HKSI Licensing Examination Paper 8 (Securities) — All Questions

The 'gearing' of a call warrant means that:

• a.Cannot ever expire worthless, because the issuer is obliged to buy it back from the holder at the original cost
• b.It pays a guaranteed dividend
• c.It reduces the investor's risk to zero
• d.It provides leveraged exposure, so a small move in the underlying can cause a larger percentage move in the warrant✓

A warrant costs far less than the underlying yet responds to the underlying's moves, giving leverage (gearing). This magnifies percentage gains and losses, and the warrant can expire worthless if it finishes out-of-the-money.

A put warrant:

• a.Confers the right to buy the underlying at the exercise price
• b.Increases in value when the underlying price falls, giving the holder downside exposure✓
• c.Pays a fixed coupon like a bond
• d.Must always be exercised into brand-new shares issued by the underlying company rather than settled for cash

A put warrant gives leveraged exposure to a fall in the underlying: its value rises as the underlying declines below the exercise price. It is the mirror image of a call warrant.

The 'premium' of a warrant measures:

• a.The percentage by which the underlying must move for a buyer who exercises the warrant to break even✓
• b.The stamp duty payable on the warrant
• c.The par or face value that is printed on the warrant and repaid to the holder when the warrant finally matures
• d.The dividend paid on the warrant

Warrant premium expresses how much extra, in percentage terms, an investor pays to gain exposure via the warrant rather than the underlying, i.e. the move needed to break even at expiry. A high premium means a larger required move.

The conversion (or entitlement) ratio of a warrant is:

• a.The fixed coupon rate that the issuer of the warrant pays to the holder at regular intervals until expiry
• b.The credit rating of the warrant issuer
• c.The number of days to the warrant's expiry
• d.The number of warrants that must be exercised to obtain one unit of the underlying asset✓

The conversion ratio tells the holder how many warrants are needed per unit of underlying. For example, a ratio of 10 means ten warrants convert into one share, which affects the warrant's price sensitivity.

An equity-linked note (ELN) is:

• a.A structured product offering an enhanced yield under which the investor may end up receiving shares, or a loss, if the linked stock falls✓
• b.A government bond
• c.A capital-guaranteed bank deposit that pays a fixed rate of interest and returns the full principal at maturity
• d.An ordinary share paying fixed dividends

An ELN pays an above-market return in exchange for the investor effectively selling downside protection on a stock. If the stock falls below the strike, the investor may be delivered the shares at a loss, so capital is at risk.

An open-ended unit trust:

• a.Pays a fixed coupon like a bond
• b.Has a permanently fixed number of units
• c.Creates and cancels units on demand, dealing at a price based on net asset value✓
• d.Trades on the stock exchange at a price set purely by supply and demand, which can differ widely from its NAV

An open-ended fund expands or contracts as investors subscribe or redeem, with dealing priced off the net asset value per unit. This contrasts with a closed-end fund, which has a fixed number of shares that trade on an exchange.

A fund holds assets worth HK$110 million and liabilities of HK$10 million, with 50 million units in issue. Its net asset value per unit is:

• a.HK$2.20
• b.HK$2.00✓
• c.HK$2.40
• d.HK$1.80

NAV per unit = (assets - liabilities) / units in issue = (110 - 10) million / 50 million = HK$2.00. NAV is the basis on which an open-ended fund's units are priced.

A closed-end fund:

• a.Is a short-term money-market instrument that is issued at a discount and redeemed at its par value at maturity
• b.Has a fixed number of shares that trade on an exchange and may stand at a premium or discount to NAV✓
• c.Creates new units on demand like an open-ended fund
• d.Always trades at exactly its NAV

A closed-end fund issues a fixed number of shares that then trade in the secondary market. Its market price is driven by supply and demand and can diverge from NAV, trading at a premium or, often, a discount.

A synthetic ETF differs from a physical ETF in that it:

• a.Is not exposed to any counterparty
• b.Holds every single constituent of the index physically, in exactly the weightings used by the index itself
• c.Replicates the index using derivatives such as swaps, introducing counterparty risk✓
• d.Guarantees it will match the index exactly

A synthetic ETF uses swaps or other derivatives rather than owning the underlying securities. This exposes investors to the risk that a swap counterparty fails, a risk not present in a fully physical (in-specie) ETF.

'Tracking error' for an ETF refers to:

• a.The bid-offer spread quoted on the exchange
• b.The extent to which the fund's return diverges from that of the index it tracks✓
• c.A penalty for late settlement
• d.A dealing mistake made by the executing broker when entering the order into the exchange's trading system

Tracking error measures how closely an index fund or ETF follows its benchmark. Fees, cash drag, sampling and replication method all cause the fund's return to differ from the index, producing tracking error.

