CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
Which of the following is most likely a benefit of derivative markets for the broader financial system?
Derivative markets most likely provide price discovery, because futures and forward prices reveal information about expected future prices of the underlying. They do not eliminate underlying volatility or guarantee profits, since derivatives transfer risk between parties and one side of each contract can lose.
- AThey remove all price volatility from underlying assets
- BThey provide information about expected future prices of underlying assetsCorrect
- CThey guarantee that every market participant earns a positive return
Explanation
Derivative prices, such as futures prices, reflect market expectations about future spot prices, so they aid price discovery. Derivatives transfer risk but do not remove volatility from the underlying. They also cannot guarantee profits, because every contract has a counterparty who may lose.
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