This question assesses the understanding of the distinct yet complementary roles of the Securities and Futures Commission (SFC) and Hong Kong Exchanges and Clearing Limited (HKEX) in regulating listed companies in Hong Kong. Statement I is incorrect. Under the dual filing regime, while the SFC reviews listing applications and can object to a listing, it is the Stock Exchange of Hong Kong (SEHK), a subsidiary of HKEX, that is the primary body responsible for approving listing applications and prospectuses. The SFC’s role is one of oversight. Statement II is correct. HKEX, through its Listing Division, is the frontline regulator responsible for administering the Listing Rules, which includes monitoring listed issuers’ ongoing compliance with disclosure requirements, such as the timely announcement of price-sensitive information. Statement III is correct. The SFC has broad statutory powers under the Securities and Futures Ordinance (SFO) to investigate and combat market misconduct, including insider dealing, market manipulation, and the dissemination of false or misleading information concerning listed securities. This is a core enforcement function of the SFC. Statement IV is incorrect. HKEX has its own disciplinary powers to sanction listed companies for breaches of the Listing Rules, which can range from private reprimands to public censures or even delisting. The SFC’s disciplinary powers are generally directed at licensed intermediaries or relate to breaches of the SFO, not breaches of the Listing Rules per se. Therefore, statements II and III are correct.

The question requires the calculation of the Effective Annual Rate (EAR) for a bond with semi-annual coupon payments. The nominal rate, or coupon rate, does not account for the effect of compounding. Since the coupon payments are made twice a year, the first payment can be reinvested for the second half of the year, earning additional interest. The EAR reflects the total return earned over a year, including this interest-on-interest. The formula to convert a nominal annual rate to an effective annual rate is EAR = (1 + i/n)^n – 1, where ‘i’ is the nominal annual interest rate and ‘n’ is the number of compounding periods per year. In this scenario, the nominal rate is 6% (0.06) and the payments are semi-annual, so n=2. The periodic rate is 6% / 2 = 3%. Plugging these values into the formula: EAR = (1 + 0.03)^2 – 1 = (1.03)^2 – 1 = 1.0609 – 1 = 0.0609, or 6.09%. This demonstrates that the effective return is slightly higher than the stated nominal rate due to the compounding of the semi-annual coupon payment.

This question tests the ability to calculate and compare simple and compound interest.
Statement I: Simple interest is calculated using the formula I = P × r × t. For Option X, the calculation is HKD25,000 × 4.25% × 3 years = HKD3,187.50. Thus, statement I is correct.
Statement II: Compound interest future value is calculated using the formula S = P(1 + r)^t. For Option Y, the calculation is HKD20,000 × (1 + 5.0%)^3 = HKD20,000 × (1.05)^3 = HKD20,000 × 1.157625 = HKD23,152.50. Thus, statement II is correct.
Statement III: To compare the interest returns, we first find the interest from Option Y, which is its future value minus the principal: HKD23,152.50 – HKD20,000 = HKD3,152.50. Comparing this to the interest from Option X (HKD3,187.50), we see that HKD3,187.50 is indeed greater than HKD3,152.50. Thus, statement III is correct.
Statement IV: This statement is conceptually false. For any investment period longer than one year, compound interest will always yield a higher return than simple interest at the same nominal annual rate because compound interest pays interest on the accumulated interest from previous periods. Therefore, statements I, II and III are correct.

