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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 211
The basis in a futures contract is defined as:
Select an option first.
Correct answer: A — Futures price minus the spot price of the underlying
Explanation: ✔ Why correct: Basis = futures price − spot price (or sometimes spot − futures depending on convention). It reflects the cost of carry and converges to zero at expiration. ✘ Why others are wrong: B is a margin concept. C is time value of an option. D is the settlement price, not basis.
Question 212
Convergence in futures markets refers to the tendency of:
Select an option first.
Correct answer: B — Futures prices to equal the spot price at expiration
Explanation: ✔ Why correct: At expiration, the futures price must equal the spot price; otherwise an arbitrage opportunity would exist. This narrowing is called convergence. ✘ Why others are wrong: A is the opposite. C is not a general rule. D contradicts convergence — basis narrows, not widens. Forward Contracts
Question 213
A forward contract is best described as:
Select an option first.
Correct answer: B — A customized, privately negotiated agreement to buy or sell an asset at a specified price on a future date
Explanation: ✔ Why correct: Forwards are bilateral OTC contracts with fully customizable terms — price, quantity, date, and settlement method are all negotiated directly between the parties. ✘ Why others are wrong: A describes a futures contract. C describes a call option. D describes a swap.
Question 214
The party that agrees to BUY the underlying asset at the forward price is called the:
Select an option first.
Correct answer: C — Long
Explanation: ✔ Why correct: The long position in a forward obligates the holder to purchase the underlying at the agreed forward price on the delivery date. ✘ Why others are wrong: A (short) agrees to sell. B (writer) is options terminology for the seller. D is the exchange infrastructure, not a contract party.
Question 215
At the initiation of a fairly priced forward contract, the value to both parties is:
Select an option first.
Correct answer: C — Zero, because no money changes hands and the price is set at fair value
Explanation: ✔ Why correct: A fair forward price is set so that the contract has zero net present value at inception — neither party pays or receives a premium. ✘ Why others are wrong: A would mean it is mispriced. B is incorrect; transaction costs are small and the contract value itself starts at zero. D is the price, not the contract value.
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Question 216
The value of a long forward contract after initiation increases when:
Select an option first.
Correct answer: B — The price of the underlying asset rises above the forward price
Explanation: ✔ Why correct: A long forward gains value when the market price of the underlying exceeds the locked-in forward price, since the long can buy cheaply and sell at market. ✘ Why others are wrong: A benefits the short. C has a secondary effect on the forward price via the cost of carry but is not the primary driver. D is incorrect; time alone does not determine value.
Question 217
The forward price of a non-dividend-paying stock is best expressed as:
Select an option first.
Correct answer: A — F = S × (1 + r)^T
Explanation: ✔ Why correct: The no-arbitrage forward price equals the current spot price compounded at the risk-free rate for the contract term: F = S(1+r)^T (or S × e^(rT) in continuous time). ✘ Why others are wrong: B discounts rather than compounds, which would underprice the forward. C is linear approximation that ignores compounding. D uses dividends when there are none.
Question 218
If a dividend-paying stock has a forward contract, the fair forward price is:
Select an option first.
Correct answer: B — Lower than a non-dividend-paying stock forward, all else equal
Explanation: ✔ Why correct: Dividends reduce the cost of carrying the stock (the stockholder receives them). The forward price is reduced by the present value of expected dividends. ✘ Why others are wrong: A is incorrect. C ignores the dividend benefit. D is nonsensical.
Question 219
Which of the following is a key limitation of forward contracts compared to futures?
Select an option first.
Correct answer: B — Forwards expose both parties to counterparty default risk
Explanation: ✔ Why correct: Without a clearinghouse, each forward party bears the risk that the other will default. This is the primary disadvantage relative to exchange-traded futures. ✘ Why others are wrong: A is wrong; currency forwards are one of the most common OTC derivatives. C is reversed — forwards are less standardized. D is not a reliable rule.
Question 220
At expiration, the payoff to a long forward position is:
Select an option first.
Correct answer: C — S_T − F_0
Explanation: ✔ Why correct: The long agreed to buy at F_0. If the spot price at expiration (S_T) is higher, the long gains. Payoff = S_T − F_0. ✘ Why others are wrong: A is a product rather than a difference. B is the short's payoff. D is the payoff of a call option, not a forward.
Question 221
A trader enters a short forward at $100. At expiration, the spot price is $115. The trader's payoff is:
Select an option first.
