CFA® Derivative Investments
Derivative Investments are financial instruments that derive their value from another asset. The underlying asset could be a stock, currency, commodity, or interest rate. Derivative Investments were initially used to hedge commodity risk, but their usefulness has grown over the years to help investors mitigate various types of risk and earn higher returns than traditional investments. Generally, Derivative Investments can be classified as forward commitments and contingent claims. The forward commitment sets an obligation between the parties to engage in a transaction at a future date on terms agreed upon in advance. In contrast, contingent claims give one party the right but not the obligation to engage in a prospective transaction on set terms.
Derivative Investments are either exchange-traded or traded over-the-counter (OTC). Exchange-traded Derivative Investments offer standardized terms and conditions, whereas OTC-based Derivative Investments are customizable.
The most common Derivative Investments used by investors are:
- Future Contracts
- Options (call and put)
- Forward Contracts
- Credit Default Swaps
What is the CFA® Level 1 Derivative Investments Topic?
The Derivative Investments curriculum has a similar weighting to that of alternative investments and portfolio management. Around 3% of Level 1 readings are dedicated to the topic, which introduces Derivative Investments.
Candidates will study various derivative instruments classified as forward commitments and contingent claims and see how these instruments derive their value and are traded in different settings.
The CFA Level 1 Derivative Investments has a weighting of 5-8% which implies that around 9-14 out of 180 CFA Level 1 exam questions focus on this topic.
|Topic Weight||No. of Readings||No. of Formulas||No. of Questions|
Syllabus, Readings & Changes Overview
The weighting of the Derivative topic will not increase in 2022. Since 2021, weighting has fluctuated between 5-8%.
Material in the Derivative Investments topic area of the 2022 curriculum remains unchanged from 2020.
Key Changes to CFA Level 1 Derivative Investments:
|Derivative Investments Level 1 Changes|
|Derivative Markets and Instruments||No Changes|
|Basics of Derivative Pricing and Valuation||No Changes|
There are a total of 60 readings and 19 study sessions for CFA Level I in 2022. Out of these, 2 readings under 1 study session are devoted to Derivative Investments. The following table provides a brief description of the study session:
|Study Session||No. of Readings||No. of LOS||Summary|
|15||02||21||Discusses the fundamentals of derivative instruments including forward commitments (e.g. futures, forwards, swaps) and contingent claims (e.g. call and put options) and derivative markets such as exchange-traded and over-the-counter derivative markets. It further explains the derivative pricing and valuation along with the introduction of the principle of arbitrage.|
Derivative Markets and Instruments
This reading provides an overview of derivative instruments and markets, distinguishing characteristics of forward commitments and contingent claims, and the underlying of Derivative Investments. It also covers the purpose, benefits, and risks of Derivative Investments, as well as criticism and potential misuse of Derivative Investments.
Basics of Derivative Pricing and Valuation
This reading focuses mainly on the pricing and valuation of derivative instruments such as futures contracts, forward contracts, swaps, and contingent claims, including call or put options. It also introduces the principle of arbitrage. Characteristics of the European and American-style call options are also discussed.
Study Tips for the CFA L1 Derivative Investments
Here are some tips for studying Derivative Investments:
- Make sure that you have got some understanding of concepts related to equity, fixed income, and alternative investments before starting with Derivative Investments.
- Focus on each LOS explicitly and make sure that the information under each LOS is completely understood.
- Memorize formulas: Spend some time comprehending formulas.
- Practice from examples and practice problems from the CFA Institute’s official curriculum.
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