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CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses

Critics argue that derivatives are "speculative instruments that resemble gambling." Which response is most consistent with the way the CFA curriculum treats this criticism?

Derivatives can be used for speculation, but they also let hedgers transfer risk to parties willing to hold it and contribute to price discovery and efficiency. The gambling criticism therefore overlooks their economic function, even though the instruments can be misused.

  1. ADerivatives are zero-sum, so they cannot create any economic value.
  2. BDerivatives allow risk transfer and price discovery, though they can also be used to speculate.Correct
  3. CDerivatives are used only by speculators, so hedgers gain nothing from them.

Explanation

The curriculum acknowledges that derivatives can be used for speculation, but they also help transfer risk from hedgers to those willing to bear it and contribute to price discovery and market efficiency. The zero-sum claim ignores these benefits, and hedgers clearly use derivatives to reduce risk.

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