Derivative Instruments: Options, Futures, and More

Question 1

A **call option** provides the holder with the right to:

Accepted Answer

Buy the underlying asset at a predefined price on or before a certain date

Answer

Sell the underlying asset at a predefined price on or before a certain date

Answer

Buy the underlying asset at any time

Answer

Sell the underlying asset at any time

Question 2

What is the primary purpose of **hedging with derivatives**?

Accepted Answer

To mitigate risk

Answer

To speculate on future price movements

Answer

To maximize potential returns

Answer

To avoid tax liabilities

Question 3

A **forward rate agreement (FRA)** is:

Accepted Answer

An agreement to exchange interest rates at a specified rate in the future

Answer

An agreement to exchange currencies at a specified rate in the future

Answer

An agreement to buy or sell a commodity at a specified price in the future

Answer

An agreement to exchange stocks at a specified price in the future

Question 4

Which of the following is an **advantage of using options as a hedging tool**?

Accepted Answer

Flexibility

Answer

Unlimited profit potential

Answer

Low risk

Answer

Tax benefits

Question 5

What is the primary **function of a clearinghouse** in the derivatives market?

Accepted Answer

To guarantee the fulfillment of contracts

Answer

To facilitate transactions between buyers and sellers

Answer

To establish the prices of derivatives

Answer

To regulate the derivatives market

Question 6

How do companies utilize derivatives to minimize the risks associated with price fluctuations?

Accepted Answer

Locking in predetermined prices for future transactions

Answer

Predicting and profiting from future stock market movements

Answer

Eliminating the requirement for physical delivery of underlying assets

Answer

Lowering the overall cost of capital

Question 7

Which of the following is a defining characteristic of derivative instruments?

Accepted Answer

Transfer of risk

Answer

Low transaction costs

Answer

Guaranteed profit

Answer

Physical delivery of the underlying asset

Question 8

What is the primary objective of forward contracts?

Accepted Answer

To mitigate price risk in future transactions

Answer

To obtain financing

Answer

To speculate on market movements

Question 9

What is a key difference between futures and forward contracts?

Accepted Answer

Futures contracts are standardized and traded on exchanges, while forward contracts are customized and traded over-the-counter.

Answer

Futures contracts are not legally binding, while forward contracts are.

Answer

Forward contracts are more liquid than futures contracts.

Answer

Futures contracts have a shorter maturity than forward contracts.

Question 10

Which of the following is NOT a potential risk associated with derivative instruments?

Accepted Answer

Guaranteed return on investment

Answer

Liquidity risk

Answer

Market risk

Question 11

What is the pricing formula for a call option according to the Black-Scholes model?

Accepted Answer

C = S * N(d1) - Ke^(-rT) * N(d2)

Answer

C = S * N(-d1) - Ke^(-rT) * N(-d2)

Answer

C = S * e^(-rT) - Ke * N(-d1)

Answer

C = S * N(d2) - Ke^(-rT) * N(d1)

Question 12

What is the primary function of a clearinghouse in derivative markets?

Accepted Answer

Acting as an intermediary to reduce counterparty risk and ensure contract settlement

Answer

Providing financial advice to market participants

Answer

Regulating derivative trading activities

Answer

Setting the prices of derivative contracts

Question 13

Which of the following is a primary benefit of using derivative instruments?

Accepted Answer

Hedging against risk

Answer

Low transaction costs

Answer

Guaranteed profits

Question 14

What is the key difference between a European option and an American option?

Accepted Answer

European options can only be exercised at expiration, while American options can be exercised at any time before expiration.

Answer

European options are more expensive than American options.

Answer

American options are more liquid than European options.

Answer

European options are only available for stocks, while American options are available for all types of underlying assets.

Question 15

Which of these is not a derivative instrument?

Accepted Answer

Bond

Answer

Option

Answer

Future

Question 16

Which of these is not a derivative instrument?

Accepted Answer

Bonds

Answer

Forwards

Answer

Options

Answer

Futures

Question 17

Which of these is NOT a derivative instrument?

Accepted Answer

Bonds

Answer

Options

Answer

Futures

Question 18

Which of the following is a defining characteristic of derivative instruments?

Accepted Answer

They derive their value from an underlying asset or index.

Answer

They are tangible assets, such as commodities.

Answer

They are forms of currency used in international trade.

Question 19

What is the primary purpose of using a forward contract?

Accepted Answer

To establish a fixed price for a future transaction.

Answer

To speculate on future price fluctuations of assets.

Answer

To generate a return on investment.

Answer

To reduce potential losses due to price changes.

Question 20

Which of the following is an example of an option strategy?

Accepted Answer

Straddle

Answer

Hedging

Answer

Short selling

Answer

Arbitrage

Question 21

What is the key distinction between a call option and a put option?

Accepted Answer

A call option grants the buyer the right to buy, while a put option grants the buyer the right to sell.

Answer

Call options are used for speculation, while put options are used for hedging.

Question 22

What is the primary role of a clearinghouse in the derivatives market?

Accepted Answer

To facilitate transactions and mitigate counterparty risk.

Answer

To regulate the issuance of derivative contracts.

Answer

To establish prices for derivative contracts.

Question 23

Which of the following are significant risks associated with using derivatives?

Accepted Answer

Market risk, liquidity risk, and counterparty risk.

Answer

Political risk, legal risk, and operational risk.

Answer

Inflation risk, interest rate risk, and exchange rate risk.

Question 24

What is a primary benefit of using derivatives?

Accepted Answer

They can be used to manage risk and speculate on financial markets.

Answer

They are guaranteed to be profitable.

Answer

They are simple and straightforward to use.

Question 25

What is the main purpose of the Black-Scholes model?

Accepted Answer

To value options.

