CFA® Derivative Investments
Summary, Syllabus, Topics, and Sample Questions (L1, L2, L3)
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 to Expect in CFA® Level 1 Derivative Investments?
The Derivative Investments curriculum has a similar weighting to that of alternative investments and portfolio management. There are 10 Level 1 learning modules dedicated to the topic. 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 Learning Modules||No. of Formulas||No. of Questions|
Level 1 Derivative Investments 2023 Syllabus, Readings, & Changes
There are a total of 73 learning modules for CFA Level I in 2023. Out of these, 10 cover the material for Derivative Investments. The key change in the Level 1 Derivative Investments curriculum is that it has been reshaped as 10, shorter learning modules (from two larger readings). The material remains largely unchanged, with minor updates. The following table provides a brief description of the topic curriculum:
|No. of Learning Modules – 10||No. of LOS – 22|
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.
The exam weight for Derivatives will not increase in 2023. Since 2021, weighting has fluctuated between 5-8%.
Basics of Derivative Pricing and Valuation
These learning modules begin with an overview of derivative instruments and markets, of distinguishing characteristics of forward commitments and contingent claims, and of the derivative’s relation to the underlying asset. They then cover the purpose, benefits, and risks of Derivative Investments, as well as criticisms and potential misuse.
The discussion then 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. Along the way, it also introduces the principle of arbitrage and its applications in derivative pricing and valuation, as well as foundational valuation models.
The learning modules for the Derivative Investments are as follows:
- Derivative Instrument and Derivative Market Features
- Forward Commitment and Contingent Claim Features and Instruments
- Derivative Benefits, Risks, and Issuer and Investor Uses
- Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
- Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities
- Pricing and Valuation of Futures Contracts
- Pricing and Valuation of Interest Rates and Other Swaps
- Pricing and Valuation of Options
- Option Replication using Put-Call Parity
- Valuing a Derivative using a One-Period Binomial Model
CFA Derivative Investments Level 1 Sample Questions and Answers
The sample questions are typical of the probing multiple-choice questions on the L1 exam. During the exam, you have about 90 seconds to read and answer each question, carefully designed to test knowledge from the CFA Curriculum. UWorld’s question bank is built to expose you to exam-like questions and illustrate and explain the concepts tested thoroughly.
Study Tips for CFA Derivative Investments
Derivative Investments are dependent on, as opposed to (more or less) correlated with, another asset, and so have a unique role in portfolio construction and management. The Level 3 CFA curriculum is more about the practical implication of Derivative Investments contracts and strategies, so candidates must have the knowledge of Level 1 and Level 2 Derivative Investments: you need to grasp the basic definitions and concepts before moving on to the more complex areas covered in CFA Level 3.
- Make sure that you have got an understanding of the underlying asset classes, that is, equity, fixed income, and alternative investments, before starting with Derivative Investments.
- CFA Level 1 curriculum focuses on what derivatives are, Level 2 on how derivative positions are calculated, and Level 3 on how to use and create positions in strategic portfolio management. And at all levels, Derivative Investments is heavy with numerical calculations.
- Memorize formulas, but as always comprehending their sense will make them easier to remember.
- Do lots of practice problems. Perhaps more than with many topic areas, practice makes the understanding and calculations involved really sink in. Practice from examples and practice problems in the CFA Institute’s official curriculum, and from UWorld’s QBank and Mock Exams.
Frequently Asked Questions
The best way to study for the exam is to practice with a QBank across all chapters and readings. UWorld’s CFA Level 2 exam prep allows you to review your progress and acts as a catalyst for expediting your preparation. We also suggest candidates attempt practice problems from the CFA Institute’s official curriculum for Level 2.
After practicing hard with QBank, the optimal approach to assess your understanding of the content is taking Mock Exams. UWorld’s mock exams closely replicate the actual CFA Level 1 exam to help you prepare and boost your confidence on test day. Like the actual CFA exam, our mock exams consist of two 2-hour and 15-minute sessions (4.5 hours total), each with 90 multiple-choice questions unique to the mock exams. The question topics and the order of the topics follow the CFA exam design to give you a truly exam-like experience.
Understanding the concept first and then going through the structure of the formula will help you grasp the formula. Think of the formula as the mathematical representation of the concept. As you build this foundation of understanding, reinforce it through repetition and application. Take a look at our CFA L1 Formula sheet for further resources and tips.