Quiz: New Trends

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5 questions to check your understanding of the chapter “New Trends”. Choose an answer and select “Check answer” to see the answer and explanation. You can also open “Answer and explanation” to see the answer first.

1. Question 1

   As a hypothetical example, an ESG-linked condition is added to a 3-year interest rate swap with a notional of 5 billion yen. The payer's fixed rate is 0.80%, reduced by 0.10 percentage points if the target for the year is met and increased by 0.10 percentage points if it is not met. The target was met in years 1 and 3 and not met in year 2. What is the total of the fixed-rate payments over the 3 years (ignoring the floating-rate payments)?

   1. A.105 million yen
   2. B.115 million yen
   3. C.120 million yen
   4. D.125 million yen
   Answer and explanation

   Answer: B

   In a year when the target is met, the fixed rate is 0.80% − 0.10% = 0.70%, and the payment for one year is 5 billion yen × 0.70% = 35 million yen. In a year when it is not met, the rate is 0.80% + 0.10% = 0.90%, and the payment is 5 billion yen × 0.90% = 45 million yen. Over the 3 years, the total is 35 + 45 + 35 = 115 million yen.

   Without the adjustment, the payment would be 5 billion yen × 0.80% = 40 million yen a year, or 120 million yen over 3 years. In a year when the target is met the payment is 5 million yen lower, and in a year when it is not met it is 5 million yen higher, so the net result is 5 million yen lower. If the target were met in all 3 years, the total would be 35 × 3 = 105 million yen, and if it were missed in 2 years, it would be 35 + 45 + 45 = 125 million yen, so the payments move up and down with the results.

   Learn more: ESG-Linked Derivatives

2. Question 2

   Which statement about ESG-linked derivative contracts in the UK is correct, according to a UK law firm's commentary of May 2023?

   1. A.The KPI (key performance indicator) terms are usually not written in the trade confirmation, but only in a separate agreement
   2. B.The body that published guidance on how to design KPIs in September 2021 was the Financial Conduct Authority (FCA)
   3. C.The payments that adjust for the result are usually made at a different time from the other payments under the transaction
   4. D.There is usually no common standard template, and the KPI terms are added to a general contract
   Answer and explanation

   Answer: D

   At that point there was no common standard template, and the terms, including the KPIs, were built by adding them to a general derivatives contract.

   The KPI terms were usually written in the trade confirmation, and in some deals they were written in a separate agreement referred to from the confirmation. The adjustment payments were usually made at the same time as the other payments. The guidance on designing KPIs in September 2021 was published by the International Swaps and Derivatives Association (ISDA). The FCA's October 2022 consultation paper, which said it did not intend to set rules specific to derivatives, is a separate matter. At that time, ESG-linked derivatives were treated much the same as other OTC derivatives for regulatory purposes.

   Learn more: ESG-Linked Derivatives

3. Question 3

   As a hypothetical example, the price of a perpetual swap stays above the spot price, and the funding rate is +0.02% per payment, paid every 8 hours. The funding rate is a rate exchanged between the long side and the short side. Here, assume a hypothetical arrangement in which the amount exchanged is the transaction amount × the rate. What is the total amount the long side pays over 2 days on a position with a transaction amount of 2 million yen, ignoring fees and price changes?

   1. A.2,400 yen
   2. B.24,000 yen
   3. C.400 yen
   4. D.1,200 yen
   Answer and explanation

   Answer: A

   The amount per payment is 2 million yen × 0.02% = 400 yen. Payments are every 8 hours, so 2 days (48 hours) have 6 payments, and the total is 400 yen × 6 = 2,400 yen. When the price is above spot, the long side pays the short side, so the long side pays 2,400 yen.

   400 yen is the value from counting only one payment, 1,200 yen is the value from counting only 3 payments, one day's worth, and 24,000 yen is the value from mistaking 0.02% for 0.2% (2 million yen × 0.2% = 4,000 yen, × 6 payments).

   Learn more: Crypto-Asset Derivatives

4. Question 4

   Which statement about the Cabinet Office Order's margin rules for a Japanese financial instruments business operator entering into a derivative transaction on a crypto-asset is correct as of October 2026 (the contents of the amending act enacted in 2026 are not covered)?

   1. A.For an individual customer, the required amount can be calculated only per transaction, and calculating it across several of the customer's transactions together is not permitted
   2. B.Margin may be deposited only with financial instruments business operators, etc., and amounts deposited with exchanges or clearing organizations do not count toward the required amount
   3. C.For an individual customer, it is a prohibited act to continue without having the shortfall deposited when, at conclusion and on each business day, the deposit adjusted for valuation gains and losses is below 50% of the transaction amount
   4. D.The 50%-of-transaction-amount minimum is not limited to individual customers, and applies in the same way to corporate customers, when the contract is concluded and on each business day
   Answer and explanation

   Answer: C

   For an individual customer, the Cabinet Office Order sets the required amount at 50% of the transaction amount. It is checked at contract time and at a set time on each business day. If the deposit is below that amount, it is a prohibited act for a financial instruments business operator to continue the contract without promptly having the shortfall deposited. The deposit used for the comparison is adjusted for valuation gains and losses.

   The required amount can be calculated either for each transaction or for a customer's several transactions taken together. The recipients that count for deposited margin include exchanges and clearing organizations as well. The 50% minimum is set for transactions with individual customers. The three incorrect options conflict with these three points. With a required amount of 50% of the transaction amount, the position can be at most twice the size of the deposit, which restrains high leverage.

   Learn more: Crypto-Asset Derivatives

5. Question 5

   How does the Financial Stability Board (FSB) report of October 2024 define tokenization?

   1. A.Entering into derivative transactions on a crypto-asset as the underlying, on an exchange
   2. B.Using new technologies to issue and represent assets such as shares, bonds, and bank deposits in an electronic form called a token
   3. C.Representing trades and trade lifecycle events as data in a common form that machines can read and execute
   4. D.Referring to every token record issued on a ledger, including crypto-assets and central bank digital currencies
   Answer and explanation

   Answer: B

   The FSB report defines tokenization as using new technologies, such as distributed ledger technology (DLT), to issue and represent assets in an electronic form called a token. The assets covered can be shares, bonds, or bank deposits.

   Derivatives on a crypto-asset are treated as distinct from tokenization. The FSB report also excludes central bank digital currencies and crypto-assets from its scope. Representing trades and lifecycle events in a common form is the role of a data model, the CDM, which is a separate movement from tokenization.

   Learn more: Digitalization: CDM and Tokenization