Statement I is correct because a Negotiable Certificate of Deposit (NCD) is a debt instrument issued directly by an authorised institution (a bank), representing a deposit made at that institution. In contrast, a banker’s acceptance originates as a bill of exchange issued by a corporation (the drawer) to finance a transaction, which is then ‘accepted’ or guaranteed by a bank. The bank’s guarantee makes it a high-quality instrument, but the underlying obligation is initially corporate. Statement II is also correct. A promissory note (or commercial paper) is a simple promise to pay between two parties: the issuer (borrower) and the holder (lender). A banker’s acceptance is more complex, involving at least three parties: the drawer (the entity creating the bill), the acceptor (the bank that guarantees payment), and the payee/holder. Statement III is incorrect. While both involve financial institutions, their risk profiles are not identical. An NCD is a direct liability of the issuing bank. A commercial bill is a liability of a corporation, which is then accepted by a bank. The market perceives a higher risk in commercial bills compared to direct bank obligations like NCDs, hence commercial bills typically trade at higher yields. Statement IV is incorrect. Exchange Fund Bills (EFBs) are issued by the Hong Kong Monetary Authority (HKMA) on behalf of the government. They are used for managing interbank liquidity and establishing a risk-free benchmark yield curve, not for corporate financing. Corporations typically issue commercial paper or commercial bills to finance their working capital. Therefore, statements I and II are correct.

Statement I is correct. The Hong Kong Monetary Authority (HKMA) established and operates the Central Moneymarkets Unit (CMU) as the central clearing, settlement, and custodian system for debt securities in Hong Kong, facilitating efficient and secure transactions. Statement II is incorrect. Exchange Fund Bills and Notes (EFBNs) are issued by the HKMA on behalf of the HKSAR Government, not by the Hong Kong Exchanges and Clearing Limited (HKEX). The primary purpose of the EFBN programme is to manage interbank liquidity and provide a benchmark yield curve for Hong Kong dollar debt. HKEX’s primary role is in the equity and derivatives markets. Statement III is correct. Direct participation in the wholesale debt market is typically limited to institutional investors. Retail investors generally gain exposure to debt securities indirectly, either by purchasing them through authorized institutions (such as banks which act as intermediaries) or by investing in collective investment schemes (funds) that hold a portfolio of debt instruments. Statement IV is incorrect. While some corporate bonds are listed on the Stock Exchange of Hong Kong (SEHK), a substantial portion of the debt market, particularly for institutional-grade securities, operates on an over-the-counter (OTC) basis. There is no requirement for all debt securities to be listed on the exchange. Therefore, statements I and III are correct.

Credit rating agencies provide an independent assessment of an issuer’s creditworthiness and the likelihood of default on a specific debt instrument. For an underwriter involved in a new bond issuance, this rating is a cornerstone of the pricing and distribution process. A strong rating signals lower credit risk, allowing the bond to be priced with a lower yield (and thus lower borrowing cost for the issuer). It also serves as a crucial piece of information for the sales and marketing teams, as many institutional investors have mandates that restrict them to investing in bonds above a certain credit rating. The rating acts as a standardized, credible signal to the market, facilitating the placement of the new issue. While the rating is a vital input, it does not replace the underwriter’s legal and regulatory obligations, such as conducting thorough due diligence as required by the Securities and Futures Commission (SFC). Furthermore, the rating influences the final coupon rate but does not legally set it; the rate is ultimately determined by the issuer based on market feedback. Lastly, the rating assesses the issuer’s risk, not the counter-party risk of the investors purchasing the bond.

Statement I is correct. A repurchase agreement (repo) is legally structured as an outright sale of securities in exchange for cash, with a simultaneous agreement to repurchase equivalent securities at a future date for an agreed price. This structure is used to obtain short-term funding. Statement II is also correct. While legally a sale and repurchase, the economic function of a repo, particularly when conducted through the HKMA’s Discount Window, is that of a collateralised loan. The authorized institution provides securities (e.g., Exchange Fund Bills) as collateral to borrow funds from the HKMA. Statement III is incorrect. The party that sells the securities to borrow cash is known as the ‘repo seller’. The party that buys the securities and lends the cash is the ‘repo buyer’. Therefore, the institution borrowing cash would be the repo seller. Statement IV is incorrect. Repurchase agreements involving the HKMA are a primary tool for monetary management and providing short-term liquidity to the banking system. The development of the secondary mortgage market is the primary function of the Hong Kong Mortgage Corporation (HKMC), which is a separate objective. Therefore, statements I and II are correct.

