CFA Level I · CFA Level I Exam
Forward Commitment and Contingent Claim Features and Instruments
A forward commitment is a binding agreement to trade an asset at a set price on a future date: forwards, futures and swaps. A contingent claim gives one side a right, not an obligation: options, credit derivatives, caps, floors and swaptions. Solve questions by drawing the payoff first, then checking who pays whom.
What this chapter covers
This chapter introduces the main derivative instruments and the split that organises them. Forward commitments bind both parties to a trade. Forwards, futures and swaps sit here. Contingent claims pay off only if a future event occurs, such as an option finishing in the money or a borrower defaulting. Options, credit default swaps, caps, floors, swaptions and convertibles sit here.
You will learn features, not full pricing. Expect questions on who is long and short, how payoffs look at expiry, how futures differ from forwards (standardisation, exchange trading, clearing, daily settlement), how a plain vanilla swap exchanges fixed for floating payments, and how a credit default swap transfers default risk. Option work includes call and put payoffs, profit at expiry, and moneyness.
This chapter is the base for the rest of the derivatives topic, including pricing, arbitrage and option strategies. It also links to Fixed Income (interest rate risk, credit spreads), Portfolio Construction and Equities (hedging and convertible securities), and Quantitative Methods (expected payoffs). Getting the vocabulary right now makes later chapters much faster.
Derivatives and Risk Management carries a topic weight of 6-9% in the 2027 curriculum, and this chapter supplies the definitions every later derivatives question assumes. The questions are mostly short, three-option items on payoffs and features, so they reward clear understanding more than long calculations. Since there is no penalty for wrong answers and each question carries equal weight, quick, reliable points here are worth the effort. Weak basics also cost you marks in Fixed Income and Portfolio Construction, where derivatives appear as hedging tools.
Forward Commitment and Contingent Claim Features and Instruments: topics in the order to study them
- 1Derivatives Basics: Forward Commitments vs Contingent ClaimsIt sets the vocabulary and the main split that every later topic uses.
- 2Forward Contracts and Futures ContractsThese are the simplest forward commitments, and they show the idea of long, short and settlement.
- 3SwapsA swap is best understood as a series of forward contracts, so it comes after forwards and futures.
- 4Options: Calls, Puts and PayoffsOptions are the core contingent claim, and their asymmetric payoffs contrast with the linear payoffs you just learned.
- 5Credit Derivatives and Credit Default SwapsA CDS works like insurance on default, so it builds on both swap mechanics and option-style payoffs.
- 6Other Contingent Claims: Caps, Floors, Swaptions and ConvertiblesThese combine ideas from options, swaps and bonds, so they are easiest to learn last.
How to prepare Forward Commitment and Contingent Claim Features and Instruments
Aim for understanding of payoffs and features first. Then use short question sets to make the recall automatic. This suits phone study in short sessions.
- Learn the two definitions in one sentence each: forward commitment means obligation for both sides, contingent claim means a right for one side.
- For every instrument, write down who is long, who is short, what each pays or receives, and when settlement happens.
- Sketch payoff diagrams for long and short forwards, calls and puts. Practise reading profit at expiry as payoff minus premium paid, and for the seller the reverse.
- Make a comparison list of forwards versus futures: customised versus standardised, over the counter versus exchange, credit risk versus clearing house, settlement at end versus daily.
- Walk through a plain vanilla swap with a simple notional amount and net the fixed and floating payments. Then link caps and floors to a series of options on interest rates.
- Do timed sets of three-option questions at about 90 seconds each. For each miss, write the trap in one line and review those lines before the exam.
Common mistakes in Forward Commitment and Contingent Claim Features and Instruments
Treating profit and payoff as the same thing for options.
Fix: Underline whether the question asks for payoff or profit. Subtract the premium paid for the buyer, and add the premium received for the seller.
Saying a forward contract requires an upfront payment like an option.
Fix: Remember that a forward usually has zero value at initiation and no premium. Only options have a premium paid upfront.
