Level I Derivative Markets and

Instruments
Test Code: L1 R56 DVMI Q-Bank
Number of questions: 56

Question Q-Code: L1-DV-DVMI-001 LOS a Section 2

1 Which of the following is not a derivative?

A) A contract to purchase shares of Infosys, a technology company, at a fixed price.

B) An asset backed security.
C) A global equity mutual fund.

Question Q-Code: L1-DV-DVMI-002 LOS a Section 2

2 Which of the following statements is most likely to be correct about derivatives?

A) A derivative is a financial instrument that derives its value based on the performance of the underlying.
B) Derivatives are standardized financial instruments and cannot be customized.
C) The performance of a derivative is derived by replicating the performance of the underlying.

Question Q-Code: L1-DV-DVMI-003 LOS a Section 2

3 Which of the following statements about derivatives is least accurate?

A) They derive their value from an underlying.

B) They have low degrees of leverage.
C) They involve two parties – a buyer and a seller.

Question Q-Code: L1-DV-DVMI-004 LOS a Section 2

4 Which of the following statements about derivatives is not true?

A) They are used for risk management.

B) They are created in the form of legal contracts.
C) They are created in the spot market.

Question Q-Code: L1-DV-DVMI-005 LOS a Section 3

5 Which of the following statements about exchange-traded derivatives is least accurate?

A) They are more transparent than over-the-counter derivatives.

B) All terms of the contract except the price are standardized.
C) They have more credit risk than over-the-counter derivatives.

Question Q-Code: L1-DV-DVMI-007 LOS a Section 3

6 Which of the following best describes a characteristic of exchange-traded derivatives?

A) They are customized financial instruments.

B) A clearing house effectively guarantees against default risk.
C) They are characterized by a low degree of regulation.

Question Q-Code: L1-DV-DVMI-008 LOS a Section 3

7 Which of the following statements about over-the-counter derivatives is least accurate ?

A) They are less liquid than exchange-traded derivatives.

B) They are less regulated than exchange-traded derivatives.
C) They offer more flexibility than exchange-traded derivatives.

Question Q-Code: L1-DV-DVMI-037 LOS c Section 3

8 One way to describe the margin in a futures market is:

A) A good faith deposit that covers possible future losses.

B) A loan to the futures trader.
C) The difference between the futures price and the spot price.

Question Q-Code: L1-DV-DVMI-006 LOS a Section 3

9 Which of the following least likely describes over-the-counter (OTC) derivatives relative to exchange-traded
derivatives? OTC derivatives are:

A) more customized.
B) less liquid.
C) less transparent.

Question Q-Code: L1-DV-DVMI-009 LOS a Section 3

10 Analyst 1: Market makers earn a profit in both exchange and over-the-counter derivatives markets by charging a
commission on each trade.
Analyst 2: Market makers earn a profit in both exchange and over-the-counter derivatives markets by buying at one
price, selling at a higher price, and hedging any risk.
Which analyst’s statement is most likely correct?

A) Analyst 1.
B) Analyst 2.
C) Neither of them.

Question Q-Code: L1-DV-DVMI-010 LOS a Section 3

11 As compared to exchange-traded derivatives, over-the-counter derivatives are more likely to have:

A) lower credit risk.

B) customized contract terms.
C) lower risk management uses.

Question Q-Code: L1-DV-DVMI-011 LOS a Section 4

12 As compared to over-the-counter options, futures contract:

A) are private, customized transactions.

B) represent a right rather than a commitment.
C) are not exposed to default risk.

Question Q-Code: L1-DV-DVMI-015 LOS b Section 4

13 Which of the following is best classified as a forward commitment?

A) A convertible bond.
B) A swap agreement.
C) An asset-backed security.

Question Q-Code: L1-DV-DVMI-016 LOS c Section 4

14 Which of the following statements about futures is least accurate?

A) They are standardized.

B) They are subject to daily price limits.
C) Their payoffs are received at settlement.

Question Q-Code: L1-DV-DVMI-017 LOS c Section 4

15 Which of the following statements is most accurate?

A) Forwards are customized whereas swaps are standardized.

B) Forwards are subject to daily price limits whereas swaps are not.
C) Swaps have multiple payments, whereas forwards have only a single payment.
Question Q-Code: L1-DV-DVMI-018 LOS c Section 4

16 Analyst 1: During daily settlement of futures contract the initial margin deposits are refunded to the two parties.
Analyst 2: During daily settlement of futures contract losses are charged to one party and gains credited to the other.
Which analyst’s statement is most likely correct ?

