Practice Questions

Chapter- Derivatives
Q.1) which of the given statements is/are not associated with Derivatives?
[a] Derivatives are financial instruments whose value depend on the value of some underlying
assets.
[b] Derivatives do not have any physical existence but emerge out of a contract between two
parties.
[c] Derivatives do not have a value of their own but their value, in turn, depend on the value of
their physical assets which are called the underlying assets.
[d] All of the above
[e] None of the above.

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Answer- [e]
Explanation- All the given statements are true about Derivatives. Here is a brief explanation about
derivatives-
 Derivatives are financial instruments whose value depend on the value of some underlying
assets.
 The performance of derivatives depends on how the underlying assets perform.
 Derivatives include forward contracts, futures contracts, options, and swaps.
 Derivatives have a valuable purpose in providing a means of managing financial risk.

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Q.2) Fill in the blank with the appropriate option given below:
The value of financial derivatives is linked to –––––––––––––––
[a] Securities that will be issued in the future.
[b] The volatility of interest rates.
[c] Previously issued securities.
[d] Government regulations specifying the allowable rate of return.
[e] None of the above.

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Answer- [c]
Explanation- The value of a financial derivative is linked to previously issued securities. For
instance, the Mumbai Stock Exchange shares Index, called Sensex, is a derivative whose value
(index for a particular day) depends upon the price of the underlying 30 shares. The weighted
average of the closing prices of 30 shares is the Sensex. If the prices of all these shares increase or
decrease, Sensex will also increase or decrease. So, Sensex derives its value from the market prices
of these 30 shares.

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Q.3) which of the following is/are included under financial derivative?
[a] stocks
[b] bonds
[c] forward contracts
[d] a) and c)
[e] a) and b)

.
Answer- [c]
Explanation- Derivatives include forward contracts, futures contracts, options, and swaps.

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Q.4) which of the following units guarantees that all buying and selling will be made by traders?
[a] Clearing House
[b] Trading House
[c] Guarantee House
[d] Professional House

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Answer- [a]
Explanation- A clearing house is an intermediary between buyers and sellers of financial
instruments. It is an agency responsible for selling trading accounts, clearing trades, collecting
and maintaining margin monies, regulating delivery, and reporting trading data.

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Q.5) which of the following statements about Forward contracts is least accurate?
[a] A forward contract can be exercised at any time.
[b] Both parties to a forward contract have potential default risk.
[c] The long promises to purchase the asset.
[d] The short promises to sell the asset.
[e] Forward contracts are customized and traded over the counter.

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Answer- [a]
Explanation- A forward contract can be exercised only on the pre-specified future settlement rate.

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Q.6) what does it refer to here?
a) It is an agreement to buy or sell an asset on a specified date for a specified price.
b) It is a customized contract between two parties.

[a] Forward Contracts

.
Answer-[a]
Explanation- A forward contract is an agreement between two parties to buy or sell an asset at a
future date at a price agreed today.
 Forward contracts are specific contracts between specific parties and cannot be set off by a
counter contract.

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Q.7) which of the following is the difference between futures and forward contracts? Futures
contracts are:
[a] larger than forward contracts
[b] Over the counter instruments
[c] Standardized
[d] Customized to the needs of the parties.

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Answer-[c]
Explanation- Forwards are over-the-counter instruments and are customized according to the
needs of the parties.

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Q.8) which of the following statements regarding futures and forward contracts is least accurate?
[a] Futures contracts are highly standardized.
[b] Forward contracts require no transactions until the delivery date, while futures require a
margin deposit when the position is opened.
[c] Both forward and futures contracts trade on organized exchanges.
[d] Default risk is the risk to either party that the other party will not fulfill their contractual
obligation.

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Answer-[c]
Explanation- Forward contracts are traded over the counter.
 Futures contracts are traded on recognized stock exchanges.

