Derivatives - Derivatives Section 1

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46. Which of the following statements about arbitrage is most accurate?

  • Option : C
  • Explanation : Arbitrage results in an acceleration of price convergence to fair values relative to instruments with equivalent payoffs.
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47. David is studying the law of one price. Which of the following statements is most likely to be correct?

  • Option : A
  • Explanation : The law of one price occurs when participants in the market engage in arbitrage activities so that identical assets sell for the same price in different markets. B refers to arbitrage and C does not account for identical assets.
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48. Which of the following most likely represents an arbitrage opportunity?

  • Option : C
  • Explanation : Arbitrage opportunities exist when the same asset or two equivalent assets, producing the same result, sell for different prices. A and B are incorrect because they do not define arbitrage opportunities.
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49. Which of the following is most likely to be a criticism of the derivatives market?

  • Option : B
  • Explanation : The criticism to derivatives is that they are ‘too risky’ especially to investors with limited knowledge of complicated instruments. Derivative markets do provide price information but also lower transaction costs. Moreover, default risk is not existent in all instruments. With exchange traded instruments such as options and futures there is virtually no default risk
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50. Which of the following statements about the feature of an option is correct?

  • Option : B
  • Explanation : There is always a possibility that short party may not fulfill its obligation if the long party decides to exercise the option. Therefore, the short party can default.
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