Certified Anti-Money Laundering Specialist Certification (CAMS) Practice Exam

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What is a derivative in financial terms?

A type of mutual fund with fixed shares
An agreement that can be traded on the stock market
A financial instrument whose price is based on something else
A method of investing in real estate

The correct answer is: A financial instrument whose price is based on something else

A derivative in financial terms is a financial instrument whose price is based on the value of another asset, which is known as the underlying asset. This could include stocks, bonds, commodities, currencies, interest rates, or market indexes. Derivatives are used for various purposes, including hedging risk, speculating on price movements, and gaining access to assets or markets without directly investing in them. For instance, options and futures contracts are common types of derivatives. In essence, the value of these derivatives is derived from the price of the underlying asset, and they can provide flexibility and leverage in financial strategies. Understanding derivatives is essential for comprehending complex financial architectures and the associated risks and benefits.