CFA Derivatives and Risk Management 1 — Questions and Answers
Question 1: A European call option gives the holder the right to:
- Sell the underlying asset at the strike price before expiration
- Buy the underlying asset at the strike price only at expiration (Correct answer)
- Buy the underlying asset at the strike price at any time before expiration
- Sell the underlying asset at any time before expiration
Correct answer: Buy the underlying asset at the strike price only at expiration
A European call option grants the right (not obligation) to buy the underlying at the strike price, but only on the expiration date, not before.
Question 2: Put-call parity states that for European options, the relationship is:
- Call price + Strike price (PV) = Put price + Current stock price (Correct answer)
- Call price + Current stock price = Put price + Strike price (PV)
- Call price – Put price = Current stock price – Strike price
- Call price = Put price always
Correct answer: Call price + Strike price (PV) = Put price + Current stock price
Put-call parity: C + PV(X) = P + S, where C = call price, PV(X) = present value of strike, P = put price, S = current stock price.
Question 3: Which of the following is the MAIN difference between a forward contract and a futures contract?
- Forwards trade on exchanges; futures are OTC instruments
- Futures are marked-to-market daily with margin requirements; forwards are settled at expiration (Correct answer)
- Forwards have no counterparty risk; futures do
- Futures can only be used for commodities; forwards can be used for any asset
Correct answer: Futures are marked-to-market daily with margin requirements; forwards are settled at expiration
Futures are exchange-traded with daily mark-to-market and margin requirements, while forwards are OTC contracts settled at maturity without daily settlement.
Question 4: Delta (Δ) of an option measures:
- The sensitivity of option price to changes in implied volatility
- The rate of change of option price with respect to a $1 change in the underlying asset price (Correct answer)
- The time decay of the option's value as expiration approaches
- The sensitivity of delta itself to changes in the underlying price
Correct answer: The rate of change of option price with respect to a $1 change in the underlying asset price
Delta measures how much the option's price changes for a $1 move in the underlying asset; it ranges from 0 to 1 for calls and –1 to 0 for puts.
Question 5: A portfolio manager wants to hedge against a decline in a stock portfolio using put options. The strategy is BEST described as:
- A covered call
- A protective put (Correct answer)
- A bull spread
- A short straddle
Correct answer: A protective put
A protective put involves holding the stock (long) and buying put options to limit downside losses while retaining upside potential.
Question 6: In a plain vanilla interest rate swap, the fixed-rate payer benefits when:
- Interest rates fall below the fixed rate agreed upon
- Interest rates rise above the fixed rate agreed upon (Correct answer)
- The floating rate equals the fixed rate throughout the swap's life
- The notional principal increases over time
Correct answer: Interest rates rise above the fixed rate agreed upon
The fixed-rate payer benefits when floating rates rise above the fixed rate, because they receive more floating payments while their fixed payment remains constant.
CFA Derivatives and Risk Management 1
A European call option gives the holder the right to: