Free Capital Markets – Specified Investment Products – Derivatives and Collective Investment Schemes (SIP) Practice Questions

Sample Practice Questions

Try these 10 sample questions from the Capital Markets – Specified Investment Products – Derivatives and Collective Investment Schemes (SIP) practice bank. Each includes the answer and explanation. Continue with the interactive practice above to review the full question set.

1. 1Which feature defines a financial contract as a derivative instrument?

   1. A.Its value depends on an underlying asset or variable.Correct answer: A
   2. B.Its value equals the issuer's paid-up share capital.
   3. C.Its value is fixed by the initial cash contribution.
   4. D.Its value reflects ownership of the issuing company.

   Explanation: CFA Institute states: "A derivative is a financial contract that derives its value from the performance of an underlying asset, which may represent a firm commitment or a contingent claim." The defining relationship is to an underlying, rather than equity ownership, paid-up capital or an unchanging contribution.

   Reference: CFA Institute: Derivative Instrument and Derivative Market Features — Introduction and Summary

2. 2What happens to gains and losses on an exchange-traded futures contract during its life?

   1. A.They are settled daily.Correct answer: A
   2. B.They are recognised only on delivery.
   3. C.They are paid only when an option is exercised.
   4. D.They are fixed at the contract's opening value.

   Explanation: The source states: "Forwards are a flexible over-the-counter (OTC) derivative instrument, whereas futures are standardized and traded on an exchange with a daily settlement of contract gains and losses." Futures gains and losses undergo daily settlement. Waiting solely for delivery, linking settlement to option exercise, and freezing the value confuse futures with other arrangements.

   Reference: CFA Institute: Forward Commitment and Contingent Claim Features and Instruments — Summary

3. 3A manufacturer must buy a commodity in three months and wants protection against an increase in its purchase price. Which futures position provides the directional hedge?

   1. A.Sell futures on the commodity.
   2. B.Buy futures on the commodity.Correct answer: B
   3. C.Buy and sell equal quantities of the same futures.
   4. D.Sell twice the matching quantity of the commodity's futures.

   Explanation: The source states: "Hedging transaction in which futures contracts are bought to protect against possible increases in the cost of commodities." Buying matching futures offsets rising purchase prices. A and D take the adverse short direction; C creates no net hedge because its equal long and short positions offset.

   Reference: CFTC Futures Glossary — Buying Hedge (or Long Hedge)

4. 4Which rights does holding a derivative warrant on a company's shares give the investor in that company?

   1. A.Voting rights without dividend rights
   2. B.Dividend rights without voting rights
   3. C.Both voting rights and dividend rights
   4. D.Neither shareholder voting rights nor dividend rightsCorrect answer: D

   Explanation: The source states: "Holders of derivative warrant do not have voting rights or the right to receive any dividends, bonus or other distributions from the issuer of the underlying stock." A warrant is a derivative exposure rather than share ownership. None of the shareholder voting or distribution rights follows merely from holding it.

   Reference: HKEX: Derivative Warrants FAQs — How are the rights of a derivative warrant holder different from the rights of a shareholder over the underlying stock?

5. 5A derivative contract is inactive unless the underlying reaches a specified barrier before expiration. Which provision is this?

   1. A.Knock-inCorrect answer: A
   2. B.Knock-out
   3. C.Daily settlement
   4. D.Cash settlement

   Explanation: The source states: "A provision in an option or other derivative contract, whereby the contract is activated only if the price of the underlying instrument reaches a specified level before a specified expiration date." A knock-in activates the contract upon the barrier condition. A knock-out cancels it; daily and cash settlement describe settlement rather than activation.

   Reference: CFTC Futures Glossary — Knock-In

6. 6What is the basic structure of a structured deposit?

   1. A.An equity purchase with a protective put option
   2. B.An issuer's debt note with a market-linked payout
   3. C.A deposit combined with an investment productCorrect answer: C
   4. D.A conventional fixed deposit with a higher fixed rate

   Explanation: The source states: "A structured deposit combines a deposit with an investment product." A structured deposit combines a deposit and an investment component. A describes hedged equity, B a structured debt note and D an ordinary fixed-rate deposit.

   Reference: MoneySense: Understanding structured deposits — What are structured deposits?

7. 7What is the investor's basic legal-economic claim when buying a structured note?

   1. A.An ownership interest in every reference asset
   2. B.An insured deposit with the reference company
   3. C.A debt claim on the issuer with linked return termsCorrect answer: C
   4. D.A direct voting interest in the issuer's share capital

   Explanation: The source states: "A structured note is a debt product whose return is linked to the performance of one or more underlying assets or benchmarks." A note is issuer debt with performance-linked terms. It is not automatically a deposit or direct equity ownership in the issuer or reference assets.

   Reference: MoneySense: Understanding structured notes — What are structured notes?

8. 8What does an investor obtain by opening a share CFD rather than buying the share?

   1. A.Legal ownership of the underlying share
   2. B.A claim to the company's shareholder voting rights
   3. C.Contractual exposure to the share's price movementCorrect answer: C
   4. D.A direct shareholding held by the company's registrar

   Explanation: The source states: "As a CFD buyer, you do not own the underlying asset" A CFD provides contractual price exposure without ownership. The alternatives all assert shareholder ownership or rights that the CFD itself does not confer.

   Reference: MoneySense: Understanding contracts for difference — Key takeaways

9. 9An investor cannot readily sell a structured product because the secondary market has insufficient trading interest. Which risk has materialised?

   1. A.Interest rate reinvestment risk
   2. B.Reference-entity credit risk
   3. C.Liquidity riskCorrect answer: C
   4. D.Settlement-currency conversion risk

   Explanation: The source states: "The secondary market may be illiquid, making it harder for you to buy or sell a DLC when you want to" Difficulty executing an exit because trading interest is inadequate is liquidity risk. It is distinct from lower reinvestment yields, reference default and currency conversion.

   Reference: MoneySense: Understanding daily leverage certificates — Liquidity risk

10. 10A processor needs 360 tonnes of an input in three months and already owns 60 tonnes reserved for that need. Each matching futures contract represents 25 tonnes. To hedge only the remaining purchase exposure against rising prices, what position should it establish?

    1. A.Sell 12 contracts
    2. B.Buy 15 contracts
    3. C.Buy 12 contractsCorrect answer: C
    4. D.Sell 15 contracts

    Explanation: The source states: "Hedging transaction in which futures contracts are bought to protect against possible increases in the cost of commodities." The source states: "Since each futures contract provides for delivery of 5,000 bushels and the expected harvest is 50,000 bushels, the farmer would sell 10 futures contracts" Remaining purchase = 360 − 60 = 300 tonnes. Matching quantity = 300 ÷ 25 = 12 whole contracts. Rising purchase prices require a long hedge, so buy 12. Sell 12 reverses the hedge. Buy 15 rounds gross need of 360 ÷ 25 = 14.4 upward without deducting stock; sell 15 also reverses direction.

    Reference: CFTC Futures Glossary — Buying Hedge (or Long Hedge)