© CFA Institute. For candidate use only. Not for distribution.
DERIVATIVES,
ALTERNATIVE
INVESTMENTS
CFA® Program Curriculum
2024 • LEVEL 1 • VOLUME 5
,© CFA Institute. For candidate use only. Not for distribution.
©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 978-1-953337-53-5 (paper)
ISBN 978-1-953337-27-6 (ebook)
May 2023
, © CFA Institute. For candidate use only. Not for distribution.
CONTENTS
How to Use the CFA Program Curriculum ix
Errata ix
Designing Your Personal Study Program ix
CFA Institute Learning Ecosystem (LES) x
Feedback x
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
, © CFA Institute. For candidate use only. Not for distribution.
iv Contents
Derivative Risks 63
Issuer Use of Derivatives 67
Investor Use of Derivatives 70
Practice Problems 72
Solutions 74
Learning Module 4 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives 75
Introduction 75
Arbitrage 78
Replication 81
Costs and Benefits Associated with Owning the Underlying 86
Learning Module 5 Pricing and Valuation of Forward Contracts and for an Underlying
with Varying Maturities 97
Introduction 97
Pricing and Valuation of Forward Contracts 100
Pricing versus Valuation of Forward Contracts 100
Pricing and Valuation of Interest Rate Forward Contracts 111
Interest Rate Forward Contracts 111
Practice Problems 123
Solutions 126
Learning Module 6 Pricing and Valuation of Futures Contracts 127
Introduction 127
Pricing of Futures Contracts at Inception 130
MTM Valuation: Forwards versus Futures 132
Interest Rate Futures versus Forward Contracts 134
Forward and Futures Price Differences 138
Interest Rate Forward and Futures Price Differences 139
Effect of Central Clearing of OTC Derivatives 141
Practice Problems 144
Solutions 146
Learning Module 7 Pricing and Valuation of Interest Rates and Other Swaps 147
Introduction 147
Swaps vs. Forwards 150
Swap Values and Prices 157
Practice Problems 164
Solutions 167
Learning Module 8 Pricing and Valuation of Options 169
Introduction 169
Option Value relative to the Underlying Spot Price 173
Option Exercise Value 173
Option Moneyness 174
Option Time Value 175
Arbitrage 178
Replication 180
DERIVATIVES,
ALTERNATIVE
INVESTMENTS
CFA® Program Curriculum
2024 • LEVEL 1 • VOLUME 5
,© CFA Institute. For candidate use only. Not for distribution.
©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 978-1-953337-53-5 (paper)
ISBN 978-1-953337-27-6 (ebook)
May 2023
, © CFA Institute. For candidate use only. Not for distribution.
CONTENTS
How to Use the CFA Program Curriculum ix
Errata ix
Designing Your Personal Study Program ix
CFA Institute Learning Ecosystem (LES) x
Feedback x
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
, © CFA Institute. For candidate use only. Not for distribution.
iv Contents
Derivative Risks 63
Issuer Use of Derivatives 67
Investor Use of Derivatives 70
Practice Problems 72
Solutions 74
Learning Module 4 Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives 75
Introduction 75
Arbitrage 78
Replication 81
Costs and Benefits Associated with Owning the Underlying 86
Learning Module 5 Pricing and Valuation of Forward Contracts and for an Underlying
with Varying Maturities 97
Introduction 97
Pricing and Valuation of Forward Contracts 100
Pricing versus Valuation of Forward Contracts 100
Pricing and Valuation of Interest Rate Forward Contracts 111
Interest Rate Forward Contracts 111
Practice Problems 123
Solutions 126
Learning Module 6 Pricing and Valuation of Futures Contracts 127
Introduction 127
Pricing of Futures Contracts at Inception 130
MTM Valuation: Forwards versus Futures 132
Interest Rate Futures versus Forward Contracts 134
Forward and Futures Price Differences 138
Interest Rate Forward and Futures Price Differences 139
Effect of Central Clearing of OTC Derivatives 141
Practice Problems 144
Solutions 146
Learning Module 7 Pricing and Valuation of Interest Rates and Other Swaps 147
Introduction 147
Swaps vs. Forwards 150
Swap Values and Prices 157
Practice Problems 164
Solutions 167
Learning Module 8 Pricing and Valuation of Options 169
Introduction 169
Option Value relative to the Underlying Spot Price 173
Option Exercise Value 173
Option Moneyness 174
Option Time Value 175
Arbitrage 178
Replication 180
