HKSI Licensing Examination Paper 8 (Securities) — All Questions

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.

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.

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.