NISM Certifications · NISM-Series-VIII: Equity Derivatives · Understanding Index
Which of the following is a reason why index returns are generally preferred as the underlying for derivatives, rather than a single stock?
Index values are harder to manipulate because they are diversified across many stocks. This makes index derivatives attractive as hedging and trading tools, while they remain cash settled and still carry systematic market risk.
- AIndex values are harder to manipulate because of diversification across many stocksCorrect
- BIndex derivatives can be settled only by physical delivery of all constituents
- CIndices are not subject to systematic risk
- DAn index has no impact cost
Explanation
An index is a diversified basket, so a single trader finds it difficult to move it, reducing manipulation risk. Index derivatives are cash settled, not physically delivered. Indices still carry systematic risk, and trading index products does involve impact cost.
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