This question assesses the fundamental differences between exchange-traded and over-the-counter (OTC) derivatives. Statement I is correct because a key feature of OTC derivatives is their flexibility; they are bespoke contracts tailored to the specific needs of the counterparties, such as matching exact notional amounts and maturity dates for a hedge. Statement II is also correct. For exchange-traded derivatives, a central clearing house (part of the exchange) acts as the counterparty to both the buyer and the seller. This process, known as novation, effectively eliminates counterparty credit risk for the participants. Statement III is incorrect; OTC derivatives are generally illiquid because their customised nature makes them difficult to transfer or sell to a third party. Exchange-traded derivatives, with their standardised terms, are the ones that offer greater liquidity. Statement IV is incorrect; the global OTC derivatives market is substantially larger in terms of total notional value outstanding compared to the market for exchange-traded derivatives. Therefore, statements I and II are correct.

This question tests the understanding of the empirical rule (also known as the 68-95-99.7 rule) for a normal distribution, a fundamental concept in statistics and risk management relevant to financial analysis. For any dataset that follows a normal distribution:
– Statement I is correct. Approximately 68% of all data points will fall within one standard deviation (plus or minus) of the mean.
– Statement II is correct. Approximately 95% of all data points will fall within two standard deviations of the mean.
– Statement III is incorrect. The probability of an observation falling within three standard deviations of the mean is approximately 99.7%. Therefore, the probability of an observation being more than three standard deviations away (an extreme event) is only about 0.3% (100% – 99.7%), not 5%. A 5% probability corresponds to the area outside of two standard deviations.
– Statement IV is incorrect. For a continuous distribution like the normal distribution, the probability of any single specific value occurring is zero. While the mean is the central point of the distribution and also the median, it does not mean 50% of the returns are exactly equal to it. Rather, 50% of the returns are expected to be above the mean and 50% are expected to be below the mean. Therefore, statements I and II are correct.

This question assesses a candidate’s understanding of the fundamental purpose, requirements, and nature of the HKSI Paper 7 licensing examination. Statement I is incorrect; the examination is designed to test the application, analysis, and evaluation of concepts, not just rote memorization of rule numbers. Statement II is correct; passing the HKSI Paper 7 examination is a key step in fulfilling the competency requirements to be licensed as a Representative by the Securities and Futures Commission (SFC), as it is a Recognised Industry Qualification. Statement III is correct; the financial industry is dynamic, and regulations change. The HKSI explicitly advises candidates that it is their own responsibility to ensure they are studying from the latest version of the manual to be aware of any updates. Statement IV is incorrect; the passing grade for the HKSI Paper 7 examination is 70%, not 50%. Therefore, statements II and III are correct.

Statement I is correct because in a repurchase agreement (repo), the party that buys the securities and agrees to sell them back later is providing funds, thus acting as a lender. The corporate client is selling the securities to receive cash, making it the borrower. Statement II is correct as the EFNs are held by the licensed corporation (the lender) for the duration of the agreement, serving as security or collateral against the funds it has provided. If the client defaults on the repurchase, the corporation can sell the EFNs to recover its funds. Statement III is correct. For a licensed corporation engaged in the business of securities dealing and financing in Hong Kong, the income generated from repo transactions (the ‘interest’ or price differential) is considered trading profit. Under the Inland Revenue Ordinance (Cap. 112), such profits sourced in Hong Kong are subject to Profits Tax. Statement IV is incorrect. The profit is not a capital gain for a financial institution whose ordinary business involves such transactions; it is revenue in nature. Furthermore, the transaction is conducted in Hong Kong, making the profit Hong Kong-sourced and taxable, not an exempt ‘offshore capital gain’. While interest income from EFNs may be exempt from profits tax, profits from trading them are not. Therefore, statements I, II and III are correct.

