Try 10 focused CISI Intro questions on Derivatives, with answers and explanations, then continue with Securities Prep.
| Field | Detail |
|---|---|
| Exam route | CISI Intro |
| Issuer | CISI |
| Topic area | Derivatives |
| Blueprint weight | 8% |
| Page purpose | Focused sample questions before returning to mixed practice |
Use this page to isolate Derivatives for CISI Intro. Work through the 10 questions first, then review the explanations and return to mixed practice in Securities Prep.
| Pass | What to do | What to record |
|---|---|---|
| First attempt | Answer without checking the explanation first. | The fact, rule, calculation, or judgment point that controlled your answer. |
| Review | Read the explanation even when you were correct. | Why the best answer is stronger than the closest distractor. |
| Repair | Repeat only missed or uncertain items after a short break. | The pattern behind misses, not the answer letter. |
| Transfer | Return to mixed practice once the topic feels stable. | Whether the same skill holds up when the topic is no longer obvious. |
Blueprint context: 8% of the practice outline. A focused topic score can overstate readiness if you recognize the pattern too quickly, so use it as repair work before timed mixed sets.
These questions are original Securities Prep practice items aligned to this topic area. They are designed for self-assessment and are not official exam questions.
Topic: Derivatives
A UK investor owns 1,000 shares in ABC plc. One exchange-traded call option contract on ABC plc covers 1,000 shares. She sells one call option contract to collect premium income, so if the buyer exercises, she can deliver shares she already owns. Which term best describes this position?
Best answer: B
What this tests: Derivatives
Explanation: Selling a call creates a short call position. Because the investor already owns the underlying shares, that short call is covered, which is why the position is described as writing a covered call.
The core concept is that a call seller is short the option, and the position is covered only if the seller already holds the underlying asset needed for delivery. Here, the investor owns 1,000 ABC plc shares and sells one call contract covering the same 1,000 shares. That means if the option is exercised, she can meet the obligation by delivering shares she already owns.
A naked call would arise if she sold the call without holding the shares. Buying a call or buying a put would both be long option positions, which does not match the stem because the investor has sold, not bought, the option.
The key takeaway is: sold call plus owned shares equals a covered call.
Because she has sold the call while already owning the underlying shares, the short call is covered rather than naked.
Topic: Derivatives
Which statement correctly matches the holder and the writer of an option contract?
Best answer: A
What this tests: Derivatives
Explanation: Writing an option means taking the short side: the writer receives the premium and accepts a possible obligation if the holder exercises. Holding an option means paying the premium to acquire a right, with downside usually limited to that premium.
The core distinction in an option is between the party who owns the choice and the party who accepts the risk. The holder buys the option, pays the premium, and gains the right to exercise or let the contract lapse. The writer sells the option, receives the premium, and takes on the obligation to perform if the holder exercises.
This also creates different exposure profiles. The holder usually has limited downside, because the maximum loss is normally the premium paid. The writer keeps the premium, but potential losses can be much greater if the market moves sharply against the written position. The incorrect statements either reverse who pays the premium, reverse who carries the obligation, or wrongly suggest both parties have the same role.
An option holder buys a right by paying the premium, while the writer receives the premium and takes the contingent obligation.
Topic: Derivatives
Which derivative involves one party paying a periodic premium in exchange for compensation if a named bond issuer suffers a credit event such as default?
Best answer: B
What this tests: Derivatives
Explanation: A credit default swap is designed to transfer credit risk rather than price or interest-rate risk. The protection buyer pays a periodic premium, and the protection seller compensates the buyer if the referenced issuer experiences a defined credit event such as default.
The core concept is that a credit default swap (CDS) is a derivative linked to the creditworthiness of a reference entity, such as a company or sovereign issuer. One party pays regular premiums to obtain protection, and the other party agrees to make a payment if a defined credit event occurs. That makes a CDS different from an interest rate swap, which exchanges interest-payment streams, a futures contract, which locks in a future price, and a put option, which gives the holder the right to sell an asset at a set price. A CDS is specifically about transferring default exposure between parties.