Leveraged and inverse (L&I) products listed in Hong Kong:

• a.Aim to deliver a multiple or the inverse of the underlying index's return over a single day and are generally unsuitable for long-term holding✓
• b.Carry no risk of loss
• c.Track the index precisely one-for-one over any period
• d.Guarantee the holder exactly double the underlying index's total return measured over a full calendar year

L&I products reset daily, so they target the stated multiple or inverse only for one day. Over longer periods, daily compounding causes returns to deviate significantly from the simple multiple, making them short-term tools.

A futures contract is:

• a.A right, but not an obligation, for the holder to buy or sell the underlying asset at an agreed future price
• b.A share representing ownership in a company
• c.A binding agreement to buy or sell an asset at a set price on a future date✓
• d.A short-term bank deposit

A futures contract obliges both parties to transact the underlying at the agreed price on the delivery date. This obligation distinguishes it from an option, where only the holder has a right and the writer the obligation.

An investor who is 'long' a futures contract:

• a.Earns a fixed coupon regardless of price
• b.Makes a profit whenever the price of the underlying asset falls below the agreed futures price before delivery
• c.Profits when the underlying price rises above the agreed futures price✓
• d.Cannot lose money on the position

A long futures position agrees to buy at the fixed price, so it gains when the market price rises above that level and loses when it falls. Futures are leveraged, so losses (as well as gains) can be substantial.

The difference between a call option and a put option is that:

• a.A call gives the right to buy and a put the right to sell the underlying at the strike price✓
• b.A call is the right to sell the underlying and a put is the right to buy it, each at the agreed strike price
• c.Both are obligations to trade the underlying
• d.Both give the right to buy the underlying

A call option is the right (not obligation) to buy at the strike; a put option is the right to sell at the strike. The buyer pays a premium; the writer takes on the corresponding obligation if exercised.

The buyer of a put option profits when:

• a.Only at the expiry date, and then only if the option is allowed to lapse completely without being exercised
• b.Market interest rates rise
• c.The underlying price falls sufficiently below the strike price✓
• d.The underlying price rises far above the strike

A put gives the right to sell at the strike, so its value increases as the underlying falls below the strike by more than the premium paid. If the underlying stays high, the put expires worthless and the loss is the premium.

The maximum loss for the buyer of an option is:

• a.Limited to the premium paid for the option✓
• b.The full market value of the underlying asset that the option is written over at the time it was purchased
• c.Unlimited
• d.The full strike price

An option buyer can walk away if exercise is unprofitable, so the most that can be lost is the premium paid. By contrast, an option writer can face much larger, potentially unlimited, losses.

The writer (seller) of an option:

• a.Has the right, but not the obligation, to walk away from the contract if exercising it would not be profitable
• b.Is obliged to deliver or take the underlying if the holder exercises, in return for the premium received✓
• c.Pays a premium to the buyer
• d.Bears no risk on the position

The writer receives the premium but takes on the obligation to perform if the buyer exercises. Because the buyer controls exercise, the writer's risk can be large relative to the premium earned.

American-style and European-style options differ in that:

• a.An American-style option can be exercised at any time up to expiry, whereas a European-style can be exercised only at expiry✓
• b.Both the American-style and the European-style option can only ever be exercised on the final expiry date itself
• c.European options can be exercised on any trading day
• d.American options can never be exercised early

The labels describe exercise timing, not geography. American-style options allow exercise at any time before expiry; European-style options can be exercised only on the expiry date.

A call option is 'in-the-money' when:

• a.The current price of the underlying asset is below the option's strike price by more than the premium paid
• b.The underlying price is above the strike price✓
• c.The option has already expired
• d.The underlying price equals the strike price

A call has intrinsic value when the underlying trades above the strike, because the holder could buy below market. If the underlying is below the strike the call is out-of-the-money; at the strike it is at-the-money.

A depositary receipt is:

• a.A negotiable certificate representing shares in a foreign company, allowing them to trade on a local market✓
• b.A simple paper slip issued by a bank to confirm that a sum of money has been deposited into a customer's account
• c.A unit in a money-market fund
• d.A type of long-dated government bond

A depositary receipt (e.g. an ADR) is issued by a depositary bank and represents underlying foreign shares held on deposit, letting investors trade and settle in their own market and currency.