A Floating Rate Note (FRN) is a debt instrument with a variable interest rate. The coupon payment is periodically reset based on a reference benchmark rate, such as the Hong Kong Interbank Offered Rate (HIBOR), plus a fixed credit spread. Statement I is correct because as the benchmark interest rate rises, the coupon payments, which are linked to this rate, will also increase at the next reset date, providing the investor with a higher income stream. Statement II is incorrect; FRNs generally exhibit lower price volatility compared to fixed-rate bonds. This is because their coupon adjusts to prevailing market rates, which helps to keep their market price closer to their par value, thus mitigating interest rate risk. Statement III is incorrect because the total coupon is composed of two parts: the variable benchmark rate and a fixed spread (or margin) that is determined at the time of issuance to compensate for the issuer’s credit risk. Statement IV is incorrect because the primary advantage of an FRN is in a rising interest rate environment. In a falling rate environment, the coupon payments would decrease, which is a disadvantage, not a form of protection, for the investor seeking stable or rising income. Therefore, statement I is correct.

The question requires an understanding of zero-coupon bond pricing and characteristics.

Statement I is correct. The price (or present value) of a zero-coupon bond is calculated by discounting its single future cash flow (the face value) back to the present. The formula is: Price = Face Value / (1 + yield)^t, where ‘t’ is the time to maturity. This statement accurately describes the calculation method.

Statement II is correct. Applying the formula with the given values: Price = HKD 100 / (1 + 0.05)^2 = HKD 100 / 1.1025 = HKD 90.7029, which is approximately HKD 90.70.

Statement III is incorrect. A fundamental principle of bond valuation is that, all else being equal, a bond’s price sensitivity to interest rate changes (duration) increases with its time to maturity. Therefore, a 2-year bond is less sensitive to interest rate fluctuations than a 10-year bond.

Statement IV is correct. A zero-coupon bond is purchased at a discount to its face value and pays no periodic interest. The investor’s return is the difference between the purchase price (HKD 90.70) and the face value received at maturity (HKD 100). This difference is treated as a capital gain. Therefore, statements I, II and IV are correct.

The Hong Kong Securities and Investment Institute (HKSI) specifies clear rules for materials and equipment permitted in the examination hall to maintain a fair and standardized testing environment. The regulations for calculators are particularly strict. Candidates are allowed to use only non-programmable electronic calculators. The key restrictions are that the calculator must be battery-powered, operate silently, and, most importantly, must not possess any print-out, graphic display, or word display functions. The presence of a feature that allows for storing text or displaying graphs disqualifies the device, regardless of whether the candidate intends to use that feature. The rule is based on the capability of the device, not the candidate’s intent, to prevent any possibility of accessing stored information.

This question assesses the understanding of currency risk, particularly in the context of emerging markets with foreign-denominated debt and pegged exchange rate regimes, drawing lessons from events like the 1997 Asian Financial Crisis. When a country’s corporations borrow heavily in a foreign currency (like the US Dollar) while its local currency is pegged to that foreign currency, a significant risk emerges if the foreign currency strengthens. A strengthening USD increases the real burden of the USD-denominated debt for these corporations, as they earn revenue in the local currency but must repay their loans in a now more valuable foreign currency. This can lead to financial distress, defaults, and a potential systemic crisis. A stronger USD, coupled with a currency peg, also makes the country’s exports more expensive and less competitive on the global market, further straining the economy. The other options are incorrect because a strengthening USD would likely make exports less competitive, not more, and would pressure the local economy downwards rather than stimulating domestic demand or causing deflationary spirals as the primary, direct risk.

This question assesses the understanding of the roles of different economic sectors within the financial system. In any economy, funds flow between sectors that have a surplus (lenders) and those that have a deficit (borrowers). The business sector, which consists of producers of goods and services, typically requires significant capital for operations, expansion, and investment. Issuing debt instruments like corporate bonds is a primary method for businesses to raise funds, positioning them as borrowers. The household sector, comprising individuals and families, represents the primary source of savings in an economy. When individuals purchase financial instruments like bonds, they are channeling their savings to other sectors, thus acting as lenders. Similarly, the overseas sector includes foreign entities that invest in the domestic economy. When a foreign fund purchases locally issued bonds, it is injecting capital into the local market, thereby functioning as a lender. Understanding these fundamental roles is crucial for analyzing capital flows and the functioning of financial markets.

