• c.It is backed by specific assets that bondholders can claim if the issuer defaults✓
• d.It can always be converted, at the holder's choosing, into a fixed number of the issuing company's ordinary shares

A secured bond is collateralised by identified assets; if the issuer defaults, holders have a claim over those assets, improving recovery. An unsecured bond ranks only as a general creditor.

Subordinated debt is debt that:

• a.Ranks behind senior debt but ahead of shareholders on a winding up✓
• b.Ranks equally with ordinary shares
• c.Carries no default risk
• d.Ranks ahead of every other creditor of the company and is repaid first of all on a winding up or liquidation

Subordinated (junior) debt is repaid only after senior creditors in a liquidation, but still before equity holders. Its lower priority means greater risk, so it typically pays a higher yield than senior debt.

A bull callable bull/bear contract (CBBC):

• a.Tracks a rising underlying and is called if the underlying falls to the call price✓
• b.Pays a fixed quarterly coupon
• c.Never expires or terminates early
• d.Is specifically designed so that the holder makes a profit whenever the underlying asset falls sharply in price

A bull CBBC gives leveraged exposure to a rise in the underlying. If the underlying touches the preset call price, a mandatory call event terminates the contract early, which is its key risk.

A bear CBBC is:

• a.A bond that pays regular dividends
• b.Designed to profit when the underlying asset falls in price✓
• c.A contract that is designed so the holder makes a profit whenever the underlying asset rises steadily in price
• d.Identical to an ordinary call warrant

A bear CBBC gives leveraged short exposure, gaining when the underlying declines. Like a bull CBBC it has a call price; if the underlying rises to that level, the contract is called and terminated early.

A mandatory call event (MCE) on a CBBC occurs:

• a.When the issuer voluntarily chooses to buy it back
• b.When the underlying asset touches the call price, causing trading to be terminated early✓
• c.Occurs only when the callable bull/bear contract quietly reaches its scheduled expiry date in the normal way
• d.Whenever a dividend is paid on the underlying

A CBBC has a call price set away from the strike. If the underlying reaches that call price at any time before expiry, an MCE is triggered, trading stops immediately and the CBBC is settled, often at little or no value.

The difference between a Category N and a Category R CBBC is that:

• a.Both guarantee the return of capital
• b.A Category R may return a residual value if it is called, whereas a Category N returns nothing✓
• c.Neither can be called before expiry
• d.A Category N contract always pays out a larger residual amount to the holder than a Category R contract does

For a Category R CBBC the call price differs from the strike, so a residual value may be paid on a call. For a Category N the call price equals the strike, so if it is called the holder receives no residual value.

A derivative warrant listed on SEHK is:

• a.Issued by a third party such as a bank and settled in cash or existing shares, raising no new capital for the underlying company✓
• b.A form of secured corporate bond
• c.Issued directly by the underlying listed company itself in order to raise fresh capital for its own business use
• d.Always exercised into newly issued shares

Unlike a company (equity) warrant, a derivative warrant is issued by a financial institution over an underlying it does not control. Exercise is usually cash-settled and creates no new shares for the underlying company.