DERIVATIVES
CFA® Program Curriculum
2025 • LEVEL 1 • VOLUME 7
,©2023 by CFA Institute. All rights reserved. This copyright covers material written
expressly for this volume by the editor/s as well as the compilation itself. It does
not cover the individual selections herein that first appeared elsewhere. Permission
to reprint these has been obtained by CFA Institute for this edition only. Further
reproductions by any means, electronic or mechanical, including photocopying and
recording, or by any information storage or retrieval systems, must be arranged with
the individual copyright holders noted.
CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the
trademarks owned by CFA Institute. To view a list of CFA Institute trademarks and the
Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org.
This publication is designed to provide accurate and authoritative information
in regard to the subject matter covered. It is sold with the understanding that the
publisher is not engaged in rendering legal, accounting, or other professional service.
If legal advice or other expert assistance is required, the services of a competent pro-
fessional should be sought.
All trademarks, service marks, registered trademarks, and registered service marks
are the property of their respective owners and are used herein for identification
purposes only.
ISBN 9781961409040 (paper)
ISBN 9781961409163 (ebook)
May 2024
, CONTENTS
How to Use the CFA Program Curriculum vii
CFA Institute Learning Ecosystem (LES) vii
Designing Your Personal Study Program vii
Errata viii
Other Feedback viii
Derivatives
Learning Module 1 Derivative Instrument and Derivative Market Features 3
Introduction 3
Derivative Features 5
Definition and Features of a Derivative 5
Derivative Underlyings 8
Equities 9
Fixed-Income Instruments 9
Currencies 9
Commodities 10
Credit 10
Other 10
Investor Scenarios 11
Derivative Markets 14
Over-the-Counter (OTC) Derivative Markets 14
Exchange-Traded Derivative (ETD) Markets 14
Central Clearing 16
Investor Scenarios 17
Practice Problems 19
Solutions 21
Learning Module 2 Forward Commitment and Contingent Claim Features and Instruments 23
Introduction 23
Forwards, Futures, and Swaps 26
Futures 29
Swaps 35
Options 38
Scenario 1: Transact (ST > X) 38
Scenario 2: Do Not Transact (ST < X) 38
Credit Derivatives 43
Forward Commitments vs. Contingent Claims 46
Practice Problems 50
Solutions 52
Learning Module 3 Derivative Benefits, Risks, and Issuer and Investor Uses 53
Introduction 53
Derivative Benefits 55
, iv Contents
Derivative Risks 63
Issuer Use of Derivatives 67
Investor Use of Derivatives 70
Practice Problems 73
Solutions 75
Learning Module 4 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives 77
Introduction 77
Arbitrage 80
Replication 83
Costs and Benefits Associated with Owning the Underlying 88
Learning Module 5 Pricing and Valuation of Forward Contracts and for an Underlying
with Varying Maturities 99
Introduction 99
Pricing and Valuation of Forward Contracts 102
Pricing versus Valuation of Forward Contracts 102
Pricing and Valuation of Interest Rate Forward Contracts 113
Interest Rate Forward Contracts 113
Practice Problems 125
Solutions 128
Learning Module 6 Pricing and Valuation of Futures Contracts 129
Introduction 129
Pricing of Futures Contracts at Inception 132
MTM Valuation: Forwards versus Futures 134
Interest Rate Futures versus Forward Contracts 136
Forward and Futures Price Differences 140
Interest Rate Forward and Futures Price Differences 141
Effect of Central Clearing of OTC Derivatives 143
Practice Problems 146
Solutions 148
Learning Module 7 Pricing and Valuation of Interest Rates and Other Swaps 149
Introduction 149
Swaps vs. Forwards 152
Swap Values and Prices 159
Practice Problems 166
Solutions 169
Learning Module 8 Pricing and Valuation of Options 171
Introduction 171
Option Value relative to the Underlying Spot Price 175
Option Exercise Value 175
Option Moneyness 176
Option Time Value 177
Arbitrage 180
Replication 182
CFA® Program Curriculum
2025 • LEVEL 1 • VOLUME 7
,©2023 by CFA Institute. All rights reserved. This copyright covers material written
expressly for this volume by the editor/s as well as the compilation itself. It does
not cover the individual selections herein that first appeared elsewhere. Permission
to reprint these has been obtained by CFA Institute for this edition only. Further
reproductions by any means, electronic or mechanical, including photocopying and
recording, or by any information storage or retrieval systems, must be arranged with
the individual copyright holders noted.
