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

Which of the following is true about derivatives?

1. They are always risk-free investments

2. They can be based on stocks, bonds, or indices

3. They can only be traded on specialized exchanges

4. They do not require collateral to trade

The correct answer is: They can be based on stocks, bonds, or indices

The statement about derivatives being based on stocks, bonds, or indices is accurate. Derivatives are financial instruments whose value is derived from the performance of an underlying asset or group of assets. These underlying assets can include a variety of financial instruments, such as equities (stocks), fixed-income securities (bonds), and market indices (like the S&P 500). The ability to base derivatives on these diverse assets is what makes them versatile tools for hedging risk or speculating on price movements. Other options present misconceptions about derivatives. For example, stating that they are always risk-free investments is misleading, as derivatives can carry significant risk depending on their structure and the market conditions. Similarly, while some derivatives are traded on specialized exchanges, many are also traded over-the-counter (OTC), which means they are not limited to specific exchanges. Lastly, collateral is frequently required in many types of derivative transactions, particularly in the context of margin trading and to mitigate counterparty risk. Thus, the understanding of derivatives as a financial tool hinges on their connection to various underlying assets.