Correct answer: B — −$15
Explanation: ✔ Why correct: Short forward payoff = F_0 − S_T = 100 − 115 = −$15. The short agreed to sell at $100 but the market price rose to $115, creating a loss. ✘ Why others are wrong: A is the long's payoff. C is the raw spot price. D would mean no gain or loss.
Question 222
The no-arbitrage principle ensures that the forward price:
Select an option first.
Correct answer: B — Is set to prevent profitable riskless trades between the spot and forward markets
Explanation: ✔ Why correct: No-arbitrage pricing ensures that buying the asset now and carrying it forward gives the same result as entering a forward. Any deviation creates a riskless profit that arbitrageurs would quickly eliminate. ✘ Why others are wrong: A is the pure expectations hypothesis. C is false when carry costs are low or storage yields are negative. D is a behavioral description, not a pricing principle.
Question 223
Cost of carry in the context of forward pricing refers to:
Select an option first.
Correct answer: B — Net costs of holding the underlying asset (financing, storage, insurance) minus any income received
Explanation: ✔ Why correct: Cost of carry = financing cost + storage + insurance − dividends/income. A higher cost of carry raises the forward price above the current spot. ✘ Why others are wrong: A is a brokerage cost. C is an exchange fee. D is variation margin.
Question 224
If the risk-free rate rises (all else equal), the fair forward price of a non-dividend-paying stock will:
Select an option first.
Correct answer: B — Rise
Explanation: ✔ Why correct: F = S(1+r)^T. Higher r increases the compounding factor, so the forward price must rise to maintain no-arbitrage. ✘ Why others are wrong: A is incorrect. C ignores the impact of r on compounding. D is impossible for a positive spot price.
Question 225
A forward rate agreement (FRA) is a forward contract on:
Select an option first.
Correct answer: C — An interest rate
Explanation: ✔ Why correct: An FRA is a bilateral OTC contract that locks in an interest rate for a future borrowing or lending period. Settlement is in cash based on the difference between the contracted rate and prevailing market rate. ✘ Why others are wrong: A is an equity forward. B is a currency forward. D is a commodity forward.
Question 226
In an FRA contract described as '3×9', the numbers refer to:
Select an option first.
Correct answer: A — 3 months until settlement, with the underlying rate covering the following 6 months
Explanation: ✔ Why correct: A 3×9 FRA starts in 3 months and the underlying reference rate spans from month 3 to month 9 (a 6-month rate). Settlement occurs at the 3-month mark. ✘ Why others are wrong: B, C, and D misread the standard FRA notation.
Question 227
A foreign currency forward is used by a multinational company primarily to:
Select an option first.
Correct answer: B — Lock in a future exchange rate for a foreign currency receivable or payable
Explanation: ✔ Why correct: The primary corporate use of currency forwards is to eliminate foreign exchange risk by fixing the rate at which future foreign cash flows will be converted. ✘ Why others are wrong: A is speculation. C describes carry trade. D is a tax strategy unrelated to forwards.
Question 228
Covered interest rate parity links the forward exchange rate to:
Select an option first.
Correct answer: B — The spot exchange rate and the interest rate differential between two countries
Explanation: ✔ Why correct: Covered interest parity states: F/S = (1 + r_domestic)/(1 + r_foreign). The forward rate adjusts to prevent arbitrage between investing domestically vs. converting and investing abroad. ✘ Why others are wrong: A is purchasing power parity. C is also PPP (absolute form). D is a macro trade concept, not a pricing relationship.
Question 229
If domestic interest rates are higher than foreign rates, the domestic currency forward rate will be:
Select an option first.
Correct answer: B — At a discount to the spot rate (domestic currency trades at a forward discount)
Explanation: ✔ Why correct: Higher domestic rates imply higher carry cost for holding domestic assets; covered interest parity requires the domestic currency to depreciate forward (trade at a discount) to equalize returns. ✘ Why others are wrong: A is backwards. C ignores the interest rate differential. D ignores covered interest parity.
Question 230
A forward contract that obligates the buyer to purchase 1,000 barrels of oil at $80 per barrel in 90 days is best described as a:
Select an option first.
Correct answer: B — Physical commodity forward
Explanation: ✔ Why correct: It is a forward (OTC, bilaterally negotiated) on a physical commodity (oil). ✘ Why others are wrong: A would be an option granting a right, not an obligation. C involves periodic cash flow exchanges. D is exchange-traded and standardized.
Question 231
The long in a forward contract profits when:
Select an option first.