A) Analyst 1.
B) Analyst 2.
C) Neither of them.

Question Q-Code: L1-DV-DVMI-023 LOS c Section 4

17 While dealing with futures contracts, the maintenance margin requirement most likely refers to:

A) collateral to ensure fulfillment of obligation.

B) amount sufficient to bring ending account balance back to initial margin.
C) the minimum account balance a trader must maintain after the trade is initiated.

Question Q-Code: L1-DV-DVMI-024 LOS c Section 4

18 In which of the following contracts would the buyer face the least default risk?

A) Cotton futures.
B) Currency forwards.
C) Over-the-counter interest rate options.

Question Q-Code: L1-DV-DVMI-025 LOS c Section 4

19 Microsoft issues 10-year fixed-rate bonds. Its treasurer expects interest rates to increase for all maturities for at least
the next 2 years. He enters into a 2-year agreement with SCB to receive semi-annual floating-rates payments
benchmarked on 6-month LIBOR and to make payments based on a fixed-rate. This agreement is best described as a:

A) Swap.
B) Futures contract.
C) Forward contract.

Question Q-Code: L1-DV-DVMI-026 LOS c Section 4

20 Ali takes a long position in 50 futures contracts on Day 1. The futures have a daily price limit of €10 and closes with a
settlement price of €105. On Day 2, the futures trade at €115 and the bid and offer move to €116 and €118,
respectively. The futures price remains at these price levels until the market closes. The marked-to-market amount the
trader receives in his account at the end of Day 2 is closest to:

A) €500.
B) €550.
C) €650.

Question Q-Code: L1-DV-DVMI-028 LOS c Section 4

21 Keene Smith, an investor, aims to invest in derivatives that can be classified as forward commitments. Which of the
following is she least likely to consider?

A) Credit default swaps.

B) Futures contracts.
C) Interest rate swaps.

Question Q-Code: L1-DV-DVMI-029 LOS c Section 4

22 Which of the following is most likely to be correct regarding interest rate swaps?

A) Interest rate swaps provide the right to buy or sell the underlying asset in the future.
B) Interest rate swaps provide the promise to provide credit protection in the event of a default.
C) Interest rate swaps involve the obligation to lend or borrow at a given rate in the future at a fixed rate.

Question Q-Code: L1-DV-DVMI-055 LOS c Section 6

23 An attribute common to both forward and futures contracts is:

 A) their mark to market feature.
B) their standardized nature.
C) their use in hedging and speculation.

Question Q-Code: L1-DV-DVMI-031 LOS c Section 4

24 Which of the following statements is least likely correct about interest rate swaps ?

A) Interest rate swaps are derivatives where two parties agree to exchange a series of cash flows.
B) Interest rate swaps might require one party to make payments based on a fixed rate.
C) Interest rate swaps give the buyer the right to purchase the underlying from the seller.

Question Q-Code: L1-DV-DVMI-036 LOS c Section 4

25 Joe is a futures trader. If on a given day his balance falls below the maintenance margin, he should add funds so as to
meet the:

A) Initial margin.
B) Maintenance margin.
C) Variation margin.

Question Q-Code: L1-DV-DVMI-035 LOS c Section 4

26 Which of the following statements is most accurate?

A) A forward contract is default free, whereas a futures contract is not.

B) A forward contact allows parties to enter into a customized transaction, whereas a futures contract does not.
C) A forward contract can easily be offset prior to expiration, whereas it is difficult to offset a futures contract prior to
expiration.

Question Q-Code: L1-DV-DVMI-032 LOS c Section 4

27 Which of the following is least likely to be subject to default?

A) Forwards.
B) Futures.
C) Interest rate swaps.

Question Q-Code: L1-DV-DVMI-033 LOS c Section 4

28 Klaus, Veronica, and Liam deal in derivatives. Liam and Veronica have a value of zero at the initiation of the contract,
while Klaus doesn’t. Which of the following correctly describes the derivative that each of these are dealing in?

Klaus Veronica Liam

A. Futures Options Forwards

B. Forwards Futures Options

C. Options Forwards Futures

A) Option A in the above table.

B) Option B in the above table.
C) Option C in the above table.