Answer

To predict stock prices.

Answer

To value futures contracts.

Answer

To calculate the risk of a derivative portfolio.

Question 26

Which of the following is an example of an exotic derivative instrument?

Accepted Answer

Asian option.

Answer

Call option.

Answer

Forward contract.

Answer

Swaption.

Question 27

What is the function of a market maker in the derivatives market?

Accepted Answer

To provide liquidity by buying and selling derivatives.

Answer

To set prices for derivatives contracts.

Answer

To regulate the issuance of derivatives contracts.

Question 28

The primary objective of using derivative instruments is to:

Accepted Answer

Manage financial risk and speculate on price movements

Answer

Improve customer service

Answer

Reduce transportation costs

Answer

Increase product quality

Question 29

A characteristic feature of futures contracts is that they are:

Accepted Answer

Standardized and traded on an exchange

Answer

Cancelable at any time without penalty

Answer

Only available for trading physical commodities

Answer

Negotiated privately and highly flexible

Question 30

The fundamental difference between a call option and a put option is that:

Accepted Answer

A call option grants the right to buy an asset, while a put option grants the right to sell an asset

Answer

Call options provide unlimited profit potential, while put options have limited profit potential

Answer

Call options are typically used for speculation, while put options are used for hedging

Question 31

In a currency futures contract, the underlying asset that is being traded is:

Accepted Answer

Currency

Answer

Bond

Answer

Stock

Answer

Commodity

Question 32

A significant potential risk associated with derivative instruments is:

Accepted Answer

Unlimited losses

Answer

Guaranteed profits

Answer

Reduced risk

Answer

Increased returns

Question 33

The primary function of an exchange-traded derivative is to:

Accepted Answer

Provide a centralized platform for trading derivatives

Answer

Issue new derivatives

Answer

Guarantee the performance of derivative contracts

Question 34

Which of the following is a type of over-the-counter (OTC) derivative?

Accepted Answer

Swap

Answer

Future

Answer

Stock

Answer

Bond

Question 35

The primary role of a clearinghouse in the derivatives market is to:

Accepted Answer

Guarantee the performance of derivative contracts

Answer

Set the prices of derivative contracts

Answer

Issue derivative contracts

Question 36

A synthetic forward differs from a traditional forward in that it:

Accepted Answer

Is created using a combination of other derivative instruments

Answer

Is always more expensive than a traditional forward

Answer

Is only available for trading physical assets

Question 37

Which of the following is NOT a characteristic of a derivative instrument?

Accepted Answer

It is a physical asset

Answer

It can be used to hedge risk

Answer

It can be used to speculate on future prices

Answer

Its value is derived from an underlying asset

Question 38

Which type of derivative instrument grants the buyer the right, but not the obligation, to purchase an underlying asset at a set price on a specific date?

Accepted Answer

Call option

Answer

Put option

Answer

Futures contract

Answer

Forward contract

Question 39

What is the primary purpose of a futures contract?

Accepted Answer

To establish a predetermined price for an underlying asset in the future

Answer

To enable speculation on future prices

Answer

To serve as insurance against price fluctuations

Answer

To provide leverage for investors

Question 40

How do over-the-counter (OTC) derivatives differ from exchange-traded derivatives?

Accepted Answer

OTC derivatives are traded directly between two parties, while exchange-traded derivatives are traded on an organized exchange

Answer

OTC derivatives are standardized, while exchange-traded derivatives are customized

Question 41

Describe the role of a clearinghouse in the derivatives market.

Accepted Answer

It acts as an intermediary between buyers and sellers, reducing counterparty risk

Answer

It regulates the derivatives market

Answer

It sets prices for derivative contracts

Question 42

Which type of derivative instrument is commonly used to speculate on interest rate movements?

Accepted Answer

Interest rate futures

Answer

Foreign exchange futures

Answer

Equity futures

Answer

Commodity futures

Question 43

Differentiate between a call spread and a call butterfly.

Accepted Answer

A call spread involves two call options with different strike prices, while a call butterfly involves three call options with different strike prices

Answer

A call spread is a bullish strategy, while a call butterfly is a bearish strategy

Question 44

Define a derivative instrument.

Accepted Answer

A financial contract whose value is derived from the underlying asset's performance.

Answer

A financial instrument used to hedge financial risk.

Answer

A financial instrument traded on a stock exchange.

Question 45

Which of the following is not a type of derivative instrument?

Accepted Answer

Bond

Answer

Swap

Answer

Futures

Answer

Option

Question 46

What's the primary purpose of using derivative instruments?

Accepted Answer

To manage risk and speculate on financial markets.

Answer

To borrow money.

Answer

To invest in financial assets.

Question 47

In an option contract, what is the underlying asset?

Accepted Answer

The asset (e.g., stock, bond, commodity) whose price forms the basis of the contract.

Answer

The number of shares the option holder can buy.

Answer

The amount the option holder must pay.

Question 48

What is the Black-Scholes model's purpose?

Accepted Answer

Calculating the theoretical value of an option contract.

Answer

Determining the ideal exercise price for an option contract.

Answer

Predicting the future price of an underlying asset.

Question 49

Which of the following is NOT an advantage of derivative instruments?

Accepted Answer

Eliminating all financial risks.

Answer

Providing leverage.

Answer

Hedging against risk.

Answer

Accessing a wider range of investment options.

Question 50

Describe the role of a clearinghouse in the derivatives market.

Accepted Answer

Acting as an intermediary between buyers and sellers, reducing default risk.

Answer

Determining the price of derivative contracts.

Question 51

Provide a practical application of derivative instruments in the real world.

Accepted Answer

Hedging against foreign exchange risk.

Answer

Investing in real estate.

Answer

Saving for retirement.

Answer

Paying for college tuition.