Derivatives

Derivatives are financial instruments whose value depends on underlying assets, indices, or reference rates. For CFA Level 1, understanding derivatives involves several key concepts. Derivatives serve multiple purposes: hedging risk, speculating on price movements, and arbitraging price differences across markets. The main categories include forwards, futures, options, and swaps. Forwards are customized contracts between two parties to exchange an asset at a predetermined future date and price. Futures are standardized, exchange-traded forward contracts with daily settlement. Options give holders the right (not obligation) to buy (call option) or sell (put option) an underlying asset at a specified price within a timeframe. The option buyer pays a premium to the seller who assumes the obligation. Swaps involve exchanging cash flows or liabilities between parties. Common types include interest rate swaps (fixed-for-floating rate exchanges) and currency swaps (principal and interest payments in different currencies). Derivatives pricing relies on principles like no-arbitrage, risk-neutral valuation, and put-call parity. The Black-Scholes-Merton model is introduced for option valuation. Risk considerations include market risk (adverse price movements), counterparty risk (default by the other party), and liquidity risk (inability to exit positions at fair values). Leverage is a critical feature of derivatives - they require small initial investments relative to their notional exposure, magnifying both gains and losses. For CFA Level 1, focus on understanding basic structures, terminology, payoff diagrams, and how these instruments transfer risk between market participants. The curriculum emphasizes conceptual understanding rather than complex mathematical modeling.

Derivatives are financial instruments whose value depends on underlying assets, indices, or reference rates. For CFA Level 1, understanding derivatives involves several key concepts. Derivatives ser…

Concepts covered: Futures Markets and Contracts, Forward Markets and Contracts, Options Markets and Contracts, Swaps, Derivative Markets and Instruments