Question Q-Code: L1-DV-DVMI-012 LOS b Section 4

29 Which of the following statements is least accurate?

A) An asset backed security is a contingent claim.

B) An interest rate swap is a forward commitment.
C) A credit default swap is a forward commitment.

Question Q-Code: L1-DV-DVMI-030 LOS c Section 4

30 Tim has a portfolio comprising of derivatives, which provide payoffs that are linearly related to the payoffs of the
underlying. Which of the following is least likely to be a part of Tim’s portfolio?

A) Forwards.
B) Interest-rate swaps.
C) Options.

Question Q-Code: L1-DV-DVMI-013 LOS b Section 4

31 Which of the following is not a forward commitment?

A) Futures contracts.
B) Interest rates swaps.
C) Asset backed securities.

Question Q-Code: L1-DV-DVMI-014 LOS b Section 4

32 Which of the following statements is least accurate about contingent claims?

A) The payoffs are not linearly related to the underlying.

B) The most the short can gain is the premium paid for the contingent claim.
C) Either party can default to the other.

Question Q-Code: L1-DV-DVMI-019 LOS c Section 4

33 Which of the following statements about options is most accurate?

A) An option is the right to buy or the right to sell the underlying.

B) An option is the right to buy and sell, with the choice made at expiration.
C) An option is an obligation to buy or sell, which can be converted into the right to buy or sell.

Question Q-Code: L1-DV-DVMI-020 LOS c Section 4

34 Which of the following is a characteristic of a put option on the stock?

A) A guarantee that the stock price will decrease.

B) A specified date on which the right to sell expires.
C) A fixed price at which the put holder can buy the stock.

Question Q-Code: L1-DV-DVMI-021 LOS c Section 4

35 Analyst 1: A credit derivative is a derivative contract in which the seller provides protection to the buyer against the
credit risk of a third party.
Analyst 2: A credit derivative is a derivative contract in which the exchange provides a credit guarantee to both the
buyer and the seller.
Which analyst’s statement is most likely correct?

A) Analyst 1.
B) Analyst 2.
C) Neither of them.

Question Q-Code: L1-DV-DVMI-022 LOS c Section 4

36 A corporation has issued 10-year, floating-rate bonds. The treasurer realizes that the interest rates are going to rise
and enters into an agreement to receive semi-annual payments based on the 6-month LIBOR and to make semi-
annual payments at a fixed rate. This agreement is best described as a(n):

A) option.
B) futures contract.
C) swap.

Question Q-Code: L1-DV-DVMI-027 LOS c Section 4

37 A market participant has a view regarding the potential movement of a stock. He sells a customized over-the-counter
put option on the stock when the stock is trading at USD46. The put has an exercise price of USD44 and the put
seller receives USD2.5 in premium. The price of the stock is USD43 at expiration. The profit or loss for the put seller at
expiration is:
 expiration is:

A) USD(1.5).
B) USD1.5.
C) USD2.5.

Question Q-Code: L1-DV-DVMI-034 LOS c Section 4

38 Which of the following accurately describes a credit derivative?

A) In a credit derivative, the seller provides the buyer with protection against credit risk of a third party.
B) At the initiation of the contract of a credit derivative, the buyer and seller provide a performance bond.
C) The buyer and seller of a credit derivative are provided with a credit guarantee by the clearinghouse.

Question Q-Code: L1-DV-DVMI-053 LOS c Section 4

39 Which of the following statements about the feature of an option is correct?​

A) Only the long party can default.

B) Only the short party can default.
C) Both long and short party can default.

Question Q-Code: L1-DV-DVMI-045 LOS d Section 4

40 Analyst 1: Derivatives can be combined with other derivatives or underlying assets to form hybrids.
Analyst 2: Derivatives can be issued on weather, electricity, and disaster claims.
Which analyst’s statement is most likely correct?

A) Analyst 1.
B) Analyst 2.
C) Both.

Question Q-Code: L1-DV-DVMI-038 LOS d Section 6

41 Which of the following is an advantage of the derivatives market?

A) They are less volatile than spot markets.

B) They make it easier and less costly to transfer risk.
C) They incur higher transaction costs than spot markets.

Question Q-Code: L1-DV-DVMI-042 LOS d Section 5

42 Sebastian is planning to invest in derivatives. Which of the following is least likely to be an advantage that he should
consider?

