Introduction to Derivatives
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Questions and Answers

What is a derivative primarily defined as?

  • An asset that is always traded in cash.
  • A contract or product whose value is derived from an underlying asset. (correct)
  • A type of security with fixed returns.
  • A product whose value is independent of other assets.

Which of the following is NOT a type of underlying asset for derivatives?

  • Agri commodities like Wheat and Sugar.
  • Energy resources like Oil and Coal.
  • Metals like Gold and Silver.
  • Equity Options. (correct)

What major event in the 1630s is known for its impact on the derivatives market?

  • The selling of wool by English monasteries.
  • Tulip Mania, where tulip futures lost value. (correct)
  • The establishment of futures markets for rice in Japan.
  • The signing of contracts in European trade fairs.

In which century did sellers at European trade fairs begin signing contracts for future deliveries?

<p>12th Century (D)</p> Signup and view all the answers

What was the primary purpose of the futures market developed in Japan near Osaka?

<p>To protect rice producers from adverse conditions. (D)</p> Signup and view all the answers

What is one of the learning objectives of studying the basics of derivatives?

<p>To learn about the significance of derivative markets. (D)</p> Signup and view all the answers

What type of market evolution involved the English Cistercian Monasteries?

<p>Early contracts for future wool sales. (D)</p> Signup and view all the answers

Which of the following is a significant risk associated with derivatives trading?

<p>All of the above. (D)</p> Signup and view all the answers

What is the primary role of the Index Committee?

<p>To determine the inclusion or removal of securities from the index (C)</p> Signup and view all the answers

Why is index maintenance necessary?

<p>To reflect the impact of corporate actions on the index (C)</p> Signup and view all the answers

What is the purpose of an index fund?

<p>To generate returns equivalent to the return on the specific index (C)</p> Signup and view all the answers

Which of the following factors triggers an index maintenance issue?

<p>Corporate actions like stock splits (A)</p> Signup and view all the answers

How do index derivatives function?

<p>They derive value directly from the index as an underlying asset (C)</p> Signup and view all the answers

What is a potential drawback of index funds?

<p>They may incur a tracking error due to fund management expenses (D)</p> Signup and view all the answers

Which of the following is NOT a major equity index in India?

<p>Nifty Select 30 (A)</p> Signup and view all the answers

What is an example of a continuous exercise related to index management?

<p>Index revision to ensure a vibrant selection of securities (D)</p> Signup and view all the answers

What is a key feature of futures contracts?

<p>They are traded on a centralized platform. (A)</p> Signup and view all the answers

Which of the following is included in the contract specifications of a futures contract?

<p>Underlying asset (C)</p> Signup and view all the answers

What is a limitation of futures contracts?

<p>There are increased administrative costs due to MTM settlement. (A)</p> Signup and view all the answers

In the context of futures contracts, what does 'contract multiplier' refer to?

<p>The size of each contract or lot traded (B)</p> Signup and view all the answers

What determines the quantity in a futures contract?

<p>The exchange regulations and contract specifications (C)</p> Signup and view all the answers

Which of the following terms refers to the value of the underlying asset in the cash market related to futures contracts?

<p>Underlying value (B)</p> Signup and view all the answers

What is one of the main purposes of a futures contract?

<p>To facilitate price discovery through buyer-seller interactions (C)</p> Signup and view all the answers

What does the term 'MTM settlement' refer to in futures trading?

<p>Mark-to-market settlement reflecting current asset values (A)</p> Signup and view all the answers

What distinguishes a forward contract from a cash market transaction?

<p>A forward contract is an agreement for future delivery. (B)</p> Signup and view all the answers

Which statement accurately describes Exchange Traded Funds (ETFs)?

<p>ETFs allow for intraday transactions on exchanges. (B)</p> Signup and view all the answers

In the context of market risk hedging, which derivative is primarily used?

<p>Index options and index futures (C)</p> Signup and view all the answers

What is one disadvantage of ETFs compared to mutual funds?

<p>Limited trading hours (B)</p> Signup and view all the answers

What term refers to the cost that arises due to a lack of liquidity in the market?

<p>Impact cost (C)</p> Signup and view all the answers

What does it mean when someone is 'long forward' in a forward contract?

<p>They have purchased the contract. (D)</p> Signup and view all the answers

Which of the following is NOT a market where forward contracts are widely used?

<p>Real estate (C)</p> Signup and view all the answers

What is the primary advantage of ETFs over traditional mutual funds?

<p>Ability to trade on exchanges (C)</p> Signup and view all the answers

What is the ideal price for a security based on the given bid and offer prices?

<p>Rs. 4.25 (A)</p> Signup and view all the answers

What is the percentage impact cost when buying 1500 shares based on the calculated prices?

