# Multiple Choice Questions And Analysis: Fundamental Concepts Of Derivatives

Question 1 Question 2 Question 3 Question 4 Question 5 Question 6 Question 7 Question 8 Question 9 Question 10 Question 11 Question 12

Option b d b b c d d d c c a b spot market derivative market no arbitrage

Question 2 Fundamental concepts of derivative markets:

What are derivatives?

Derivatives can be defined as the instruments whose value depends on the value of underlying assets which may be a commodity, metal, money currency, any stock or indices. The main purpose of derivatives is to avoid risk.

Major uses of derivatives Following are the major uses of derivatives

Risk management and Financial engineering

Derivatives are used to avoid risk through hedging and managing finance through derivative technique.

To

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Why are derivatives Synthetic

Synthetic is financial instrument term which pretend the ownership on the primary benchmark asset but depend on the economic results of real transaction. Same deems fit for the derivatives as derivatives depend on the value and transaction of underlying assets therefore we can call derivatives as synthetic derivatives.

Examples:

Example of synthetic derivative is the synthetic short stock that grows and underlying asset move down for long put that has short call option.

Convertible bond is ideal example for synthetic derivatives that is convertible against higher return.

Zero Sum Games

Zero sum game is the term used to express that one-person gain is nearly equal to other person loss. This term is also used for derivatives. It means that from using derivative instrument one person get advantage and other person have to bear loss. I agree with this term because derivative is the technique to avoid risk and put other under the risk. Suppose if someone use derivate to avoid risk of currency fluctuations through hedging. If the price does not fluctuate the first person have to pay while second person will gain. On the other hand, if currency devalue with good percentage the second person have to bear loss and first one will save due to derivatives. Therefore, derivative is not win-win

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Question 3 True or False

Part A

True: derivative contracts and stocks are traded on the same market. Its example is the futures contracts that are traded on the same market. ETDs is another example of derivative contracts on exchanges.

Part B:

False: derivatives markets can exist if the underlying asset is non-traded. There is the type of derivatives some are traded while other underlying assets are non-traded. The best example is the derivate on weathers and index that are non-traded.

Question 4 Application of Arbitrage

Arbitrage:

Arbitrage is a technique used by financial experts whereby the purchase and sell at the same time by exploiting the difference in price. It is the risk-free profit. There don’t have to be any investment.

Arbitrage can be compared with trading or selling the product without buying. Under arbitrage one person buy stock on say New York Stock exchange at lower prices and sell it in other stock exchange at the same time at higher price.

Example

Suppose the Facebook price in New York stock exchange is $20 and in London stock exchange it is $22. The person will buy Facebook stocks from New York Stock exchange and sell it to London stock exchange to gain profit of $2 per share. This is arbitrage