CFA® Level 1 Study Notes – Derivatives

CFA® Level 1 Study Notes – Derivatives

Study Session 16

Reading 48 (45 in 2022) – Derivative Markets and Instruments

LOS 48a: define a derivative and distinguish between exchange-traded and over-the-counter derivatives
LOS 48b: contrast forward commitments with contingent claims
LOS 48c: define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives and compare their basic characteristics
LOS 48d: determine the value at expiration and profit from a long or a short position in a call or put option
LOS 48e: describe purposes of, and controversies related to derivative markets
LOS 48f: explain arbitrage and the role it plays in determining prices and promoting market efficiency

Reading 49 (46 in 2022) – Basics of Derivative Pricing and Valuation

LOS 49a: explain how the concepts of arbitrage, replication, and risk neutrality are used in pricing derivatives
LOS 49b: distinguish between value and price of forward and futures contracts
-LOS 49c: calculate a forward price of an asset with zero, positive, or negative net cost of carry;
LOS 49d: explain how the value and price of a forward contract are determined at expiration, during the life of the contract, and at initiation
LOS 49e: describe monetary and nonmonetary benefits and costs associated with holding the underlying asset and explain how they affect the value and price of a forward contract
LOS 49f: define a forward rate agreement and describe its uses
LOS 49g: explain why forward and futures prices differ
LOS 49h: explain how swap contracts are similar to but different from a series of forward contracts
LOS 49i: distinguish between the value and price of swaps
LOS 49j: explain how the value of a European option is determined at expiration
LOS 49j: explain the exercise value, time value, and moneyness of an option
LOS 49k: identify the factors that determine the value of an option and explain how each factor affects the value of an option
LOS 49l: explain put–call parity for European options
LOS 49m: explain put–call–forward parity for European options
LOS 49n: explain how the value of an option is determined using a one-period binomial model
LOS 49o: explain under which circumstances the values of European and American options differ

Past LOS (until 2017) – Risk Management Applications of Option Strategies

determine the value at expiration, the profit, maximum profit, maximum loss, breakeven underlying price at expiration, and payoff graph of the strategies of buying and selling calls and puts and determine the potential outcomes for investors using these strategies
determine the value at expiration, profit, maximum profit, maximum loss, breakeven underlying price at expiration, and payoff graph of a covered call strategy and a protective put strategy, and explain the risk management application of each strategy

2022 Curriculum

Reading 45: Derivative Markets and Instruments

LOS 45a: define a derivative and distinguish between exchange-traded and over-the-counter derivatives
LOS 45b: contrast forward commitments with contingent claims
LOS 45c: define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives and compare their basic characteristics
LOS 45d: determine the value at expiration and profit from a long or a short position in a call or put option
LOS 45e: describe purposes of, and controversies related to derivative markets
LOS 45f: explain arbitrage and the role it plays in determining prices and promoting market efficiency

Reading 46: Basics of Derivative Pricing and Valuation

-LOS 46a: explain how the concepts of arbitrage, replication, and risk neutrality are used in pricing derivatives;

-LOS 46b: explain the difference between value and price of forward and futures contracts; 

-LOS 46c: calculate a forward price of an asset with zero, positive, or negative net cost of carry;

-LOS 46d: explain how the value and price of a forward contract are determined at expiration, during the life of the contract, and at initiation;

-LOS 46e: describe monetary and nonmonetary benefits and costs associated with holding the underlying asset and explain how they affect the value and price of a forward contract; 

-LOS 46f: define a forward rate agreement and describe its uses;

-LOS 46g: explain why forward and futures prices differ;

-LOS 46h: explain how swap contracts are similar to but different from a series of forward contracts;

-LOS 46i: explain the difference between value and price of swaps; 

-LOS 46j: explain the exercise value, time value, and moneyness of an option; 

-LOS 46k: identify the factors that determine the value of an option and explain how each factor affects the value of an option; 

-LOS 46l: explain put–call parity for European options; 

-LOS 46m: explain put–call–forward parity for European options; 

-LOS 46n: explain how the value of an option is determined using a one-period binomial model; 

-LOS 46o: explain under which circumstances the values of European and American options differ. 

2023 Curriculum

(Reading 48) Module 1: Derivative Instrument and Derivative Market Features

LOS: define a derivative and describe basic features of a derivative instrument
LOS: describe the basic features of derivative markets, and contrast over-the-counter and exchange-traded derivative markets

(Reading 49) Module 2: Forward Commitment and Contingent Claim Features and Instruments

LOS: define forward contracts, futures contracts, swaps, options (calls and puts), and credit derivatives and compare their basic characteristics
LOS: determine the value at expiration and profit from a long or a short position in a call or put option
LOS: contrast forward commitments with contingent claims

(Reading 50) Module 3: Derivative Benefits, Risks, and Issuer and Investor Uses 

LOS: describe the benefits and risks of derivative instruments
LOS: compare the use of derivatives among issuers and investors

(Reading 51) Module 4: Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

LOS: explain how the concepts of arbitrage and replication are used in pricing derivatives
LOS: explain the difference between the spot and expected future price of an underlying and the cost of carry associated with holding the underlying asset

(Reading 52) Module 5: Pricing and Valuation of Forward Contracts and For An Underlying with Varying
Maturities 

LOS: Explain how the value and price of a forward contract are determined at initiation, during the life of the contract, and at expiration
LOS: Explain how forward rates are determined for an underlying with a term structure and describe their uses

(Reading 53) Module 6: Pricing and Valuation of Futures Contracts 

LOS: compare the value and price of forward and futures contracts
LOS: explain why forward and futures prices differ

(Reading 54) Module 7: Pricing and Valuation of Interest Rate and Other Swaps

LOS: describe how swap contracts are similar to but different from a series of forward contracts
LOS: contrast the value and price of swaps

(Reading 55) Module 8: Pricing and Valuation of Options 

LOS: Explain the exercise value, moneyness, and time value of an option
LOS: Contrast the use of arbitrage and replication concepts in pricing forward commitments and contingent claims
LOS: Identify the factors that determine the value of an option and describe how each factor affects the value of an option

(Reading 56) Module 9: Option Replication Using Put-Call Parity 

LOS: explain put–call parity for European options
LOS: explain put–call forward parity for European options

(Reading 57) Module 10: Valuing a Derivative Using a One-Period Binomial Model 

LOS: explain how to value a derivative using a one-period binomial model
LOS: describe the concept of risk neutrality in derivatives pricing

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