<p>0.84% (A)</p> Signup and view all the answers

What is the primary focus of index construction?

<p>Choosing stocks and calculating index methodology (D)</p> Signup and view all the answers

What does a well-diversified index best reflect?

<p>The behavior of the overall market/economy (D)</p> Signup and view all the answers

What causes the variance in impact cost between buying and selling transactions?

<p>Transaction size and market liquidity (D)</p> Signup and view all the answers

Which of the following statements is correct regarding risk reduction in an index?

<p>Risk reduction plateaus after a significant increase in the number of stocks. (B)</p> Signup and view all the answers

What is the role of specialized agencies in index management?

<p>Managing index construction and maintenance (B)</p> Signup and view all the answers

What is a significant factor affecting the ideal price of shares in an infinitely liquid market?

<p>The distance between buy and sell prices (C)</p> Signup and view all the answers

What happens to open interest when a trader closes a long position by selling contracts?

<p>Open interest decreases if all positions are closed. (B)</p> Signup and view all the answers

If a futures contract's previous day closing price is Rs.100, what would be the price range for the next trading day if the price band is set at 10%?

<p>Rs.90 to Rs.110 (C)</p> Signup and view all the answers

Which of the following accurately describes a long position in the derivatives market?

<p>A trader holds a buy position that is yet to be settled. (A)</p> Signup and view all the answers

What is the consequence of a trader closing a short position by buying back contracts?

<p>Open interest decreases if the position is completely closed. (B)</p> Signup and view all the answers

When do price bands for futures contracts get decided?

<p>On the day of the contract's first trading. (C)</p> Signup and view all the answers

Which scenario illustrates an increase in open interest?

<p>A trader buys 100 contracts without altering previous positions. (A)</p> Signup and view all the answers

What is one of the factors that can justify the expansion of price bands during trading?

<p>Discretion of the exchanges based on market volatility. (D)</p> Signup and view all the answers

What occurs in the derivatives market when a trader goes short in 100 contracts?

<p>New short positions are created, increasing open interest. (B)</p> Signup and view all the answers

Flashcards

Derivative

A contract or product whose value is based on another asset (the underlying asset).

Underlying asset

The asset whose value determines the value of a derivative.

Examples of Underlying Assets

Metals, energy resources, agricultural commodities, and financial assets (like stocks, bonds, and currencies).

Derivatives Market (History)

A market where contracts are traded, tracing back centuries with examples from Europe, Japan, and the Dutch tulip market.

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Tulip Mania

A speculative market boom in 17th-century Holland involving tulip futures, which ended in financial losses.

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Futures contract

A contract to buy or sell an asset at a specific future date and price.

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Early derivative market examples

European trade fairs contracts, English monasteries' wool contracts, Japanese rice futures contracts

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Significance of derivatives market

Derivatives markets allow hedging and speculation, affecting risk management and investment opportunities. Provides instruments to manage risk from factors like price change

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Ideal Price

The average of the best bid and offer prices.

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Impact Cost

The percentage difference between the actual transaction price and the ideal price when buying or selling shares.

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Impact Cost

Differs with transaction size and buy/sell side in trading.

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Index Management

The process of constructing, maintaining, and revising an index, typically handled by specialized agencies.

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Index Construction

The process of choosing the stocks and calculation methodology for the index.

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Index Maintenance

Adjusting the index to accommodate corporate actions like stock splits or mergers.

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Index Revision

Changing the index composition by replacing stocks due to market changes or investor interest shift.

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Index Diversification

The practice of including a variety of stocks in an index to reduce risk.

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Index Eligibility Criteria

The rules used to decide if a stock qualifies for inclusion in an index.

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Index Committee

The group that makes the final decisions on which stocks are included or excluded from the index.

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Index Fund

A fund that invests in the stocks of an index in the same proportions as they appear in the index.

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Index Derivatives

Derivative contracts based on an index as the underlying asset.

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Tracking Error

Difference between an index fund's return and the index's return, primarily from fund management expenses and maintaining cash reserves.

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Futures Contract Feature

An agreement between two parties through an exchange, where one party agrees to buy and the other to sell an asset at a specific future date and price.

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Centralised Trading Platform

An exchange provides the infrastructure for buyers and sellers to interact and set the price for futures contracts.

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Price Discovery

The exchange enables free interaction between buyers and sellers, allowing the price of a futures contract to be determined.

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Margin

A deposit held by both parties (buyer and seller) as a security against potential losses in futures trading.

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Standardized Contract

Futures contracts are predefined with clear terms and specifications. They are not customized or negotiable between parties other than the price.

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Contract Maturity

The date on which a futures contract expires and the underlying asset is bought or sold at the agreed price.

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Contract Multiplier

The number of units of an underlying asset that are traded in one futures contract.

