Unit study guide · NISM Series XIII
Basics of Derivatives (Equity, Currency and Interest Rate)
6 questions in this unit
What this unit covers
- Which statement most accurately describes the nature of a financial derivative contract?
- Which participant uses derivatives mainly to reduce an existing exposure to price changes?
- Which feature most clearly distinguishes a standard exchange-traded derivative from a privately negotiated OTC contract?
- An importer expects to pay US dollars in three months. Which action most directly addresses rupee depreciation risk?
- Which risk remains when a hedge instrument does not move exactly with the exposure being hedged?
- A trader offsets an OTC derivative with an economically opposite contract. The original counterparty becomes insolvent. Which risk remains?
Key ideas
From the practice bank · 1
Which statement most accurately describes the nature of a financial derivative contract?
A derivative derives its value from an underlying price, rate, index or other variable. Remember: Derivatives depend on an underlying variable.
Hint Common mistake: Do not confuse a derivative contract with a share. Focus on where the contract gets its value.
XIII-001From the practice bank · 2
Which participant uses derivatives mainly to reduce an existing exposure to price changes?
A hedger uses derivatives to offset an existing or expected exposure. Remember: Hedging aims to reduce a specific exposure.
Hint Common mistake: Do not mistake a hedge for a risk-free guarantee. Think about reducing an existing risk.
XIII-002From the practice bank · 3
Which feature most clearly distinguishes a standard exchange-traded derivative from a privately negotiated OTC contract?
Exchange-traded derivatives use standardized contract specifications and generally a clearing mechanism. Remember: Exchange contracts trade on standard terms.
Hint Common mistake: Clearing does not eliminate trading risk. Compare standardization and trading arrangements.
XIII-003From the practice bank · 4
An importer expects to pay US dollars in three months. Which action most directly addresses rupee depreciation risk?
Locking a suitable exchange rate can reduce the importer's uncertainty about the rupee cost. Remember: Match a hedge to the exposure being hedged.
Hint Common mistake: The direction of the foreign-currency obligation matters. Identify the exposure created by a dollar payment.
XIII-004From the practice bank · 5
Which risk remains when a hedge instrument does not move exactly with the exposure being hedged?
Basis risk arises when the price relationship between the hedge and the exposure changes unexpectedly. Remember: Imperfect hedges can retain basis risk.
Hint Common mistake: A hedge need not track the exposure perfectly. Think about imperfect price co-movement.
XIII-005From the practice bank · 6
A trader offsets an OTC derivative with an economically opposite contract. The original counterparty becomes insolvent. Which risk remains?
Opposite economic positions do not necessarily cancel the original OTC counterparty's payment obligation. Remember: Market hedging and counterparty risk are different.
Hint Common mistake: Do not assume an economic offset is a legal closeout. Consider whether opposite exposure closes a legal obligation.
XIII-006