101 Concepts for the Level I Exam

Concept 88: Forward Contracts, Futures Contracts, Options (Calls and Puts), Swaps, and Credit Derivatives

Forward contract is an obligation for one party to buy and another party to sell, an underlying asset at a specific price at a specific time in the future. It is an over-the-counter contract.

Futures contract is similar to a forward contract but is a standardized contract and is traded on a futures exchange. Since it is an exchange traded derivative instrument, there is a daily settling of gains and losses.

An option is a derivative contract in which the option buyer pays a sum of money to the option seller, and receives the right to either buy or sell an underlying asset at a fixed price at some time in the future. A call is an option that provides the right to buy the underlying. A put is an option that provides the right to sell the underlying.

A swap is an over-the-counter derivative contract in which two parties agree to exchange a series of cash flows. Typically one party will pay variable cash flows that depend on an underlying rate and the other party will pay fixed cash flows.

A credit derivative is a contract that provides a payment to the credit protection buyer if a specified credit event occurs. The most widely used credit derivative is a credit default swap.