Exchange Fund Bills (and Treasury bills) are:

• a.Derivative warrants
• b.Long-dated equity investments that give the holder an ownership stake and a variable dividend in the issuer
• c.Perpetual bonds with no maturity
• d.Short-term instruments issued by the government or monetary authority and regarded as low risk✓

Exchange Fund Bills are short-term paper issued by the Hong Kong Monetary Authority; like Treasury bills elsewhere they are money-market instruments carrying very low credit risk and high liquidity.

A certificate of deposit (CD) is:

• a.An option on a currency
• b.A long-term bond issued by the government to finance public spending over a period of many years or decades
• c.A share in a bank
• d.A negotiable receipt issued by a bank for a fixed-term deposit that pays interest✓

A CD evidences a time deposit at a bank and pays a stated rate of interest. Being negotiable, it can be sold before maturity in the money market, giving the holder liquidity.

A share priced at HK$6.00 pays an annual dividend of HK$0.30. Its dividend yield is:

• a.20%, being the annual dividend of HK$0.30 expressed relative to a notional par value of just HK$1.50 per share
• b.5.0%✓
• c.2.0%
• d.0.5%

Dividend yield = annual dividend / share price = HK$0.30 / HK$6.00 = 5.0%. It measures the income return a shareholder earns relative to the current price.

An ordinary (common) share confers on its holder:

• a.A fixed dividend paid ahead of all other shareholders, plus priority over the company's creditors on a winding up
• b.A guaranteed return of the amount invested
• c.A fixed maturity date on which capital is repaid
• d.Voting rights, a variable dividend and a residual claim on assets after creditors✓

Ordinary shareholders own the residual interest in the company: they vote, receive dividends that vary with profits and policy, and rank last (after all creditors) if the company is wound up. There is no maturity or guaranteed income.

A redeemable preference share is one that:

• a.Carries unlimited voting rights
• b.Can be bought back (redeemed) by the company on predetermined terms✓
• c.Can never be repaid by the company
• d.Automatically converts into a fixed-rate corporate bond of the same issuer on a predetermined future date

A redeemable preference share may be repurchased by the issuer at a set price and date under its terms, giving the company flexibility to retire the shares. Irredeemable preference shares have no such repayment provision.

A participating preference share is distinctive because it:

• a.Ranks behind the ordinary shares both for dividends and for the return of capital when the company is wound up
• b.Receives no dividend at all
• c.Receives its fixed preference dividend and may also share in surplus profits alongside ordinary shareholders✓
• d.Pays a coupon that floats with HIBOR

A participating preference share earns its fixed preferential dividend and can additionally participate in extra distributions when profits are strong, giving some upside beyond the fixed rate.

A convertible preference share:

• a.Can be converted into the company's ordinary shares on set terms✓
• b.Pays no dividend of any kind
• c.Ranks behind the ordinary shares for the payment of dividends and for the return of capital on a winding up
• d.Must always be redeemed for cash at par

A convertible preference share offers a fixed preferential dividend plus the option to convert into ordinary shares, letting the holder switch to an equity stake if the company performs well.

An index fund is designed to:

• a.Invest exclusively in bonds
• b.Aims to beat the market consistently through active stock selection and frequent trading by the fund manager
• c.Guarantee a positive return every year
• d.Replicate the performance of a market index, usually at low cost✓

An index (passive) fund aims to match, not beat, a chosen benchmark by holding the index constituents or a representative sample. Low turnover and management effort mean lower fees than active funds.

Under the Hong Kong REIT regime, a listed REIT must:

• a.Distribute at least 50% of its income
• b.May retain all of its rental profits within the trust and reinvest them rather than paying them to unit holders
• c.Distribute at least 90% of its audited net income after tax to unit holders✓
• d.Pay no distributions to unit holders

The SFC's Code on REITs requires a Hong Kong REIT to distribute at least 90% of its audited annual net income after tax to unit holders, which is why REITs are valued largely for their income.

On a company's winding up, the ranking of a bondholder versus an ordinary shareholder is that:

• a.Bondholders are paid last, after shareholders
• b.Bondholders, as creditors, are paid before ordinary shareholders✓
• c.Ordinary shareholders, as the owners of the company, are always paid in full before any of the bondholders
• d.They rank exactly equally

Bonds are debt, so bondholders are creditors who must be satisfied before any distribution to shareholders. Ordinary shareholders hold the residual claim and are paid last, which is why equity is riskier than debt.

A 'high-yield' (junk) bond:

• a.Pays a lower yield than a top-rated bond
• b.Is fully guaranteed by the government as to both its coupon payments and the repayment of the principal sum
• c.Carries no default risk
• d.Is rated below investment grade and offers a higher yield to compensate for greater default risk✓

High-yield bonds are issued by less creditworthy borrowers rated below investment grade. The higher probability of default means investors demand a higher yield as compensation for the extra risk.

