CFA (Chartered Financial Analyst) Derivatives and Alternative Investments Syllabus

Derivatives and Alternative Investments syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Derivatives and Alternative Investments in CFA (Chartered Financial Analyst), not a summary of it.

1. 1

   Derivative Markets and Instruments

   4 topics

   • Derivative markets, types, and uses
   • Forward commitments
     • Forwards and futures pricing and valuation
     • Swaps (interest rate, currency, equity)
   • Arbitrage, replication, and cost of carry
   • Hedging and risk management applications
2. 2

   Options Valuation

   4 topics

   • Option features, payoffs, and put-call parity
   • Binomial option pricing
     • One-period and multi-period models
     • Risk-neutral valuation
   • Black-Scholes-Merton model and the Greeks
   • Option strategies for portfolios
3. 3

   Alternative Investments

   4 topics

   • Categories, features, and structures of alternatives
   • Private capital and real estate
     • Private equity and private debt
     • Real estate and infrastructure
   • Hedge funds and natural resources/commodities
   • Performance, fees, and risk-return considerations

Derivatives and Alternative Investments flashcards for CFA (Chartered Financial Analyst)

22 of 50 cards from the Derivatives and Alternative Investments deck — real questions with worked answers.

1. What is a derivative, and what underlies its value?

   A derivative is a financial instrument whose value is derived from the performance of an underlying asset, rate, index, or other variable (the 'underlying'). It creates a contractual payoff between two parties based on movements in that underlying.

2. Distinguish between forward commitments and contingent claims.

   A forward commitment obligates both parties to transact in the future at a preset price (forwards, futures, swaps). A contingent claim gives one party a right but not an obligation, with payoff contingent on an outcome (options).

3. Contrast exchange-traded derivatives (ETDs) with over-the-counter (OTC) derivatives.

   ETDs are standardized, exchange-listed, cleared through a clearinghouse (low counterparty risk), and transparent. OTC derivatives are customized, privately negotiated, less liquid, and carry greater counterparty/credit risk (though central clearing now covers many).

4. List the main purposes/uses of derivatives.

   Risk management (hedging), price discovery, speculation/directional bets, gaining cost-efficient exposure (leverage), arbitrage to exploit mispricing, and modifying portfolio characteristics (e.g., duration, asset allocation) more cheaply than trading the underlying.

5. Define a forward contract and identify the long and short positions.

   A forward contract is an OTC agreement to buy/sell an asset at a fixed forward price on a future date. The long agrees to buy (benefits if price rises); the short agrees to sell (benefits if price falls).

6. How do futures contracts differ from forwards?

   Futures are standardized, exchange-traded, marked-to-market daily with margin and a clearinghouse guarantee. Forwards are customized OTC contracts settled at expiration with no daily settlement and higher counterparty risk.

7. What is the value of a forward contract at initiation, and why?

   Zero. The forward price is set so that neither party pays the other at inception; there is no upfront cost (ignoring transaction costs/collateral).

8. State the no-arbitrage forward price formula on an asset with no income or cost.

   $$F_{0}(T) = S_{0}(1+r)^{T}$$ where $S_{0}$ is the spot price, $r$ the risk-free rate, and $T$ the time to maturity (continuous version: $F_{0}=S_{0}e^{rT}$).

9. Give the forward price formula when the underlying has carry benefits ($I$) and carry costs ($C$).

   $$F_{0}(T) = (S_{0} - I + C)(1+r)^{T}$$ Benefits (dividends, coupons, convenience yield) reduce the forward price; costs (storage, insurance) raise it.

10. What is the value of a long forward position before expiration?

    $$V_{t}(T) = \frac{F_{t}(T) - F_{0}(T)}{(1+r)^{T-t}}$$ the present value of the difference between the current forward price and the originally contracted price.

11. Define the cost-of-carry model.

    It prices forwards/futures as spot plus the net cost of carrying the asset to delivery: financing cost plus storage cost minus any income/convenience yield. Forward price equals future value of (spot + carry costs - carry benefits).

12. What is contango versus backwardation?

    Contango: forward/futures price exceeds the spot (upward-sloping curve), typical when carry costs dominate. Backwardation: forward/futures price is below spot (downward-sloping), often when convenience yield or income dominates.

13. Explain the principle of replication in derivatives pricing.

    A derivative's payoff can be reproduced by a portfolio of the underlying and risk-free borrowing/lending. By no-arbitrage, the derivative must equal the cost of the replicating portfolio.

14. State the law of one price as it relates to arbitrage.

    Two assets or portfolios with identical future cash flows must have the same price today. If not, a riskless arbitrage profit exists by buying the cheaper and selling the dearer.

15. Define a plain-vanilla interest rate swap and its cash-flow structure.

    An agreement to exchange a fixed-rate payment for a floating-rate payment (e.g., on a reference rate) on a notional principal over time. The notional is not exchanged; only net interest differences are settled periodically.

16. How is the fixed (swap) rate on a plain-vanilla interest rate swap determined at initiation?

    It is set so the present value of fixed-leg payments equals the present value of expected floating-leg payments, giving the swap zero value at initiation: $$\text{swap rate} = \frac{1 - PV_{n}}{\sum_{i=1}^{n} PV_{i}}$$ using discount factors $PV_i$.

17. Describe a currency swap.

    Counterparties exchange principal and interest payments denominated in two different currencies. Unlike interest rate swaps, notional principals are usually exchanged at initiation and re-exchanged at maturity.

18. Describe an equity swap.

    One party pays the return on an equity (stock/index) — possibly including dividends — while receiving a fixed rate, floating rate, or another equity return on a notional. Used to gain/reduce equity exposure synthetically.

19. How can a swap be interpreted as a series of forward contracts?

    A swap is economically equivalent to a portfolio (strip) of forward contracts maturing on each settlement date. Off-market forwards offset so the overall swap has zero value at initiation.

20. Define call and put options, including holder rights and writer obligations.

    A call gives the holder the right to buy the underlying at the strike; a put gives the right to sell at the strike. The writer (short) has the corresponding obligation if exercised. The holder pays a premium for this right.

21. Distinguish European-style and American-style options.

    European options can be exercised only at expiration; American options can be exercised any time up to and including expiration. American options are worth at least as much as otherwise-identical European options.

22. Write the expiration payoff of a long call and a long put.

    Long call: $\max(0,\, S_{T} - X)$. Long put: $\max(0,\, X - S_{T})$, where $S_{T}$ is the underlying price at expiration and $X$ is the strike.

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