The key distinction is that a CDS targets issuer credit risk, not general market-price or interest-rate movements.
A credit default swap transfers credit risk by exchanging a premium for protection against a specified credit event.
Topic: Derivatives
A company wants to exchange its floating-rate interest payments for fixed-rate payments on a notional amount, while keeping the original loan in place. Which derivative matches this feature?
Best answer: C
What this tests: Derivatives
Explanation: An interest-rate swap is used to change interest-rate exposure by exchanging payment streams, commonly fixed for floating, on a notional principal. It helps a borrower alter the pattern of interest payments without refinancing the original debt.
The defining feature of an interest-rate swap is that two parties exchange interest cash flows calculated on a notional amount. Usually, the notional principal itself is not exchanged; instead, each side pays interest based on a different rate basis, such as fixed versus floating. This allows a firm to reshape its exposure to interest-rate movements without changing the underlying loan or bond. For example, a borrower paying a floating rate can swap into an effective fixed rate if it wants more certainty over future interest costs. The key idea is an ongoing exchange of interest payment streams over time. A forward rate agreement is the closest alternative, but it relates to a single future interest period rather than a continuing series of exchanges.
An interest-rate swap exchanges one stream of interest payments for another, typically fixed for floating, without replacing the underlying borrowing.
Topic: Derivatives
A UK investor owns shares in an LSE-listed company. She wants protection against a fall in the share price over the next three months, but still wants to benefit if the shares rise. She is willing to pay an upfront premium for this flexibility. Which derivative term best matches this position?
Best answer: D
What this tests: Derivatives
Explanation: A long put option matches an investor who wants downside protection without giving up upside. The premium buys the right to sell at a set price, so the shares can still benefit from any rise in the market.
The key concept is the difference between a derivative that gives a right and one that creates an obligation. A long put gives the holder the right, but not the obligation, to sell the shares at a fixed strike price during the option period. For someone who already owns the shares, that works like insurance against a fall in price. If the shares drop, the put gains value or can be exercised; if the shares rise, the investor can ignore the put and keep the upside on the shares. The upfront premium is the cost of that flexibility. By contrast, a short futures position would hedge downside but would also broadly offset gains if the share price rises.
A long put gives the right, but not the obligation, to sell at a fixed price, protecting downside while keeping upside after paying a premium.
Topic: Derivatives
A UK fund holds £5 million of sterling corporate bonds issued by one company. The manager wants to keep the bonds and their coupon income, but reduce the loss if that company defaults. Which action best applies this need?
Best answer: D
What this tests: Derivatives
Explanation: A credit default swap is the derivative used to hedge or transfer credit-risk exposure. By buying protection on the bond issuer, the fund can keep the bonds and coupons while reducing the loss if a credit event such as default occurs.
The key principle is matching the hedge to the specific risk. Here, the fund’s concern is not interest rates, equity-market moves, or currency changes; it is the chance that one bond issuer may default. A credit default swap is designed for exactly that purpose: the protection buyer pays a premium to the protection seller, and if a defined credit event occurs, the seller compensates the buyer under the swap terms. This lets the fund retain the underlying sterling corporate bonds and their income while transferring much of the issuer’s credit risk.
The closest distractor is the interest rate swap, but that manages fixed-versus-floating rate exposure, not default risk.
A credit default swap transfers the issuer’s credit risk to the protection seller while the fund keeps holding the bonds.
Topic: Derivatives
A UK company has a GBP loan whose interest rate moves with SONIA. The finance director wants more predictable borrowing costs but does not want to refinance the loan. Which action best applies the purpose of an interest-rate swap?
Best answer: A
What this tests: Derivatives
Explanation: An interest-rate swap is commonly used to exchange one stream of interest payments for another, usually fixed for floating. A borrower with a floating-rate loan who wants certainty would typically pay fixed and receive floating under the swap, so the floating receipts offset the floating loan cost.