For a given change in market interest rates, which bond's price tends to move most?

• a.Only the coupon, never the maturity, affects sensitivity
• b.Shorter-dated bonds are more sensitive in price, because their principal is returned to the holder much sooner
• c.A longer-dated bond is generally more sensitive in price than a shorter-dated one✓
• d.Maturity has no effect on price sensitivity

Longer-maturity bonds have cash flows further in the future, so a change in the discount rate has a bigger effect on their present value. Hence, other things equal, longer-dated bonds show greater price volatility (duration).

A benefit of holding a floating-rate note when interest rates are rising is that:

• a.It stops paying interest when rates rise
• b.Its market price falls sharply as soon as market interest rates rise, in the same way as a fixed-coupon bond
• c.Its coupon rises with market rates, so its price stays relatively stable as rates increase✓
• d.It automatically converts into equity

Because an FRN's coupon resets upward with market rates, its income keeps pace with rising rates and its price shows little change, unlike a fixed-coupon bond whose price falls when rates rise.

A practical difference between an ETF and an open-ended unit trust is that:

• a.A unit trust trades continuously on the exchange like a share
• b.Neither an ETF nor a unit trust can be sold at any point during the trading day once it has been purchased
• c.Both can only be traded once per day
• d.An ETF can be bought and sold throughout the trading day at market prices, whereas an open-ended unit trust normally deals once a day at NAV✓

An ETF lists and trades intraday like a share, so investors can buy or sell at live prices. A traditional open-ended fund is dealt at a single daily NAV-based price after a cut-off, giving less intraday flexibility.

When taking a futures position, the investor generally:

• a.Can never lose more than the initial margin
• b.Only lodges a margin deposit, which gives leverage that magnifies both gains and losses✓
• c.The full value of the futures contract must be paid to the exchange in cash before the position can be opened
• d.Needs to deposit nothing at all

Futures are traded on margin: a small deposit controls a large contract value, creating leverage. Adverse moves can generate losses exceeding the initial margin, triggering margin calls, so risk is amplified.

An interest-rate swap is:

• a.A short-term bank deposit
• b.An agreement between two parties to exchange streams of interest payments, for example fixed for floating✓
• c.A type of government bond
• d.An exchange of whole blocks of ordinary shares between two companies that wish to take stakes in each other

In an interest-rate swap, counterparties exchange interest cash flows on a notional amount, typically swapping a fixed rate for a floating rate. It is used to manage or transform interest-rate exposure.

A key difference between a forward and a futures contract is that:

• a.A forward is a customised over-the-counter contract, whereas a futures contract is standardised and exchange-traded✓
• b.A forward is standardised while a future is bespoke
• c.Futures are traded only over the counter
• d.Both the forward and the futures contract are standardised instruments that trade only on a regulated exchange

Forwards are private, tailor-made OTC agreements with counterparty risk and no daily margining. Futures are standardised, exchange-traded and centrally cleared with daily marking to market, reducing counterparty risk.

An investor in a structured product should understand that it is:

• a.Fully guaranteed by the Securities and Futures Commission against any loss the investor might otherwise suffer
• b.Exposed to the credit risk of the issuer, so that if the issuer fails the investor may lose money✓
• c.Always fully capital protected
• d.Entirely free of issuer risk

Many structured products are unsecured obligations of the issuer. Even if the market view is correct, the investor can suffer loss if the issuer becomes insolvent, so issuer credit quality is a central risk.

A company with a dual-class (weighted voting rights) share structure is one where:

• a.The shares pay no dividend
• b.The shares are actually a form of bond
• c.Some share classes carry more votes per share than others, allowing founders to keep control✓
• d.Every share of the company carries exactly one vote each, so control follows the size of each holder's stake

Under a weighted voting rights structure, one class of shares carries extra votes, letting founders retain control with a minority economic stake. This raises corporate-governance considerations for other investors.

A 'blue-chip' share typically refers to:

• a.A large, well-established and financially sound company, such as a Hang Seng Index constituent✓
• b.A unit in a money-market fund
• c.A newly listed shell company that has no real trading business and only a small, illiquid free float of shares
• d.A defaulted bond issuer

Blue chips are shares in large, reputable, financially strong companies with a track record of stable earnings, often index constituents. They are generally more liquid and less volatile than smaller companies.

How does a growth stock generally differ from an income stock?