CFA®, Chartered Financial Analyst®, AIMR-PPS®, and GIPS® are just a few of the
trademarks owned by CFA Institute. To view a list of CFA Institute trademarks and the
Guide for Use of CFA Institute Marks, please visit our website at www.cfainstitute.org.
This publication is designed to provide accurate and authoritative information
in regard to the subject matter covered. It is sold with the understanding that the
publisher is not engaged in rendering legal, accounting, or other professional service.
If legal advice or other expert assistance is required, the services of a competent pro-
fessional should be sought.
All trademarks, service marks, registered trademarks, and registered service marks
are the property of their respective owners and are used herein for identification
purposes only.
ISBN 9781961409040 (paper)
ISBN 9781961409163 (ebook)
May 2024
, CONTENTS
How to Use the CFA Program Curriculum vii
CFA Institute Learning Ecosystem (LES) vii
Designing Your Personal Study Program vii
Errata viii
Other Feedback viii
Derivatives
Learning Module 1 Derivative Instrument and Derivative Market Features 3
Introduction 3
Derivative Features 5
Definition and Features of a Derivative 5
Derivative Underlyings 8
Equities 9
Fixed-Income Instruments 9
Currencies 9
Commodities 10
Credit 10
Other 10
Investor Scenarios 11
Derivative Markets 14
Over-the-Counter (OTC) Derivative Markets 14
Exchange-Traded Derivative (ETD) Markets 14
Central Clearing 16
Investor Scenarios 17
Practice Problems 19
Solutions 21
Learning Module 2 Forward Commitment and Contingent Claim Features and Instruments 23
Introduction 23
Forwards, Futures, and Swaps 26
Futures 29
Swaps 35
Options 38
Scenario 1: Transact (ST > X) 38
Scenario 2: Do Not Transact (ST < X) 38
Credit Derivatives 43
Forward Commitments vs. Contingent Claims 46
Practice Problems 50
Solutions 52
Learning Module 3 Derivative Benefits, Risks, and Issuer and Investor Uses 53
Introduction 53
Derivative Benefits 55
, iv Contents
Derivative Risks 63
Issuer Use of Derivatives 67
Investor Use of Derivatives 70
Practice Problems 73
Solutions 75
Learning Module 4 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives 77
Introduction 77
Arbitrage 80
Replication 83
Costs and Benefits Associated with Owning the Underlying 88
Learning Module 5 Pricing and Valuation of Forward Contracts and for an Underlying
with Varying Maturities 99
Introduction 99
Pricing and Valuation of Forward Contracts 102
Pricing versus Valuation of Forward Contracts 102
Pricing and Valuation of Interest Rate Forward Contracts 113
Interest Rate Forward Contracts 113
Practice Problems 125
Solutions 128
Learning Module 6 Pricing and Valuation of Futures Contracts 129
Introduction 129
Pricing of Futures Contracts at Inception 132
MTM Valuation: Forwards versus Futures 134
Interest Rate Futures versus Forward Contracts 136
Forward and Futures Price Differences 140
Interest Rate Forward and Futures Price Differences 141
Effect of Central Clearing of OTC Derivatives 143
Practice Problems 146
Solutions 148
Learning Module 7 Pricing and Valuation of Interest Rates and Other Swaps 149
Introduction 149
Swaps vs. Forwards 152
Swap Values and Prices 159
Practice Problems 166
Solutions 169
Learning Module 8 Pricing and Valuation of Options 171
Introduction 171
Option Value relative to the Underlying Spot Price 175
Option Exercise Value 175
Option Moneyness 176
Option Time Value 177
Arbitrage 180
Replication 182
