Synthetic replication uses derivative contracts (swaps) to track an index without directly holding the underlying assets.

Why is Option C Correct?

The fund manager enters into a swap agreement with an investment bank.

The bank provides the return of the target index, while the fund pays a fixed rate or cash return.

This is common for emerging markets or illiquid assets, where direct replication is difficult.

Why Not Other Options?

A (Full replication) → Buys all index components, no swaps used.

B (Stratified sampling) → Buys representative index samples, no swaps.

D (Optimisation) → Uses mathematical models to track an index, no swaps.

???? Reference: CFA Institute (Index Replication Strategies), CISI Wealth & Investment Management.