Derivatives for CFA Level 1: Unveiling the Mysteries of Financial Instruments

Hello again, future finance aficionados! In this article, we’ll tackle the Derivatives topic of the CFA Level 1 exam, guiding you through each learning module to help you unravel the mysteries of these powerful financial instruments. So, let’s dive into the world of derivatives and uncover their hidden secrets!

1. Derivative Instrument and Derivative Market Features

Get ready to dive into the world of derivatives, their underlying assets, and the variety of types available! This lesson introduces the foundational concepts of derivatives, how they function, and why they’re used, including risk management and speculation. You’ll also explore the differences between exchange-traded and over-the-counter derivatives, and the aftermath of the 2008 global financial crisis on derivatives trading.

►Ready to step into the derivatives market? Let’s begin here.

2. Forward Commitment and Contingent Claim Features and Instruments

Buckle up for a deep dive into the major types of derivatives, focusing on the differences between forward commitment and contingent claim derivatives. This lesson will explore the intricacies of forwards, futures, and swaps, and delve into contingent claim derivatives such as options and credit derivatives. By the end, you’ll have a clear understanding of the classes of derivatives and the distinctive features of forward commitment and contingent claim derivatives.

►Ready to delve deeper into derivatives? Learn more here.

3. Derivative Benefits, Risks, and Issuer and Investor Uses

Embark on a journey through the intriguing world of derivative benefits and risks, gaining insight into the allure of derivatives over cash markets and the inherent perils. The lesson also illuminates how issuers and investors use derivatives to hedge risks and speculate. By the end of this, derivatives will be less of a mystery and more of a tool!

►Keen on unraveling the secrets of derivatives? Start your adventure here.

4. Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives

This lesson will take you on a journey through the basics of derivative pricing, beginning with the four key factors that shape underlying asset pricing. It links these principles to derivative pricing, covering crucial concepts like arbitrage, replication, and risk-neutral pricing. After this lesson, the seemingly complex world of derivative pricing will feel much more manageable.

►Keen to unravel the mystery of derivative pricing? Dive in here.

5. Pricing and Valuation of Forward Contracts

We’ll dissect the pricing and valuation of forwards, particularly forward rate agreements. We’ll clarify the difference between price and value in derivatives, reveal how these change over the contract’s lifespan, and show how holding costs and benefits factor into the equation. Finally, we’ll tackle forward rate agreements, preparing you for any related queries that might pop up in your CFA Level I Fixed Income exam.

►Eager to master the nuances of forward pricing and valuation? Let’s get started here.

6. Pricing and Valuation of Futures Contracts

This lesson is your ticket to understanding futures contracts, with a lens on interest rate futures, and their comparison with forward contracts. We’ll demystify the differences in price and value between the two, illustrate how futures prices are calculated, the importance of margin requirements, and the mark-to-market routine. We’ll also discuss the factors contributing to price variations between forwards and futures and teach you how to price and value interest rate futures.

►Curious about the world of futures contracts? Start exploring here.

7. Pricing and Valuation of Interest Rates and Other Swaps

Welcome to the world of swaps. You’ll understand how swaps and forwards are similar, how a swap can be viewed as a series of forward contracts, and the concept of off-market forwards in swap pricing. We’ll wrap up by discussing how to price interest rate swaps and the principles of no-arbitrage.

►Ready to swap your doubts for knowledge? Click here.

8. Pricing and Valuation of Options

This lesson takes you on a journey through the land of options, focusing on European-style ones. You’ll get to grips with basic option concepts, the idea of moneyness, and the components of an option’s value, including intrinsic and time value. We’ll also walk you through the six key factors influencing option values.

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9. Option Replication Using Put-Call Parity

In this lesson, you’re going to explore the principle of put-call parity and how it influences options pricing. You’ll learn about protective puts and fiduciary calls, which lay the foundation for the put-call parity relationship. Additionally, we’ll talk about how put-call parity aids in uncovering arbitrage opportunities, ensuring fair pricing, and linking to forward contracts.

►Ready to put your options knowledge into parity? Click here.

10. Valuing a Derivative Using a One-Period Binomial Model

This final lesson unwraps the binomial model, a handy tool for valuing derivatives over time. You’ll learn to build the model, use it to value options, and understand the hedge ratio. Also, you’ll delve into the concept of no-arbitrage value and the role of the hedge ratio in determining it.

►Eager to add a new model to your financial toolkit? Learn more here.