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 derivatives markets for the broader financial system?
Derivatives provide price discovery, because their prices embed market participants' expectations about future values of the underlying. They transfer risk instead of eliminating it from the economy, and they typically add liquidity to underlying markets rather than reducing it.
- AThey remove all price risk from the economy
- BThey provide information about expected future prices of the underlyingCorrect
- CThey guarantee that the underlying market becomes less liquid
Explanation
Derivative prices reflect market expectations about future values of the underlying, so they contribute to price discovery. Derivatives transfer risk rather than eliminate it from the economy, and they usually improve rather than reduce liquidity in the underlying market.
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