Correct answer: C — The spot price at expiration exceeds the forward price
Explanation: ✔ Why correct: The long committed to buy at the forward price. If the spot price ends up higher, the long buys cheap and could sell at market — payoff = S_T − F_0 > 0. ✘ Why others are wrong: A benefits the short. B misunderstands that the forward price is fixed at initiation. D has a secondary effect but is not the direct payoff driver.
Question 232
Netting in a forward contract refers to:
Select an option first.
Correct answer: B — Offsetting mutual obligations so only the net amount is paid
Explanation: ✔ Why correct: When two counterparties have multiple forwards with each other, netting offsets gains and losses so only the net obligation transfers, reducing settlement risk. ✘ Why others are wrong: A is a margin calculation. C is rolling. D would be simple aggregation, not netting.
Question 233
A forward contract on a bond that pays coupon payments before expiration will have a forward price:
Select an option first.
Correct answer: B — Lower than F = S(1+r)^T because coupon income reduces the cost of carry
Explanation: ✔ Why correct: Coupons are income received by the holder of the underlying bond. Like dividends, they reduce the net cost of carrying the position, lowering the fair forward price. ✘ Why others are wrong: A is backwards. C ignores the income adjustment. D is incorrect.
Question 234
The settlement of a non-deliverable forward (NDF) is:
Select an option first.
Correct answer: B — Cash payment of the difference between the contracted rate and the spot rate at maturity
Explanation: ✔ Why correct: NDFs are cash-settled. They are common in currencies where physical delivery is restricted by capital controls. The net difference is paid in a convertible currency. ✘ Why others are wrong: A describes a deliverable forward. C and D do not reflect NDF mechanics.
Question 235
An equity portfolio manager who wants to reduce market exposure temporarily without selling stocks can most efficiently use:
Select an option first.
Correct answer: B — A short equity forward or futures contract on the index
Explanation: ✔ Why correct: A short position in an index forward or futures hedges a long equity portfolio. Gains on the short derivative offset losses in the portfolio when prices fall. ✘ Why others are wrong: A only locks in value for actual delivery, not a flexible portfolio hedge. C increases exposure. D does not hedge equity risk.
Question 236
Which of the following best explains why a forward price is not an unbiased predictor of the future spot price?
Select an option first.
Correct answer: B — The forward price includes a risk premium that may be positive or negative
Explanation: ✔ Why correct: The forward price is a no-arbitrage price based on cost of carry. It may incorporate a risk premium (systematic risk in the underlying), so it can be a biased predictor of the future spot. ✘ Why others are wrong: A is wrong. C is the expectations hypothesis, which is not always correct. D is wrong; the forward price is known at inception.
Question 237
When an investor takes a long forward position at F_0 and the contract is later worth V > 0, the value V is best described as:
Select an option first.
Correct answer: A — The new forward price minus the original forward price, discounted to the present
Explanation: ✔ Why correct: Mid-contract value of a long forward = PV(F_1 − F_0) where F_1 is the current forward price for the remaining term. This reflects how much the position has moved in favor of the long. ✘ Why others are wrong: B is the spot price, not contract value. C is the notional, not contract value. D is the accrued forward price, not contract value.
Question 238
An investor shorts a forward on a commodity at $50/unit. Three months later the commodity spot price is $45. Which of the following is true?
Select an option first.
Correct answer: B — The short has a gain because the commodity price is below the contracted price
Explanation: ✔ Why correct: Short forward payoff = F_0 − S_T. Here F_0 = $50 and the spot has moved toward $45. Mid-contract, the short has an unrealized gain because S_T is expected to be lower than $50. ✘ Why others are wrong: A is backwards. C is wrong; the price is still $50 per the contract. D is wrong; the mid-contract value has changed.
Question 239
A portfolio manager enters a forward contract to sell 1 million shares of an index at $500 per share in six months. This position is a:
Select an option first.
Correct answer: C — Short forward hedge (if the manager owns those shares)
Explanation: ✔ Why correct: Agreeing to sell (short forward) shares the manager already owns is a classic hedge — locking in a sale price to eliminate downside price risk. ✘ Why others are wrong: A and D are long positions. B would be speculation only if the manager does not own the shares.
Question 240
The difference between a forward and a futures contract that is most relevant to risk management is:
Select an option first.
Correct answer: B — Futures have daily mark-to-market cash flows; forwards settle entirely at expiration
Explanation: ✔ Why correct: The daily settlement of futures means cash flows in and out daily, creating liquidity risk but reducing credit exposure. Forward cash flows are deferred to expiration, concentrating both credit and liquidity risk at one point. ✘ Why others are wrong: A is incorrect; both expire. C is not a rule. D is the opposite of typical practice in many markets. Futures Contracts
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