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Q.9) which of the following is likely a characteristic of futures contracts?
Futures Contracts:
[a] are backed by clearing house.
[b] require weekly settlement of gains and losses.
[c] are traded in an active secondary market.
[d] Forward contracts are customized and traded over the counter

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Answer-[b]
Explanation- Futures contracts are standardized and hence backed by clearing house. They are
actively traded in the secondary market.

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Q.10) The party to a forward contract that is obligated to purchase the asset is called the:
[a] Long
[b] Equities
[c] Bonds
[d] Commodities

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Answer- [a]
Explanation- Long is said to be a long instrument when she purchases that particular instrument.
By instrument is meant the derivative being talked about.

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[a]Q.11)
50,000consider the following statements about Short Sales and Identify the incorrect one/s.
[b][a] Short sale means sale of a security one does not own.
20,000
[c][b] Short-seller expects the price of the security to go down.
35,000
[d][c]
15,000
Securities that are sold short are to be invariably delivered on the settlement date.
*[e]
[d]25,000
Potential for gain is unlimited whereas the potential for loss is limited.

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[a] 50,000
[b]Answer-
20,000 [d]
[c] 35,000
Explanation- The potential for gain is limited whereas the potential for loss is unlimited.
[d] 15,000
*[e] 25,000

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 Q.12) when purchasing a futures contract, the initial requirement refers to the:
[a]50,000
[a] minimum account balance required as price changes.
[b]
[b]20,000
minimum amount to buy a futures contract to ensure fulfillment of the obligation by the future
[c] 35,000
buyer.
[d]
[c]15,000
amount needed to finance the purchase of the underlying assets.
*[e] 25,000
[d] a) and b)
[e] a) and c)

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[a] 50,000
[b]Answer-[b]
20,000
[c]Explanation-
35,000 It is correct because the initial margin is required to ensure the performance of the
[d]terms
15,000of the contract.
*[e] 25,000

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 Q.13) which of the following statements about arbitrage opportunities is correct?
[a][a] Engaging in arbitrage requires a large amount of capital for reinvestment.
50,000
[b]20,000
[b] When an opportunity exists to profit from arbitrage, it usually lasts for several trading
[c]days.
35,000
[d]
[c]15,000
Pricing errors in securities are instantaneously corrected by the first arbitrageur to
*[e] 25,000 them.
recognize
[d] Arbitrage can cause markets to be less efficient.

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[a] 50,000 [c]
Answer-
[b] 20,000
Explanation- Arbitrage does not require a large amount of investment. Arbitrage opportunity does
[c] 35,000
not last for several days. It may last only for a few seconds after the prices are balanced. After the
[d] 15,000
arbitrage opportunity is made use of, the markets become efficient.
*[e] 25,000

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 Q.14) which one of the following statements is not true about Options.
[a][a] An option is a contract, which offers the buyer of the contract the right but not the obligation
50,000
to20,000
[b] buy or sell a security or other financial asset.
[c][b] Option contracts have an asymmetric risk profile.
35,000
[c]15,000
[d] Stock-based option trading was allowed by SEBI in 1992
*[e]
[d]25,000
a) and b)
[e] b) and c)

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[a] 50,000
[b]Answer-
20,000 [c]
[c]Explanation-
35,000 Stock-based option trading was allowed by SEBI in 2002
[d] 15,000
*[e] 25,000

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 Q.15) which of the following options can be exercised at any time on or before its expiration
[a]date?
50,000
[b][a]
20,000
European option
[c][b]
35,000
Naked option
[d][c]15,000
American option
*[e] 25,000
[d] Covered option

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[a] 50,000
[b]Answer-
20,000 [c]
[c]Explanation-
35,000 American-styled options can be exercised at any time up and including the expiry
[d]date.
15,000
*[e] 25,000

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 Q.16) which of the below terms correctly describes the option backed by the asset which is
[a]owned
50,000by the option writer?
[b][a]
20,000
European option
[c][b]
35,000
Naked option
[d] 15,000
[c] American option
*[e] 25,000
[d] Covered option

