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Derivatives【Reading 60】Sample

Which of the following statements regarding exchange-traded derivatives is NOT correct? Exchange-traded derivatives:
A)
often trade in a physical location.
B)
are illiquid.
C)
are standardized contracts.



Derivatives that trade on exchanges have good liquidity in most cases. They have the other characteristics listed.

A derivative security:
A)
is like a callable bond.
B)
has a value dependent on the shape of the yield curve.
C)
is one that is based on the value of another security.



A derivative security is one that ‘derives’ its value from that of another security.

TOP

A financial instrument that has payoffs based on the price of an underlying physical or financial asset is a(n):
A)
option.
B)
derivative security.
C)
future.



Options and futures are examples of types of derivative securities.

TOP

A derivative security:
A)
has no default risk.
B)
has a value based on stock prices.
C)
has a value based on another security or index.



This is the definition of a derivative security. Those based on stock prices are equity derivatives.

TOP

Which of the following is most likely an exchange-traded derivative?
A)
Equity index futures contract.
B)
Bond option.
C)
Currency forward contract.



Futures are exchange-traded derivatives. Forward contracts and swaps are over-the-counter derivatives. Bond options are traded almost entirely in the over-the-counter market.

TOP

Which of the following definitions involving derivatives is least accurate?
A)
A call option gives the owner the right to sell the underlying good at a specific price for a specified time period.
B)
An option writer is the seller of an option.
C)
An arbitrage opportunity is the chance to make a riskless profit with no investment.



A call option gives the owner the right to buy the underlying good at a specific price for a specified time period.

TOP

Which of the following is NOT an over-the-counter (OTC) derivative?
A)
A futures contract.
B)
A forward contract.
C)
A bond option.



Futures contracts are exchange-traded; forwards and most bond options are OTC derivatives.

TOP

Over-the- counter derivatives:
A)
have good liquidity in the over-the-counter (OTC) market.
B)
are backed by the OTC Clearinghouse.
C)
are customized contracts.



OTC derivative contracts (securities) are customized and have poor liquidity. The contract is with a specific counterparty and there is default risk since there is no clearinghouse to guarantee performance.

TOP

Which of the following is most accurate regarding derivatives?
A)
Exchange-traded derivatives are created and traded by dealers in a market with no central location.
B)
Derivative values are based on the value of another security, index, or rate.
C)
Derivatives have no default risk.



Derivatives “derive” their value from the value or return of another asset or security. Exchange-traded derivatives are standardized and backed by a clearinghouse. An over-the-counter derivative, such as a forward contract or a swap, exposes the derivative holder to the risk that the counterparty may default.

TOP

Derivatives are often criticized by investors with limited knowledge of complex financial securities. A common criticism of derivatives is that they:
A)
increase investor transactions costs.
B)
can be likened to gambling.
C)
shift risk among market participants.



Derivatives are often likened to gambling due to the high leverage involved in the payoffs. One of the benefits of derivatives is that they reduce transactions costs. Another benefit of derivatives is that they allow risk to be managed and shifted among market participants.

TOP

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