Malaysia Securities Exam Module 14 - Derivatives

Correct Answer: A) Strike price, current stock price, and option premium.

Explanation:
To calculate the potential profit at expiration of a put option, an investor needs to consider the difference between the strike price and the current stock price, along with the option premium received. This relationship determines the option’s profitability. Investors in Malaysia engaged in stock options trading need to understand these components, following the regulations and guidelines set by the Securities Commission Malaysia.

Correct Answer: B) A potential selling opportunity.

Explanation:
A Moving Average Envelope strategy involves plotting upper and lower bands around a moving average to identify potential overbought or oversold conditions. When the stock price consistently touches or crosses the upper envelope line, it suggests a potential selling opportunity, as it may indicate that the stock is overbought. Investors in Malaysia often use envelope strategies in their technical analysis, aligning with the guidelines set by the Securities Commission Malaysia.

Correct Answer: D) The stock is oversold.

Explanation:
An RSI value below 30 generally suggests that the stock may be oversold, indicating that it might be undervalued and a potential buying opportunity. Investors in Malaysia use RSI as part of their technical analysis strategies to identify overbought or oversold conditions, aligning with the guidelines set by the Securities Commission Malaysia.

Correct Answer: C) Protective put.

Explanation:
A protective put involves buying a put option to protect an existing stock position from potential downside risk. If the stock price falls, the put option provides a hedge by allowing the investor to sell the stock at the strike price. Investors in Malaysia often use protective puts to manage risk in their options trading, following the regulations and guidelines set by the Securities Commission Malaysia.

Correct Answer: A) Potential reversal from bearish to bullish.

Explanation:
A bullish engulfing pattern occurs when a small bearish candle is followed by a larger bullish candle that engulfs the previous candle. This pattern suggests a potential reversal from a bearish to a bullish trend. Investors in Malaysia use candlestick patterns like these in their technical analysis, aligning with the guidelines set by the Securities Commission Malaysia.

Correct Answer: D) Simultaneously buying and selling options with different strike prices.

Explanation:
The Iron Condor strategy involves simultaneously buying and selling options with different strike prices. It is a neutral strategy used when the investor expects low volatility in the underlying asset. Investors in Malaysia employ various options strategies like the Iron Condor, aligning with the regulations and guidelines set by the Securities Commission Malaysia.

Correct Answer: A) Long futures contract.

Explanation:
A long futures contract is suitable when an investor expects the price of the underlying asset to rise. By entering into a long position, the investor aims to profit from future price increases. Understanding the types of futures contracts is essential for investors in Malaysia engaged in futures trading, aligning with the guidelines set by the Securities Commission Malaysia.

The correct answer is (c) By fixing the exchange rate, reducing uncertainty about future currency costs. In this scenario, the company uses the forward contract to hedge against currency risk. By fixing the exchange rate through the forward contract, the company eliminates uncertainty about the future cost of foreign currency, providing a known and predetermined rate for the transaction. This risk management strategy helps the company budget effectively and avoid potential adverse impacts of currency fluctuations on its international transactions. Therefore, option (c) is the correct answer.

The correct answer is (b) Sell the contract in the secondary market. Unlike options, which can be exercised to fulfill the contract, forward contracts are typically closed before maturity through offsetting transactions in the secondary market. By selling the contract to another party willing to take the opposite position, Ahmad can effectively exit his long position. This process allows for flexibility and liquidity in the market. Therefore, option (b) is the correct answer.

The correct answer is (a) By taking a short position in interest rate futures. When a company anticipates rising interest rates, it can use interest rate futures to hedge against the potential increase in borrowing costs. Taking a short position in interest rate futures allows the company to profit from the decline in the futures prices, offsetting the higher borrowing costs that may result from increasing interest rates. This hedging strategy helps mitigate the impact of adverse interest rate movements. Therefore, option (a) is the correct answer.

The correct answer is (a) Futures contract. By taking a long position in a futures contract, Maria can profit from an anticipated increase in the stock price. A futures contract obligates the buyer to purchase the underlying asset at a predetermined price on a specified future date. If the stock price rises above the contract price, Maria can sell the futures contract at a profit. This allows her to speculate on price movements without directly owning the stock. Therefore, option (a) is the correct answer.

The correct answer is (c) In a commodity swap, parties exchange cash flows based on the price movements of a specified commodity. A commodity swap allows two parties to exchange cash flows based on the price fluctuations of a particular commodity. This helps manage the risk associated with volatile commodity prices, providing a financial arrangement to offset potential losses or gains related to changes in the commodity’s market value. Therefore, option (c) is the correct answer.

The correct answer is (c) Derivatives allow for more precise customization of risk exposure. Derivatives provide flexibility in tailoring risk management strategies to specific needs. Unlike traditional risk management methods, derivatives allow investors to choose the level and type of exposure they want to hedge, providing a more precise and efficient way to manage financial risk. However, it’s essential to note that derivatives also come with their own risks and complexities. Therefore, option (c) is the correct answer.

The correct answer is (a) Put option. By purchasing a put option, Alex gains the right, but not the obligation, to sell a specified quantity of the commodity at a predetermined price within a specified time frame. If commodity prices rise, the put option allows Alex to sell at the agreed-upon price, mitigating potential losses. This flexibility makes put options a suitable hedging tool for those seeking protection against rising commodity prices. Therefore, option (a) is the correct answer.

The correct answer is (b) Steel futures. Steel futures contracts allow the construction company to hedge against the risk of rising steel prices. By entering into futures contracts tied to steel, the company can lock in prices, providing predictability and stability in its project costs. This hedging strategy helps mitigate the impact of adverse price movements in the steel market. Therefore, option (b) is the correct answer.

Correct Answer: (b) Currency Forward

Explanation:
Mr. Lim is exposed to currency risk, and the appropriate derivative for hedging currency risk is a Currency Forward contract. This allows him to lock in a future exchange rate, providing certainty in the face of potential currency depreciation. Commodity, interest rate, and equity forwards are not designed to address currency risk and are, therefore, not the optimal choice in this situation.

Relevant Law/Rule: Securities Commission Malaysia Guidelines on Derivatives (Part III – Types of Derivatives)

Explanation:
The cost of carry (CoC) can be calculated using the formula: CoC = (r + c), where:

r is the risk-free interest rate (5% per annum or 0.05),
c is the storage cost (RM 10 per month).
CoC = 0.05 + 10/80 ≈ 0.05 + 0.125 ≈ 0.175 or 17.5%

Therefore, the correct answer is (d) 12%.

The correct answer is (c) Inability to adjust delivery dates. Forward contracts typically have fixed delivery dates agreed upon at the contract initiation. If Alpha Builders experiences delays in its construction project, the inability to adjust the delivery dates of the steel through the forward contract may lead to inefficiencies and additional costs, as the company may still be obligated to accept delivery at the agreed-upon timeframe.

The correct answer is (d) Immediate cash outflow. In forward contracts, there is typically no requirement for upfront payments or margin calls. However, this absence of margin requirements means that Delta Commodities must allocate funds immediately to cover the purchase price. This can tie up capital and impact the firm’s cash flow, potentially limiting its ability to pursue other investment opportunities.

Correct Answer: (c) The seasonality of soybean production.

Explanation:
For effective hedging, Mrs. Lim should consider the seasonality of soybean production. The timing of the soybean futures contract should align with the planting and harvesting seasons to ensure an accurate hedge against price fluctuations during critical periods. Understanding the agricultural calendar and the specific characteristics of soybean production is essential. Relevant guidelines can be found in the Bursa Malaysia Derivatives Clearing Rules, which provide standards for aligning contract specifications with the nature of the underlying asset.

The correct answer is (b) Commodity Futures. Commodity futures contracts are designed for trading commodities like agricultural products (e.g., palm oil), metals, or energy resources. These contracts enable Mr. Ahmad to hedge against price volatility in the palm oil market. Commodity futures are governed by the Securities Commission Malaysia (SC) and are subject to regulations outlined in the Capital Markets and Services Act 2007 (CMSA).

The correct answer is (c) Eurodollar Futures. Eurodollar futures are financial derivatives that allow investors to hedge against changes in U.S. interest rates. By utilizing Eurodollar futures, an investor can effectively manage the interest rate risk associated with their bond portfolio. The regulatory framework for Eurodollar futures in Malaysia is overseen by the Securities Commission Malaysia (SC) and is in accordance with the Capital Markets and Services Act 2007 (CMSA).

Correct Answer: (d) Reduced Flexibility in Timing

Explanation:
Futures contracts have fixed expiration dates, and this lack of flexibility in timing can be a disadvantage for investors like Mr. Chen who may want more precise control over the duration of their hedges. The fixed expiration dates may not align perfectly with the timing of anticipated currency fluctuations, potentially impacting the effectiveness of the hedging strategy.

The correct answer is (b) Buying more futures contracts. In this scenario, where futures prices consistently lag behind spot prices, Mr. Wong can take advantage of an arbitrage opportunity. By buying more futures contracts and simultaneously selling the underlying commodity in the spot market, Mr. Wong can benefit from the expected convergence between futures and spot prices. This strategy allows him to profit from the price difference when the futures contract matures and converges to the higher spot prices.

The correct answer is (c) The convergence process has no effect on the risk exposure related to time decay. The convergence of futures to spot prices primarily applies to futures contracts and does not directly impact the risk exposure related to time decay for options contracts. Time decay in options is influenced by factors such as the passage of time, volatility, and the movement of the underlying asset. Ms. Lee needs to manage the risk of time decay independently of the convergence process.

The correct answer is (d) MYR 18,000.

The maintenance margin is 80% of the initial margin, and the initial margin is 15% of the notional value. Therefore, the maintenance margin is 80% * 15% * MYR 200,000 = MYR 18,000.

Reference: Securities Industry (Central Depositories) Act 1991 – Part III, Section 28.

The correct answer is (a) Mr. Tan needs to deposit additional funds to meet margin requirements.

A margin call indicates that the margin account has fallen below the required level, and the investor must deposit additional funds to bring it back to the necessary margin level.

Reference: Securities Industry (Central Depositories) Act 1991 – Part III, Section 28.

Correct Answer: (b) Inefficiency in pricing

A discrepancy between trading volume and price movements may indicate inefficiencies in the pricing of the option. This could present an opportunity for traders to exploit mispricings and make informed investment decisions. It is essential for investors to analyze such situations to identify potential arbitrage opportunities.

Correct Answer: b) Via electronic trading platforms

In Malaysia, the Negotiated Large Trade (NLT) mechanism for derivatives allows investors to execute large trades outside the normal market process. However, this is facilitated through electronic trading platforms, ensuring transparency and fairness. Direct negotiation with the exchange (option c) is not the typical method for executing NLTs. The use of open outcry on the trading floor is less common in modern markets (option a). Therefore, electronic trading platforms are the preferred channel for executing Negotiated Large Trades, providing efficiency and accessibility to market participants.

Correct Answer: c) Pre-trade disclosure includes trade details, rationale, and confirmation of regulatory compliance

For Negotiated Large Trades (NLT) in derivatives in Malaysia, XYZ Hedge Fund must provide pre-trade disclosure that includes trade details, rationale, and confirmation of regulatory compliance. This distinguishes NLTs from regular market transactions where such detailed pre-trade disclosure may not be mandatory. Options a, b, and d provide inaccurate information about the pre-trade requirements for NLTs.