• a.Both pay identical dividends by definition
• b.An income stock never pays any dividend
• c.A growth stock reinvests earnings for capital appreciation, whereas an income stock pays higher, steadier dividends✓
• d.A growth stock pays out most of its earnings as a high dividend and rarely reinvests to expand its business

Growth companies retain profits to expand, so returns come mainly from a rising share price. Income (or yield) stocks distribute more of their earnings, appealing to investors who want regular dividend income.

If a listed warrant is out-of-the-money at expiry:

• a.It expires worthless and the holder loses the amount originally paid✓
• b.It converts automatically into a bond
• c.It is always redeemed by the issuer at its full par value, so the holder is guaranteed to recover the amount paid
• d.The issuer must buy it back at the investor's cost

A warrant has no value at expiry unless the underlying is beyond the exercise price in the holder's favour. If it finishes out-of-the-money, it lapses worthless and the entire premium paid is lost.

How does a rights entitlement differ from a warrant?

• a.They are exactly the same instrument
• b.A warrant is always the shorter-dated of the two
• c.A rights entitlement is a form of secured corporate bond that pays the holder a fixed coupon until it matures
• d.A rights entitlement is short-dated and offered to existing shareholders pro rata, whereas a warrant usually has a longer life and trades in its own right✓

A rights issue gives current shareholders a brief window to subscribe for new shares pro rata, usually at a discount. A warrant is a longer-lived, freely traded right to subscribe at a set price, often issued to the wider market.

The main attraction of a convertible bond to an investor is that it:

• a.Combines regular coupon income with the potential to benefit from a rise in the issuer's share price through conversion✓
• b.Always pays a materially higher coupon than any comparable straight bond issued by the very same company
• c.Is guaranteed by the government
• d.Carries no credit risk whatsoever

A convertible offers bond-style income and capital protection while retaining upside: if the shares rise, the holder can convert and share in the gain. This optionality usually means a lower coupon than a plain bond.

A physical (full-replication) ETF:

• a.Invests only in government bonds
• b.Holds no underlying assets at all
• c.Relies entirely on total-return swaps with a counterparty and holds none of the index's underlying securities
• d.Holds the actual constituent securities of the index it tracks✓

A physical ETF buys and holds the index's underlying securities (in full or by sampling). Because it owns the assets, it avoids the swap counterparty risk that a synthetic ETF carries.

A money-market fund typically:

• a.Guarantees a high fixed return
• b.Invests mainly in long-dated equities and property in the pursuit of high long-term capital growth for holders
• c.Uses heavy leverage to boost returns
• d.Invests in short-term, low-risk instruments, aiming to preserve capital and provide liquidity✓

A money-market fund holds short-term, high-quality instruments such as Treasury bills, CDs and commercial paper. Its objectives are capital preservation and liquidity, with modest income rather than growth.

A bond trading below its par value (at a discount) will have a yield to maturity that is:

• a.Exactly equal to its coupon rate
• b.Higher than its coupon rate, because the holder also gains as the price rises toward par at maturity✓
• c.Lower than its coupon rate, because the holder suffers a capital loss as the price falls back toward par value
• d.Always zero

When a bond trades below par, the investor earns the coupon plus a capital gain as the price pulls to par by maturity. That extra gain lifts the YTM above the coupon rate.

For a bond trading above par (at a premium), the yield to maturity is:

• a.Always negative
• b.Below its coupon rate✓
• c.Higher than its coupon rate, because the holder also enjoys a capital gain as the price rises toward par value
• d.Exactly equal to its coupon rate

A premium bond will fall in price toward par by maturity, producing a capital loss that offsets some coupon income. As a result its YTM is lower than the coupon rate.

Compared with buying a single share, buying one broad index ETF:

• a.Exposes the investor to just one company
• b.Is, by its very nature, always riskier than holding any single one of the individual shares within the index
• c.Cannot be sold once purchased
• d.Gives diversified exposure to many index constituents in a single transaction✓

An index ETF holds a basket of securities, so one purchase spreads exposure across many companies, reducing company-specific risk relative to owning a single stock, while still trading like a share.

A key benefit of investing through a unit trust rather than buying shares directly is:

• a.Access to professional management and a diversified portfolio that would be hard to build with a small sum✓
• b.The complete absence of any fees
• c.A guaranteed positive return
• d.Full voting control over each of the underlying companies whose shares are held within the unit trust's portfolio

A unit trust pools investors' money so that even a small investor gains professional management and a diversified spread of holdings. It charges fees and does not guarantee returns, and the manager, not the investor, votes the underlying shares.