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Underlying Price

The current market price of the asset on which a futures contract is based.

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Index Futures

A contract to buy or sell a specific index at a specific date and price. They allow investors to hedge against market risk by taking a long or short position, often used for index tracking and portfolio management.

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Exchange Traded Funds (ETFs)

A type of investment fund that tracks a specific index, sector, or commodity. They are traded on exchanges like individual stocks, offering instant liquidity and low costs. They provide a way to diversify investments.

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Cash Market

The market where goods and services are traded for immediate delivery and payment.

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Forward Contract

An agreement between two parties to buy or sell an asset at a specific future date and price. It's a custom agreement that offers flexibility, but lacks liquidity.

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Spot Price

The price of an asset for immediate delivery.

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Forward Price

The price agreed upon for a future delivery of an asset in a forward contract.

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Long Forward

The position of a party in a forward contract who has agreed to buy an asset at a specific future date and price.

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Open Interest

The total number of outstanding contracts (both long and short) for a particular asset at a given time.

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Traded Volume

The number of contracts bought and sold during a particular period (usually a day).

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What is the relationship between Open Interest and Traded Volume?

Traded volume reflects the transactions that happen each day, while Open Interest represents the total number of outstanding contracts - those that are still 'alive' and haven't been closed out.

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Price Band

The price range within which a contract is allowed to trade during a day.

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How is Price Band Calculated?

The price band is calculated based on the previous day's closing price, with a percentage range usually specified in the contract.

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Long Position

An outstanding or unsettled 'buy' position in a contract. You are betting on the price of the asset going up.

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Short Position

An outstanding or unsettled 'sell' position in a contract. You are betting on the price of the asset going down.

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What are some key terms commonly used in derivatives markets?

Key terms used in derivatives markets include long position, short position, and open position. These terms help traders understand whether someone is betting on a price increase or decrease.

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Study Notes

NISM Series VIII: Equity Derivatives

  • This workbook is designed to prepare candidates for the NISM Series VIII: Equity Derivatives Certification Examination.
  • The workbook version is September 2024.
  • It is published by the National Institute of Securities Markets (NISM).
  • NISM's address is 5th Floor, NCL Co-operative Society, Plot No. C-6 E-Block, Bandra Kurla Complex, Bandra East, Mumbai – 400 051, India.
  • NISM's website is www.nism.ac.in
  • The publication is for use by candidates taking the NISM Series VIII: Equity Derivatives Certification Examination on or after November 29, 2024.

Foreword

  • NISM provides high-end professional education, certifications, and research in financial markets.
  • NISM engages in capacity building among stakeholders in the securities markets.
  • NISM certification programs aim to enhance the quality and standards of professionals in the financial sector.

Disclaimer

  • The contents of the publication do not necessarily constitute an endorsement or recommendation by NISM or SEBI.
  • The publication is for general reading and educational use only.
  • NISM and SEBI do not assume any responsibility for any actions taken based on the information provided in the publication.
  • Readers should consult professional advice before taking any action based on the information in the publication.

Acknowledgement

  • The workbook was developed jointly by the NISM Certification Team and Dr. Aparna Bhat.
  • NISM acknowledges the contribution of the Examination Committee, consisting of representatives from stock exchanges and industry experts.

Examination Objectives

  • Candidates should understand the basics of the Indian equity derivatives market.
  • Candidates should understand various trading strategies utilizing futures and options on stocks and indexes.
  • Candidates should understand clearing, settlement, and risk management in equity derivatives markets.
  • Candidates should have knowledge of the regulatory environment in which the equity derivatives markets operate in India.

Assessment Structure

  • The NISM Series VIII: Equity Derivatives Certification Examination consists of 100 multiple choice questions.
  • The examination duration is 2 hours.
  • There is a negative marking of 25% for each incorrect answer.
  • The passing score is 60%.

How to Register and Take the Examination

  • Visit www.nism.ac.in to register and find more details about the examination.

Important Information

  • The examination workstations are equipped with Microsoft Excel or OpenOffice Calc.
  • Sample questions and caselets are for reference and the difficulty level may vary in the actual examination.

Contents (Outline of Chapters)

  • (The following list details the topics covered in the workbook, with page numbers.) Includes sections on Derivatives, Understanding Index, Forwards and Futures, Introduction to Options and various strategies, Trading Mechanism, Legal and Regulatory Environment, Accounting and Taxation, Sales Practices and Investor Protection Services etc.

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NISM Series VIII - Equity Derivatives PDF

Description

Explore the fundamentals of derivatives with this quiz. Test your knowledge on types of underlying assets, historical events affecting the derivatives market, and significant risks in derivatives trading. This quiz is essential for anyone studying finance or investments.

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