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Free Questions › CFA › Derivatives
Free CFA Derivatives Practice Questions & Answers
500 exam-style Derivatives questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 271
A plain vanilla interest rate swap involves:
Select an option first.
Correct answer: B — One party paying a fixed rate while the other pays a floating rate on the same notional
Explanation: ✔ Why correct: In a plain vanilla IRS, the notional is never exchanged. One side pays fixed (say 4%) and receives floating (say SOFR), and the other does the opposite on the same notional amount. ✘ Why others are wrong: A describes initial principal exchange, which is not done in IRSs. C describes a cross-currency swap. D describes a repo.
Question 272
The net payment in an interest rate swap is made by:
Select an option first.
Correct answer: B — The party that owes the larger amount paying the difference to the other
Explanation: ✔ Why correct: Swap cash flows are netted. Only the difference between the fixed and floating amounts is actually transferred, reducing settlement risk. ✘ Why others are wrong: A is gross settlement, not standard in IRSs. C is wrong; either party could owe more depending on rates. D mischaracterizes how most swaps settle.
Question 273
A company that currently has floating-rate debt and wants to convert it to fixed-rate payments should:
Select an option first.
Correct answer: A — Enter a swap as the floating-rate receiver / fixed-rate payer
Explanation: ✔ Why correct: The company already pays floating on its debt. By entering a swap to PAY fixed and RECEIVE floating, the floating receipts offset the debt payments, leaving a net fixed-rate obligation. ✘ Why others are wrong: B would make the company pay floating twice. C and D are hedging tools but do not create a clean fixed-rate conversion.
Question 274
In a currency swap, unlike an interest rate swap:
Select an option first.
Correct answer: B — The notional principal is usually exchanged at initiation and at maturity
Explanation: ✔ Why correct: Currency swaps typically exchange the notional principal at both the start (at spot rate) and the end (at the same agreed exchange rate), in addition to periodic interest payments in the respective currencies. ✘ Why others are wrong: A is wrong; cash flows are exchanged in both directions. C would make it an IRS, not a currency swap. D describes amortizing swaps, not currency swaps generally.
Question 275
Which of the following describes an equity swap?
Select an option first.
Correct answer: A — One party pays the return on an equity index and receives a fixed or floating interest rate
Explanation: ✔ Why correct: In an equity swap, one side pays the total return of an equity index (dividends + price appreciation) and receives a fixed or floating rate from the other side. ✘ Why others are wrong: B is a strategic share exchange. C is an equity derivative strategy. D is short selling.
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Question 276
The fixed rate in a new interest rate swap is set so that the swap has an initial value of:
Select an option first.
Correct answer: C — Zero, making it a fair deal for both parties at inception
Explanation: ✔ Why correct: The swap fixed rate (also called the par rate or swap rate) is set at the level that makes the present value of fixed payments equal to the present value of expected floating payments — resulting in zero net present value at inception. ✘ Why others are wrong: A and B imply one party receives value for free. D confuses the swap rate with the current floating rate.
Question 277
An interest rate cap provides the buyer with:
Select an option first.
Correct answer: A — The right to receive payments when the floating rate exceeds the cap strike
Explanation: ✔ Why correct: An interest rate cap is a series of call options on the reference rate. The buyer receives cash when the rate rises above the strike, protecting against rising rates. ✘ Why others are wrong: B describes a fixed-rate payer in a swap. C would be a floor. D is unrelated.
Question 278
An interest rate floor provides:
Select an option first.
Correct answer: B — Payments to the holder when the reference rate falls below the floor strike
Explanation: ✔ Why correct: A floor is a series of put options on the floating rate. If rates fall below the strike, the buyer receives the difference — useful for floating-rate lenders. ✘ Why others are wrong: A is a cap. C is unrelated. D overstates the guarantee.
Question 279
An interest rate collar is:
Select an option first.
Correct answer: B — A combination of buying a cap and selling a floor (or vice versa)
Explanation: ✔ Why correct: A collar combines a long cap (protects against rate increases) and a short floor (sacrifices some benefit from rate decreases). The premium received from selling the floor offsets the cap premium. ✘ Why others are wrong: A is not a standard structure. C is a floating-for-floating basis swap. D is a structured note.
Question 280
A credit default swap (CDS) is best described as:
Select an option first.