A) Effective risk management.

B) Greater opportunities to go short compared to the spot market.
C) Similar payoffs to those of underlying.

Question Q-Code: L1-DV-DVMI-056 LOS d Section 5

43 When the implied volatility on equity market index options goes up, it is safe to assume that:

A) market interest rates have increased.

B) the market uncertainty has increased.
C) the market index value has increased.

Question Q-Code: L1-DV-DVMI-041 LOS d Section 5

44 Which of the following is most likely to be greater for derivative markets compared to underlying spot markets?

A) Capital requirements.
B) Liquidity.
C) Transaction costs.

Question Q-Code: L1-DV-DVMI-044 LOS d Section 5

45 Compared to the underlying spot market, the derivatives market is least likely to have:
 A) lower liquidity.
B) lower transaction costs.
C) lower capital requirements.

Question Q-Code: L1-DV-DVMI-052 LOS e Section 6

46 Which of the following is most likely to be a criticism of the derivatives market?

A) Derivatives provide price information but only at a cost of increasing transaction costs.
B) Derivatives are highly speculative instruments and effectively permit legalized gambling.
C) Default risk exists within all instruments of the derivative market.

Question Q-Code: L1-DV-DVMI-039 LOS d Section 6

47 Which of the following statements about derivatives is least accurate?

A) Options convey the volatility of the underlying.

B) Swaps convey the price at which uncertainty in the underlying can be eliminated.
C) Futures convey the most widely used strategy of the underlying.

Question Q-Code: L1-DV-DVMI-040 LOS d Section 6

48 While responding to criticism that derivatives can be destabilizing to the market, an analyst makes the following
statements:
Statement 1: Market crashes and panics have occurred since long before derivatives existed.
Statement 2: Derivatives are sufficiently regulated that they cannot destabilize the spot market.
Which statement is most likely correct?

A) Statement 1.
B) Statement 2.
C) Both.

Question Q-Code: L1-DV-DVMI-043 LOS d Section 6

49 The benefits of derivatives can result in a destabilizing consequence. Which of the following is this most likely to be?

A) Arbitrage activities due to market price swings.

B) Asymmetric performance as a result of trading strategies created.
C) Defaults on the part of speculators and creditors.

Question Q-Code: L1-DV-DVMI-046 LOS e Section 7

50 Arbitrage is often referred to as the:

A) law of one price.

B) law of similar prices.
C) law of limited profitability.

Question Q-Code: L1-DV-DVMI-047 LOS e Section 7

51 When an arbitrage opportunity exists, the combined action of all arbitrageurs:

A) results in a locked-limit situation.

B) results in sustained profit to all.
C) forces the prices to converge.

Question Q-Code: L1-DV-DVMI-048 LOS e Section 7

52 Analyst 1: An arbitrage is an opportunity to make a profit at no risk and with the investment of no capital.
Analyst 2: An arbitrage is an opportunity to earn a return in excess of the return appropriate for the risk assumed.
Which analyst’s statement is most likely correct?

A) Analyst 1.
B) Analyst 2.
C) Both.

Question Q-Code: L1-DV-DVMI-049 LOS e Section 7

53 Which of the following statements about arbitrage is most accurate?

A) Arbitrage imposes penalty on rapid trading.

B) Arbitrage redistributes risk among market participants.
C) Arbitrage helps prices to converge to their relative fair values.

Question Q-Code: L1-DV-DVMI-050 LOS e Section 7

54 David is studying the law of one price. Which of the following statements is most likely to be correct?

A) The law of one price explains that two assets producing equal future cash flows would sell for equal prices.
B) The law of one price describes how a risk-free profit can be earned without capital commitments.
C) The true fundamental value of the asset can be described by the law of one price.

Question Q-Code: L1-DV-DVMI-051 LOS e Section 7

55 Which of the following most likely represents an arbitrage opportunity?

A) A risk free rate is earned by the combination of the underlying asset and a derivative.
B) Sale of the shares of a takeover target and purchase of shares of the potential acquirer.
C) Two identical assets or derivatives are sold for different prices in different markets.

Question Q-Code: L1-DV-DVMI-054 LOS e Section 7

56 Which of the following characteristics is least likely needed for the existence of riskless arbitrage? The underlying
security:

A) can be short sold.

B) is relatively liquid.
C) is a financial asset.