A credit rating downgrade signifies an increase in the perceived credit risk of the issuer, meaning there is a higher probability of default. In the secondary market, investors will demand a higher return, or yield, to compensate for taking on this additional risk. For a fixed-income security with a fixed coupon rate, the only way for its yield to increase is for its market price to decrease. This reflects the inverse relationship between a bond’s price and its yield. The coupon rate itself is fixed at the time of issuance and does not change based on market events or credit rating changes. Therefore, the immediate market reaction to a downgrade is a fall in the bond’s price and a corresponding rise in its yield.

Monetary policy actions by a central bank, such as adjusting short-term interest rates, have a significant impact on the availability of credit within an economy. When a central bank implements a contractionary policy by raising interest rates, it increases the cost of borrowing for commercial banks. To maintain their profit margins and manage heightened credit risk associated with higher borrowing costs for their clients, banks typically pass on this increase by raising their own lending rates. Furthermore, to safeguard against a potential rise in loan defaults in a less favorable economic environment, banks often become more cautious. This caution manifests as a tightening of lending standards, meaning they may require higher credit scores, more collateral, or lower debt-to-income ratios from potential borrowers. This phenomenon, where higher interest rates lead to reduced credit availability, is known as the credit effect.

Statement I is incorrect. Government debt, such as Exchange Fund Bills (EFBs), is issued on the primary market through a competitive tender system involving recognised dealers, not through a syndication process which is typical for corporate debt. Statement II is correct. The primary issuance of corporate debt is usually undertaken through syndication, where an offering document like a prospectus is provided to potential investors, and underwriters guarantee to cover any subscription shortfall. Statement III is incorrect. The secondary debt market in Hong Kong is predominantly an over-the-counter (OTC) market, not primarily conducted on the Stock Exchange of Hong Kong (SEHK). While some specific instruments like certain EFNs are listed, the bulk of trading occurs OTC. Statement IV is correct. The listing of Exchange Fund Notes (EFNs) on the SEHK was a strategic move to appeal to retail investors, offering them a low-risk investment tool with potential for capital growth as an alternative to traditional bank deposits. Therefore, statements II and IV are correct.

According to the SFC’s Code on Unit Trusts and Mutual Funds, there are specific diversification requirements to mitigate concentration risk in authorized funds. Two primary rules are that a fund generally cannot invest more than 10% of its Net Asset Value (NAV) in securities issued by a single entity, and it cannot hold more than 10% of the ordinary shares issued by any single entity. The purpose of these limits is to ensure that the fund’s performance is not overly dependent on the success or failure of a small number of issuers. When evaluating the proposed investments, one must calculate the investment amount as a percentage of the fund’s total NAV and also assess the holding as a percentage of the target company’s total issued shares. An investment that is exactly at the 10% threshold is compliant, but any amount exceeding it constitutes a breach. Therefore, a portfolio manager must adhere strictly to these quantitative limits when constructing or rebalancing a fund’s portfolio.

This question assesses the understanding of duration as a measure of interest rate risk and its inherent limitations. Duration measures the sensitivity of a bond’s price to a one-percent change in interest rates. A key underlying assumption of this calculation is that all interest rates along the yield curve move by the same amount, which is known as a parallel shift. However, in reality, yield curves rarely shift in a perfectly parallel manner. They can steepen, flatten, or invert, meaning short-term rates and long-term rates change by different magnitudes. When a significant, non-parallel shift occurs, the linear approximation provided by duration becomes less accurate. More advanced measures, such as convexity, are used to account for the curvature in the relationship between bond prices and yields, providing a better risk estimate for larger or non-parallel interest rate movements. The other options describe different types of financial risk: credit risk (changes in issuer creditworthiness), liquidity risk (ability to sell an asset without impacting its price), and a misunderstanding of how duration functions (it measures sensitivity to both increases and decreases in rates).

