CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
An investor uses a derivative to gain exposure equal to a $10 million equity position while paying only $0.6 million upfront. This feature is best described as:
This feature is best described as leverage. The investor controls a $10 million exposure with only $0.6 million paid upfront, so small price moves in the underlying produce large percentage gains or losses on the capital invested. It is not arbitrage or price discovery.
- Aarbitrage
- BleverageCorrect
- Cprice discovery
Explanation
Controlling a large notional exposure with a small initial outlay is leverage, which magnifies both gains and losses. Arbitrage is a riskless profit from mispricing. Price discovery refers to information revealed by derivative prices.
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