Mixing up which side of a CDS pays the premium.
Fix: Think of insurance: the protection buyer pays the premium and collects if default happens; the protection seller collects the premium and pays out.
Confusing the long and short positions in a put.
Fix: Long and short refer to owning or writing the contract, not to the market view. The long put holder owns the right to sell and is bearish on the underlying.
Calling a forward and a futures contract identical.
Fix: Keep a short list of differences and check each answer option against it, especially counterparty risk and daily settlement.
Assuming swaps exchange the full notional amount.
Fix: In a plain vanilla interest rate swap the notional is only a reference for calculating payments, and usually only the net interest difference is paid.
Last-day revision: Forward Commitment and Contingent Claim Features and Instruments
- Forward commitments (forwards, futures, swaps) bind both parties; contingent claims give one party a right.
- A forward or futures contract has a payoff that is linear in the underlying price; the long gains when the price rises and the short gains when it falls.
- Forwards are customised and traded over the counter; futures are standardised, exchange-traded and cleared, with daily settlement.
- A plain vanilla swap exchanges fixed payments for floating payments on a notional amount, usually netted.
- Call payoff at expiry for the buyer = max(0, S − X); put payoff = max(0, X − S).
- Option profit for the buyer = payoff − premium; the buyer's maximum loss is the premium.
- Option sellers receive the premium and face the opposite payoff of the buyer; a short call has unlimited loss potential.
- A call is in the money when S > X; a put is in the money when S < X.
- A credit default swap: the protection buyer pays periodic premiums and receives compensation if the credit event occurs.
- A cap is a series of interest rate calls; a floor is a series of interest rate puts.
- A swaption is an option to enter a swap; a convertible bond lets the holder exchange the bond for shares.
Forward Commitment and Contingent Claim Features and Instruments practice questions
- A fund manager enters a long forward contract to buy 1,000 units of an asset at 50 per unit. At expiry, the spot price is 56 per unit. The p…
- Compared with a forward contract, a futures contract is most likely to feature:
- Compared with a plain vanilla interest rate swap, a currency swap most likely differs because it typically involves:
- Compared with a single-name CDS, an index CDS referencing a basket of 125 equally weighted issuers will most likely:
- A trader holds a long forward to buy 1,000 units at 50. At expiration the spot price is 46. A separate holder owns a put on 1,000 units with…
- Which of the following events most likely qualifies as a credit event that triggers a payout under a standard credit default swap on a corpo…
- A corporation holds a payer swaption that gives it the right to enter a pay-fixed, receive-floating swap at a fixed rate of 4.0%. At expirat…
- Which of the following best describes the maximum loss and maximum gain for the buyer of a European put option on a non-dividend-paying shar…
Forward Commitment and Contingent Claim Features and Instruments in other exams
The same ground in other exams, if you are preparing for more than one or want another angle on it.
Forward Commitment and Contingent Claim Features and Instruments: frequently asked questions
What is the difference between a forward commitment and a contingent claim?
A forward commitment obliges both parties to carry out the trade at the agreed terms. A contingent claim pays off only if a specified future event happens, and the holder usually has a right rather than an obligation. Forwards, futures and swaps are forward commitments, while options and credit derivatives are contingent claims.
Do I need to calculate option prices in this chapter?
This chapter focuses on features, payoffs and profit at expiry, not on pricing models. You should be comfortable with simple calculations such as max(0, S − X) and subtracting the premium. Pricing relationships are covered in later derivatives material.
Is a financial calculator needed for this chapter?
Mostly not. The calculations are simple arithmetic on payoffs and swap payments, so you can do them mentally or with the basic functions of the TI BA II Plus or HP 12C. Save calculator practice for time value of money and bond questions elsewhere.
How should I answer three-option questions on payoffs?
Work out the payoff yourself before reading the options, using a quick sketch if needed. Then eliminate the two options that get the sign, the direction or the premium treatment wrong. This is quicker than testing each option in turn and fits the 90-second guide per question.