Correct answer: B — A contract where the protection buyer pays a premium and receives a payment if a credit event occurs
Explanation: ✔ Why correct: In a CDS, the protection buyer pays periodic premiums to the protection seller. If a specified credit event (default, restructuring) occurs, the seller compensates the buyer for the loss. ✘ Why others are wrong: A describes a currency swap. C is a bond swap or exchange. D is a credit futures contract.
Question 281
In a CDS, the 'protection seller' is:
Select an option first.
Correct answer: B — The party that accepts the credit risk and receives the premium
Explanation: ✔ Why correct: The protection seller agrees to compensate the buyer in case of default, in exchange for regular premium payments. They are essentially short the credit risk. ✘ Why others are wrong: A is the protection buyer. C is the entity whose debt is referenced. D is the clearinghouse function.
Question 282
The swap spread refers to:
Select an option first.
Correct answer: B — The difference between the swap fixed rate and the yield of a comparable maturity government bond
Explanation: ✔ Why correct: Swap spread = swap rate − risk-free rate (typically government bond yield). It reflects credit risk, liquidity premium, and supply/demand in the interbank market. ✘ Why others are wrong: A is the bid-ask spread. C is the dealer's markup, though related to the spread. D describes collateral requirements.
Question 283
A swaption is best described as:
Select an option first.
Correct answer: B — An option to enter into a swap at a specified fixed rate in the future
Explanation: ✔ Why correct: A swaption gives the holder the right (not obligation) to enter a swap at a predetermined fixed rate on or before a future date. ✘ Why others are wrong: A describes a cancellable swap. C is not a swaption. D is a structured product.
Question 284
A payer swaption gives the buyer the right to:
Select an option first.
Correct answer: B — Pay fixed and receive floating in the underlying swap
Explanation: ✔ Why correct: A payer swaption is the right to enter a swap as the fixed-rate payer. It gains value when interest rates rise (making a fixed payment increasingly favorable relative to higher floating rates). ✘ Why others are wrong: A is a receiver swaption. C and D are not how swaptions work.
Question 285
Which of the following best describes a basis swap?
Select an option first.
Correct answer: A — A swap where both legs pay a floating rate, but referenced to different indices
Explanation: ✔ Why correct: In a basis swap, both sides pay floating, but each is tied to a different reference rate (e.g., SOFR vs. fed funds rate). It is used to hedge basis risk between two floating benchmarks. ✘ Why others are wrong: B is an equity swap. C is a currency swap. D is not a standard swap type.
Question 286
An amortizing swap is one in which:
Select an option first.
Correct answer: B — The notional principal decreases over the life of the swap
Explanation: ✔ Why correct: In an amortizing swap, the notional decreases (like mortgage amortization), aligning with a declining loan balance. This reduces both parties' exposure over time. ✘ Why others are wrong: A confuses the rate with the notional. C is about payment frequency. D describes an inflation-linked swap.
Question 287
In an overnight index swap (OIS), the floating rate is typically:
Select an option first.
Correct answer: B — The compounded overnight rate (e.g., SOFR) over the swap term
Explanation: ✔ Why correct: OIS floats at the compounded overnight rate (SOFR in USD, EONIA historically in EUR). It has minimal credit risk because the rate resets daily and is benchmarked to nearly risk-free overnight lending. ✘ Why others are wrong: A is how a standard LIBOR swap works. C and D are not OIS reference rates.
Question 288
The OIS-LIBOR spread (or OIS-SOFR spread) is watched by market participants as an indicator of:
Select an option first.
Correct answer: B — Stress in the bank lending market and perceived credit risk among banks
Explanation: ✔ Why correct: The OIS rate is nearly risk-free (overnight, minimal credit risk). LIBOR/term rates include bank credit risk. A wide OIS spread signals that banks distrust each other, a key indicator of financial stress. ✘ Why others are wrong: A is measured by VIX or options markets. C is measured by breakeven inflation. D is FX specific. Options — Basics
Question 289
The premium paid for an option represents:
Select an option first.
Correct answer: B — The maximum loss the option buyer can incur
Explanation: ✔ Why correct: The option buyer's downside is capped at the premium paid. If the option expires worthless, the total loss is the premium. ✘ Why others are wrong: A is wrong; the premium is a cost, not a guaranteed profit. C is the margin requirement for the seller. D is a futures concept.
Question 290
As an option approaches expiration, all else equal, its time value:
Select an option first.
