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

Which statement best describes how derivatives contribute to market efficiency?

Derivatives improve efficiency because their low cost and flexibility let traders exploit mispricings between the derivative and the underlying quickly. This arbitrage activity pushes prices toward fair value and helps information be reflected faster, rather than blocking price movements.

  1. AThey let traders exploit mispricings, pushing prices toward fair valueCorrect
  2. BThey prevent the underlying price from moving on new information
  3. CThey require investors to hold the underlying until expiration

Explanation

Low costs and flexibility let traders act quickly on mispricings between derivative and underlying, which restores consistent prices. Derivatives do not block price changes, and most do not require holding the underlying.

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