The global foreign exchange (FX) market is fundamentally a decentralized, over-the-counter (OTC) market. This means there is no single, centralized physical exchange like a stock market. Instead, transactions are conducted electronically between a network of participants, primarily banks, financial institutions, corporations, and central banks, across various time zones. While the US dollar is the most traded currency and acts as a vehicle currency in many transactions, it is not the mandatory settlement currency for all trades. Currency pairs that do not involve the US dollar, such as EUR/JPY or AUD/CHF, are known as ‘cross rates’. The value of these cross rates is typically derived from the respective exchange rates of each currency against the US dollar (e.g., the EUR/JPY rate is calculated using the EUR/USD and USD/JPY rates).

This question tests the candidate’s understanding of how to calculate a forward foreign exchange rate using the interest rate parity (IRP) principle. The IRP formula is: Forward Rate = Spot Rate × [(1 + Interest Rate of Quote Currency × Time Fraction) / (1 + Interest Rate of Base Currency × Time Fraction)]. In the GBP/HKD pair, GBP is the base currency and HKD is the quote currency. The time fraction is calculated as the number of days in the forward period divided by the day count convention (180/365). The currency with the higher interest rate (GBP at 5.0%) will trade at a discount in the forward market compared to the currency with the lower interest rate (HKD at 2.0%). Therefore, the forward GBP/HKD rate must be lower than the spot rate. The calculation is as follows: 9.8500 × [(1 + 0.020 × (180/365)) / (1 + 0.050 × (180/365))] = 9.8500 × [1.009863 / 1.024657] ≈ 9.7077. This calculation is a fundamental skill for anyone dealing with foreign exchange products, a core activity for Type 3 licensed corporations under the Securities and Futures Ordinance (SFO).

The Pilot Programme allows certain securities listed on NASDAQ and AMEX to be traded on the Stock Exchange of Hong Kong (SEHK). A key feature of this programme is its regulatory treatment. Statement I is incorrect because these securities are specifically listed for trading purposes only and do not constitute a public offering in Hong Kong. Consequently, they are not subject to the prospectus requirements under the Companies (Winding Up and Miscellaneous Provisions) Ordinance. Statement II is correct; all trading activities for these securities on the SEHK fall under the jurisdiction of Hong Kong law and the SEHK’s listing rules, ensuring investor protection and market integrity within Hong Kong. Statement III is incorrect because the programme is not limited to equity shares. As the example in the scenario (iShares MSCI Taiwan Index Fund) illustrates, the programme also includes exchange-traded funds (ETFs). Statement IV is correct and reinforces the point made in the explanation for Statement I; the arrangement is a secondary listing for trading and is explicitly not considered a public offer in the Hong Kong context. Therefore, statements II and IV are correct.

A repurchase agreement, commonly known as a ‘repo’, is a critical tool used by the Hong Kong Monetary Authority (HKMA) to manage liquidity in the banking system. When an authorized institution requires short-term Hong Kong Dollar funds, it can access the HKMA’s Discount Window. The transaction involves the institution selling eligible securities, such as Exchange Fund Bills and Notes, to the HKMA in exchange for cash. Crucially, this is accompanied by a simultaneous agreement to buy back equivalent securities at a specified future date and at a pre-agreed price. Although economically similar to a collateralised loan, the legal structure is that of an outright sale and subsequent repurchase. This means that legal ownership of the securities temporarily transfers to the HKMA. This mechanism is distinct from securities margin financing, which is used to fund the purchase of other securities, and from a simple discount sale, which does not include a repurchase obligation.