Correct answer: C — Decreases toward zero
Explanation: ✔ Why correct: Time decay (theta) causes time value to erode as expiration nears. At expiration, an option is worth only its intrinsic value (zero for OTM). ✘ Why others are wrong: A is backward. B ignores theta. D confuses time value with intrinsic value.
Question 291
Put-call parity states that for European options on a non-dividend-paying stock:
Select an option first.
Correct answer: A — Call − Put = S − PV(K)
Explanation: ✔ Why correct: C + PV(K) = P + S → C − P = S − PV(K). This is the put-call parity relation. It ensures no arbitrage between calls, puts, the stock, and the risk-free asset. ✘ Why others are wrong: B adds instead of netting. C implies calls always equal puts. D misarranges the formula.
Question 292
Which of the following is true about an option's delta?
Select an option first.
Correct answer: B — Delta measures the change in option price per unit change in the underlying price
Explanation: ✔ Why correct: Delta = ∂V/∂S. For calls, delta ranges from 0 to 1; for puts, from −1 to 0. ATM options have delta near ±0.5. ✘ Why others are wrong: A is true only at expiration for deep ITM options. C is wrong for calls. D describes theta (time sensitivity).
Question 293
Gamma measures:
Select an option first.
Correct answer: B — The rate of change of delta with respect to a change in the underlying price
Explanation: ✔ Why correct: Gamma = ∂²V/∂S² = rate of change of delta. High gamma means delta changes rapidly, requiring frequent rebalancing for delta-neutral hedges. ✘ Why others are wrong: A is theta. C is vega. D is rho.
Question 294
Vega measures the sensitivity of an option's price to:
Select an option first.
Correct answer: C — Changes in the volatility of the underlying asset
Explanation: ✔ Why correct: Vega = ∂V/∂σ. Higher implied volatility increases option premiums (for both calls and puts), since there is a greater chance of a large move. ✘ Why others are wrong: A is delta. B is theta. D is rho.
Question 295
Rho measures:
Select an option first.
Correct answer: B — The option price change per 1% change in the risk-free interest rate
Explanation: ✔ Why correct: Rho = ∂V/∂r. Calls have positive rho (benefit from higher rates); puts have negative rho. ✘ Why others are wrong: A is vega. C is gamma. D is theta.
Question 296
An option that can be exercised at ANY time is described as:
Select an option first.
Correct answer: C — American
Explanation: ✔ Why correct: American options allow exercise at any point up to and including expiration, making them more flexible (and typically more valuable) than European options. ✘ Why others are wrong: A is expiration-only. B is a broader category of non-standard options. D (Bermuda) allows exercise only on specific scheduled dates.
Question 297
The Black-Scholes-Merton model prices options assuming that the underlying asset's returns are:
Select an option first.
Correct answer: B — Normally distributed (lognormal price distribution)
Explanation: ✔ Why correct: The BSM model assumes continuous trading and that log returns of the underlying follow a normal distribution, which implies the asset price is lognormally distributed. ✘ Why others are wrong: A and C are not the BSM assumptions. D describes the binomial model, not BSM.
Question 298
The risk-neutral probability in the binomial model is used to:
Select an option first.
Correct answer: B — Price the option as if all investors are risk-neutral, discounting at the risk-free rate
Explanation: ✔ Why correct: Risk-neutral pricing constructs a probability measure under which all assets earn the risk-free rate. This allows discounting expected payoffs at r, regardless of investor risk preferences. ✘ Why others are wrong: A is the real-world probability. C is a separate calculation. D is a statistical estimate.
Question 299
All else equal, a longer time to expiration typically makes an option:
Select an option first.
Correct answer: B — More valuable, because there is more time for a favorable move
Explanation: ✔ Why correct: More time = more time value. The option has greater probability of moving ITM. This is true for both calls and puts (generally — some edge cases with deep ITM European puts exist). ✘ Why others are wrong: A is backward. C ignores time value. D applies to the risk-free rate effect (PV of waiting), which is secondary.
Question 300
The BSM formula for a European put is derived from put-call parity. The put price equals:
Select an option first.
Correct answer: B — K × e^(−rT) × N(−d2) − S × N(−d1)
Explanation: ✔ Why correct: Using put-call parity: P = C − S + K × e^(−rT). Substituting the call formula yields P = K e^(−rT) N(−d2) − S N(−d1). ✘ Why others are wrong: A is the put's intrinsic value approximation. C is the call formula. D is not properly derived.
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