AF_L1

Question 1

Derivative

Answer 1

• A financial instrument derived from an underlying asset
• Examples include options, warrants, futures, swaps

Question 2

Option

Answer 2

• Grants the right, but not the obligation, to buy or sell a security
• Common types: call and put

Question 3

Call Option

Answer 3

• Right to buy a security at a set strike price
• Profit if share price rises above strike

Question 4

Put Option

Answer 4

• Right to sell a security at a set strike price
• Profit if share price falls below strike

Question 5

Option Premium

Answer 5

• The price paid to purchase the option
• Includes intrinsic value + time value

Question 6

Intrinsic Value

Answer 6

• Immediate payoff if exercised now
• Calculated as max(S – EX, 0) for calls or max(EX – S, 0) for puts

Question 7

Time Value

Answer 7

• The extra option value above intrinsic value
• Reflects uncertainty before expiration

Question 8

Expiration Date

Answer 8

• Last day on which the option may be exercised
• American: exercise any time up to expiration
• European: exercise only on expiration date

Question 9

Put–Call Parity

Answer 9

• For European options: C + PV(EX) = P + S
• Ensures no-arbitrage among calls, puts, and shares

Question 10

Value Drivers of a Call

Answer 10

• Increases with share price (S)
• Decreases with exercise price (EX)
• Increases with risk-free rate r_f
• Increases with time to expiration
• Increases with volatility (σ²)

Question 11

Payoff Diagrams

Answer 11

• Call buyer: limited loss (premium), unlimited upside
• Put buyer: limited loss (premium), profit if price drops
• Call seller: collects premium, risk if price rises
• Put seller: collects premium, risk if price falls

Question 12

Straddle

Answer 12

• Buy call and put with same strike
• Profits if price moves substantially up or down

Question 13

Butterfly

Answer 13

• Combination of buying and selling calls at different strikes
• Profits when price remains near middle strike
• Bet on low volatility

Question 14

Sustainability-Linked Derivatives

Answer 14

• Derivatives with ESG components
• Encourage meeting sustainability targets or maintaining an ESG rating

Question 15

Key Insight

Answer 15

• Options provide flexibility and can limit losses
• Value depends on timing, price, and volatility