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[a] 50,000
[b]Answer-
20,000 [d]
[c]Explanation-
35,000 Covered option is covered or backed by the asset which is owned by the option
[d]writer.
15,000So if the option holder exercises the option, the option writer can deliver the asset.
*[e] 25,000

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 Q.17) An agreement that gives the holder the right, but not the obligation, to buy an asset at a
[a]specified
50,000 price on a specified future date is:
[b][a] put option
20,000
[c][b] buy option
35,000
[d][c]
15,000
call option
*[e]
[d]25,000
forward
[e] swap

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[a] 50,000 [c]
Answer-
[b] 20,000
Explanation- A call option provides the holder a right to buy specified assets at a specified price on
[c] 35,000
or15,000
[d] before a specified date. In case of a call option, she has a right to call from the
market
*[e] (option writer) the specified asset.
25,000

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 Q.18) An agreement that gives the holder the right, but not the obligation, to sell an asset at a
[a]specified
50,000 price on a specific future date is a :
[b][a] put option
20,000
[c][b] buy option
35,000
[d][c]15,000
call option
*[e]
[d]25,000
forward
[e] swap

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[a] Answer-
50,000 [a]
[b] 20,000
Explanation- A put option provides the holder a right to sell specified assets at a specified
[c] 35,000
price on or before a specified date. In case of a put option, she has a right to put the specified
[d] 15,000
*[e]asset in the market (option writer).
25,000

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 Q.19) Financial instruments are claims on a stream of income and assets of another
economic unit and are held as a store of value and for an expected return. Under which
[a] 50,000
[b]of20,000
the following heads do future contracts come?
[c][a] Primary securities
35,000
[d][b] Secondary securities
15,000
[c]25,000
*[e] Over the counter
[d] Options

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 Answer- [b]
[a]Explanation-
50,000 The term secondary securities market is used to describe the financial
[b] 20,000
markets where investors purchase securities from other investors. Futures, being derivatives, do
[c] 35,000
not
[d] have a new issue and are therefore not part of the primary market. Futures are traded on an
15,000
exchange
*[e] 25,000 and in contrast forward contracts are traded over the counter. Future contracts have an
active secondary market whereas, forwards have no secondary market.

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[a]Q.20)
50,000The intrinsic value of an option is always zero:
[b][a] at expiration
20,000
[c][b] when its time value is zero
35,000
[d][c] when it is out-of-the-money
15,000
*[e]
[d]25,000
when it is in-the-money

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[a] 50,000
Answer-
[b] 20,000 [c]
[c]Explanation-
35,000 It is correct because an out-of-the-money option will have an intrinsic value of zero
[d]
at15,000
all times.
*[e] 25,000

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 Q.21) which of the following statement is incorrect?
[a] A swap is a derivative contract through which two parties exchange the cash flows or liabilities
from two different financial instruments.
[a][b]
50,000
Swaps are traded on recognized stock exchanges.
[b] 20,000
[c] Companies doing business abroad often use currency swaps to get more favorable loan rates in
[c] 35,000
[d]the local currency than they could if borrowed money from a bank in that country.
15,000
[d]25,000
*[e] An interest rate swap is a type of derivative contract through which two counterparties agree to
exchange one stream of future interest payments for another, based on a specified principal
amount. In most cases, interest rate swaps include the exchange of a fixed interest rate for a
floating rate.

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[a] 50,000
[b]Answer-
20,000 [b]
[c]Explanation-
35,000 Swaps are traded over-the-counter and not recognized stock exchanges.
[d] 15,000
*[e] 25,000

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 Q.22) what is the difference between the spot price and the futures price of an asset called?
[a][a]
50,000
Margin
[b][b]
20,000
Basis
[c][c]
35,000
Spread
[d] 15,000
[d] Swap
*[e] 25,000
[e] Cotango

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[a] 50,000
[b]Answer-
20,000 [b]
[c]Explanation-
35,000 The difference between the spot price and the futures price of an asset Is called Basis.
[d] 15,000
*[e] 25,000