Lesson 4.1: What Are Derivatives?
A financial instrument whose value depends upon the value of another asset is known as A)a derivative. B)a security. C)an investment contract. D)a commodity.
A)a derivative. Explanation The definition of a derivative is that its value is based on some underlying asset. Included in the term are options, forwards, futures, and convertible securities. Some derivatives are securities, such as options on stock, while others such as forwards and futures contracts are specifically excluded from the definition of a security.
Which of the following financial instruments is not a derivative? A)A put option B)LEAPS C)A share of stock D)A call option
C)A share of stock Explanation A derivative is a type of financial instrument that derives its value from another asset or combination of assets. The best known examples of derivatives are options, of which puts, calls, and LEAPS are examples.
Which of the following would not be considered derivatives? A)An ETF tracking the Bloomberg Commodity Index B)Forward contracts C)Futures contracts D)Equity options
A)An ETF tracking the Bloomberg Commodity Index Explanation An exchange-traded fund (ETF) is an investment company, regardless of what is contained in its portfolio. Forwards, futures, and equity options are derivatives.
The term derivative would apply to all of the following except A)options B)hedge funds C)futures D)forwards
B)hedge funds Explanation Hedge funds are pooled investments, a form of investment company, and are not derivatives as are the other three choices. This is an example of a question where you get the correct answer by knowing the other three choices are not the exception.
Standardized equity options are issued and guaranteed by A)the Chicago Board Options Exchange (CBOE). B)the Options Clearing Corporation (OCC). C)the National Futures Association (NFA). D)the Commodities Futures Trading Commission (CFTC).
B)the Options Clearing Corporation (OCC). Explanation The OCC has the role of issuer and guarantor of all standardized equity options. That means if one party to an options contract fails to perform, the OCC steps in and takes that role (and then goes after the recalcitrant party).
The term derivative would not apply to which of the following? A)Warrants B)Forwards C)Futures D)REITs
D)REITs Explanation REITs are not based on the value of something other than their own assets. Warrants (and rights) derive their value from the underlying security. Futures and forwards are contracts whose value is based on some underlying asset.
Standardized equity options are issued by A)the Options Clearing Corporation (OCC). B)the issuer of the underlying security. C)the Chicago Board Options Exchange (CBOE). D)all of these.
A)the Options Clearing Corporation (OCC). Explanation Standardized equity options are issued and guaranteed by the OCC. They are traded on the CBOE and other exchanges. The issuer of the underlying stock is not involved in any way.
Which of the following is not considered a derivative? A)Call option B)Futures contract C)Unit investment trust D)Warrant
C)Unit investment trust Explanation All of the other choices "derive" their value from some underlying asset. A UIT is an investment company, and its value is based on its own assets.
