1. Which of the following is a key characteristic of a derivative?
- A. It has intrinsic value like stocks
- B. It always guarantees fixed returns
- C. Its value is derived from an underlying asset
- D. It can only be traded in physical markets
Derivatives derive their value from an underlying asset like stocks, commodities, currencies, or interest rates.
2. Which of the following is NOT a common function of derivatives?
- A. Hedging against risk
- B. Generating guaranteed profits without risk
- C. Speculation on price movements
- D. Arbitrage opportunities
Derivatives are used for hedging, speculation, and arbitrage, but they do not provide guaranteed profits without risk.
3. A bank enters into a forward contract to lock the price of foreign currency. This is primarily an example of:
- A. Speculation
- B. Arbitrage
- C. Investment in equity
- D. Hedging
Using a derivative to lock in a future price protects the bank from exchange rate risk, which is hedging.
4. Which of the following is a derivative instrument?
- A. Futures contract
- B. Savings account
- C. Fixed deposit
- D. Bank loan
Futures, forwards, options, and swaps are common derivative instruments, whereas savings accounts and deposits are not.
5. Which characteristic of derivatives allows banks to take positions on price movements without owning the underlying asset?
- A. Leverage
- B. Derivative nature
- C. Physical delivery
- D. Risk-free
Derivatives allow exposure to price movements without owning the underlying asset, enabling leverage and speculative positions.
6. Who primarily uses derivatives to protect against adverse price movements?
- A. Hedgers
- B. Speculators
- C. Arbitrageurs
- D. Regulators
Hedgers use derivatives to mitigate risk from fluctuations in prices, interest rates, or exchange rates.
7. Which type of user of derivatives aims to make profit by taking positions on future price movements without having the underlying asset?
- A. Hedger
- B. Regulator
- C. Speculator
- D. Investor in bonds
Speculators take derivative positions to profit from expected price movements without owning the underlying asset.
8. Arbitrageurs use derivatives primarily to:
- A. Hedge against interest rate risk
- B. Invest in long-term assets
- C. Speculate on commodity prices
- D. Exploit price differences across markets
Arbitrageurs take positions in derivatives to profit from price discrepancies in different markets simultaneously.
9. Which of the following is a typical user of currency derivatives in banks?
- A. Retail customers
- B. Treasury department
- C. Loan recovery team
- D. Branch operations staff
Banks’ treasury departments use currency derivatives to hedge foreign exchange risks and manage liquidity.
10. Corporates often use derivatives to:
- A. Avoid taxation on profits
- B. Increase operational costs
- C. Hedge against price, interest rate, or currency risks
- D. Speculate for guaranteed returns
Corporates use derivatives to protect against financial risks like fluctuations in commodity prices, interest rates, and foreign exchange rates.
11. A futures contract is best described as:
- A. An agreement to buy/sell an asset immediately at current market price
- B. A standardized agreement to buy/sell an asset at a predetermined price on a future date
- C. A contract that can only be exercised in foreign markets
- D. A non-binding agreement to purchase commodities
Futures contracts are standardized agreements traded on exchanges to buy or sell an underlying asset at a future date at a predetermined price.
12. Which of the following is a key feature of futures contracts?
- A. They are customized between two parties
- B. They can only be settled physically
- C. They are standardized and traded on exchanges
- D. They cannot be used for hedging
Futures are standardized contracts with specific quantities, quality, and settlement dates, and are traded on regulated exchanges.
13. A bank enters into an interest rate futures contract to lock the rate on a future loan. This is an example of:
- A. Speculation
- B. Arbitrage
- C. Investment in bonds
- D. Hedging
Using a futures contract to lock in a future interest rate is a hedge against interest rate fluctuations.
14. Which of the following is TRUE about margin in futures trading?
- A. Both parties are required to deposit an initial margin with the exchange
- B. Margin is optional for hedgers
- C. Margin is not required if settlement is physical
- D. Only the buyer pays margin
Futures exchanges require both buyer and seller to deposit an initial margin to ensure contract performance and limit default risk.
15. Which of the following is an advantage of futures contracts for banks?
- A. Guaranteed profits without risk
- B. No capital requirement
- C. Hedging against price or interest rate risk
- D. Avoiding regulatory compliance
Banks use futures to hedge exposures in interest rates, currencies, and commodity prices, reducing financial risk.
16. A Forward Rate Agreement (FRA) is primarily used to:
- A. Lock in the price of commodities
- B. Lock in an interest rate for a future period
- C. Exchange currencies immediately
- D. Hedge against equity market fluctuations
FRAs allow banks and corporates to fix an interest rate for a future period, protecting against interest rate volatility.
17. Which of the following is TRUE about the settlement of FRAs?
- A. FRAs always result in physical delivery of the principal
- B. Settlement occurs by buying an underlying asset
- C. Settlement is done in cash based on the difference between agreed and actual interest rates
- D. FRAs are settled by exchanging foreign currency
FRAs are cash-settled contracts; the payment is based on the difference between the contracted interest rate and the actual market rate.
18. Who are the typical users of FRAs?
- A. Retail investors
- B. Commodity traders
- C. Regulators
- D. Banks and corporates managing interest rate exposure
FRAs are mainly used by banks and large corporates to hedge or manage exposure to fluctuations in interest rates.
19. Which of the following distinguishes FRAs from standard interest rate swaps?
- A. FRAs are short-term contracts with a single settlement, whereas swaps involve multiple periods
- B. FRAs involve exchange of currencies, while swaps do not
- C. Swaps are always exchange-traded, FRAs are not
- D. FRAs always require physical delivery of assets
FRAs are short-term agreements with a single cash settlement, unlike swaps which may have multiple settlement periods.
20. If a bank expects interest rates to rise, entering into an FRA allows it to:
- A. Benefit from falling commodity prices
- B. Lock in a borrowing rate before rates increase
- C. Lock in foreign exchange rates
- D. Avoid paying taxes on interest income
By entering an FRA, a bank can secure a fixed borrowing rate in advance, protecting against expected increases in market interest rates.
21. What is the primary purpose of an interest rate swap?
- A. Exchange currencies at a fixed rate
- B. Hedge against commodity price risk
- C. Exchange fixed and floating interest rate payments
- D. Buy or sell underlying equities
Interest rate swaps allow two parties to exchange fixed and floating interest rate payments to manage interest rate exposure.
22. Which of the following is a common type of swap used by banks?
- A. Currency option
- B. Commodity futures
- C. Forward contract
- D. Interest rate swap
Banks commonly use interest rate swaps to manage exposure to fluctuating interest rates and optimize funding costs.
23. A call option gives the holder the right to:
- A. Sell the underlying asset at a specified price
- B. Buy the underlying asset at a specified price
- C. Exchange the asset for another asset
- D. Borrow funds from the issuer
A call option gives the holder the right, but not the obligation, to buy the underlying asset at a predetermined price within a specified period.
24. A put option provides the holder the right to:
- A. Buy the underlying asset
- B. Exchange currencies
- C. Sell the underlying asset at a predetermined price
- D. Enter into a forward contract
A put option allows the holder to sell the underlying asset at a predetermined price, protecting against price declines.
25. Which of the following correctly distinguishes options from futures?
- A. Options provide the right, not obligation, whereas futures obligate both parties
- B. Futures can only be traded OTC, options only on exchanges
- C. Options always require physical delivery
- D. Futures are risk-free, options carry unlimited risk
Options give the holder the right but not the obligation to transact, while futures contracts legally bind both parties to execute the contract.