Statement I is incorrect. Due to the Linked Exchange Rate System (LERS), the Hong Kong dollar is pegged to the US dollar. Consequently, the Hong Kong Monetary Authority (HKMA) typically follows the monetary policy of the U.S. Federal Reserve to maintain the peg’s stability. A significant interest rate hike in the U.S. would almost certainly lead to a corresponding increase in Hong Kong’s base rate, directly impacting interbank rates and the broader economy. Statement II is correct. As a major international financial centre, Hong Kong’s securities markets are heavily influenced by the asset allocation decisions of global institutional investors. A strategic decision to reduce exposure to Asian markets would likely trigger significant capital outflows from Hong Kong, leading to selling pressure and a decline in stock market values. Statement III is incorrect. A major currency crisis in a neighbouring economy typically creates regional instability and financial contagion risk. This would likely lead to a ‘risk-off’ sentiment among investors, causing them to withdraw capital from the region, including Hong Kong, which would be detrimental to the local market. Statement IV is correct. Hong Kong’s economy is closely linked with that of mainland China. Many companies listed in Hong Kong have extensive business operations, manufacturing facilities, or supply chains in the mainland. The imposition of international tariffs on Chinese goods would disrupt these operations, potentially reducing revenues and profitability, thereby negatively impacting their stock valuations. Therefore, statements II and IV are correct.

In Hong Kong, short selling is a regulated activity governed by the Securities and Futures Ordinance (SFO) and the Rules of the Exchange. A key principle is that ‘naked’ or ‘uncovered’ short selling is illegal. A seller must have a ‘presently exercisable and unconditional right to vest’ the securities at the time of the sale, which typically means they have already borrowed the shares. Furthermore, short selling is only permitted for specific securities known as ‘Designated Securities’. For the execution of such trades on the Stock Exchange of Hong Kong (SEHK), a specific pricing rule, often referred to as the ‘tick rule’, applies. This rule stipulates that a short sale order cannot be placed on the exchange at a price below the best current ask price. This rule replaced the former ‘uptick rule’ and is designed to prevent short sellers from aggressively driving down a stock’s price.

In the context of exchange-traded derivatives in Hong Kong, novation is a critical legal process managed by the Hong Kong Clearing Corporation (HKCC), which acts as a central counterparty (CCP). When a buyer and a seller agree to a futures contract, their trade is registered with the HKCC. Through novation, the single original contract between the buyer and seller is legally extinguished and replaced by two new, separate, and legally distinct contracts. The first new contract is between the original buyer and the HKCC, and the second is between the original seller and the HKCC. The primary effect of this is that the HKCC becomes the counterparty to every trade. This substitution fundamentally changes the risk profile for market participants. Instead of facing the credit risk of their original trading partner, both the buyer and the seller now face the credit risk of the clearing house (HKCC). This process is central to mitigating counterparty risk and ensuring the integrity and stability of the futures market, as the HKCC guarantees the performance of all contracts it clears.

The global foreign exchange (FX) market is fundamentally an Over-the-Counter (OTC) market. This means it is a decentralized network where participants, such as banks, financial institutions, and corporations, trade directly with one another rather than through a centralized exchange like a stock market. While the US dollar is the world’s primary reserve and vehicle currency, involved in the vast majority of transactions, it is not a requirement for all FX trades to be settled against it. Parties can freely trade and settle any currency pair, such as EUR/JPY or AUD/NZD. A ‘cross rate’ is specifically an exchange rate between two currencies, neither of which is the US dollar. For instance, GBP/CHF is a cross rate. An exchange rate involving the USD, such as EUR/USD, is typically referred to as a ‘major’ pair, not a cross rate. FX dealers at banks perform dual functions: they act as market makers and traders for the bank’s own account (proprietary trading) and also as distributors who provide FX products and services to corporate and retail clients.

Under the Banking Ordinance, Hong Kong operates a three-tier system of authorized institutions supervised by the Hong Kong Monetary Authority (HKMA). Statement I is correct; Licensed Banks form the first tier and are the only institutions that can operate current and savings accounts and accept deposits of any size and maturity. Statement II is correct; Restricted Licence Banks (RLBs) form the second tier, are often involved in merchant banking, and can accept deposits of HK$500,000 or more without any maturity restrictions. Statement III is correct; Deposit-taking Companies (DTCs) form the third tier and are limited to accepting deposits of HK$100,000 or more with a minimum maturity of three months. Statement IV is incorrect because only licensed banks can use the label ‘bank’ without qualification. RLBs and DTCs cannot offer cheque-clearing services to the public, a function typically reserved for licensed banks. Therefore, statements I, II and III are correct.