The core concept is interest-rate risk management. An interest-rate swap lets two parties exchange interest cash flows on a notional amount, most commonly one fixed-rate stream for one floating-rate stream. Here, the company already has floating-rate debt linked to SONIA and wants more predictable costs. By entering a swap where it pays fixed and receives SONIA, the floating receipt from the swap broadly offsets the floating interest on the loan, leaving a more stable net fixed-style cost.
Receiving fixed and paying floating would do the opposite, increasing floating-rate exposure rather than reducing it. A credit default swap addresses credit risk, and an FX forward addresses currency risk, so neither is the right tool for managing this company’s interest-rate exposure.
This exchanges floating-rate exposure for fixed-rate payments, making the company’s net borrowing cost more predictable.
Topic: Derivatives
Which statement correctly distinguishes hedging from speculation when derivatives are used?
Best answer: A
What this tests: Derivatives
Explanation: The key distinction is purpose. Hedging uses derivatives to reduce or manage an existing risk, whereas speculation uses derivatives to take a view on future price movements in the hope of making a profit.
At foundation level, derivatives are commonly used for hedging, speculation, and exposure management. Hedging means using a derivative to offset or reduce the effect of an adverse move in an existing position, such as protecting a shareholding or currency exposure. Speculation is different: the investor takes on market exposure through the derivative because they expect prices to move in their favour.
A derivative does not have to eliminate all risk to be a hedge; it is used to manage risk. Equally, speculation does not require owning the underlying asset first. Both futures and options can be used for either purpose, depending on the objective.
The main test is the intention behind the trade: risk reduction points to hedging, while seeking gain from price direction points to speculation.
Hedging offsets or limits an existing exposure, while speculation deliberately takes exposure to profit from market moves.
Topic: Derivatives
A UK retail investor has a three-month view that crude oil prices will rise and wants maximum market exposure for a small initial outlay. He buys an exchange-traded oil futures contract using margin. What is the single best description of the main benefit and main risk of this choice?
Best answer: B
What this tests: Derivatives
Explanation: An oil futures contract is a derivative that gives price exposure without paying the full contract value upfront. That is the main advantage, but the leverage means crude oil volatility can create large gains or losses, and losses may be greater than the initial margin.
The core concept is leverage in commodity derivatives. A futures contract derives its value from the underlying oil price, and the investor only posts margin rather than the full contract value. That small initial outlay increases exposure, which is attractive for a short-term view on rising oil prices. However, commodity prices can be very volatile, and futures are marked to market, so adverse movements can trigger margin calls and total losses greater than the original margin deposit.
Exchange trading can reduce counterparty risk compared with some over-the-counter contracts, but it does not remove market risk. The key takeaway is that futures offer efficient exposure, but leverage magnifies both upside and downside.
A futures contract uses margin to create leverage, so oil price moves can produce losses greater than the initial deposit.
Topic: Derivatives
A UK breakfast-cereal producer will need to buy a large quantity of wheat in three months. It has no storage capacity today and wants to lock in its input price now. Which action is the single best answer?
Best answer: A
What this tests: Derivatives
Explanation: A futures contract is a standardised agreement to buy or sell an asset at a future date at a price agreed today. Because the producer must buy wheat later and cannot store it now, buying wheat futures is the best way to lock in the future purchase price.
The core concept is a long futures hedge. A futures contract is a standardised exchange-traded agreement to buy or sell an asset on a set future date at a price fixed today. Here, the cereal producer knows it will need wheat in three months, so its main risk is that wheat prices rise before then. By buying wheat futures now, gains on the futures position can offset a higher cash price when the wheat is eventually purchased, effectively locking in the future cost.
That means the futures position is being used for hedging a future purchase rather than for speculation.
Buying wheat futures creates a long hedge that can offset a rise in the cash price when the wheat is needed.
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