Chapter 6: Derivative Benefits, Risks, and Uses

In this section

• Risk Management and Hedging
  Risk Management and Hedging (CFA Level 1): Derivatives as Hedging Instruments, Establishing Hedge Objectives & The Hedge Ratio, and Long vs. Short Hedges. Key definitions, formulas, and exam tips.
• Speculation and Leverage
  Speculation and Leverage (CFA Level 1): Speculative Goals vs Hedging, Role of Leverage in Speculative Positions, and Margin Requirements: Exchange-Traded and OTC. Key definitions, formulas, and exam tips.
• Derivative-Related Risks
  Derivative-Related Risks (CFA Level 1): Market Risk, Counterparty Credit Risk, and Liquidity Risk. Exam-focused explanations with key terms and takeaways.
• Counterparty Risk in OTC Markets
  Counterparty Risk in OTC Markets (CFA Level 1): Bilateral Nature of OTC Derivatives, Credit Analysis of the Counterparty, and Collateral and Margin Agreements. Key definitions, formulas, and exam tips.
• Uses of Derivatives by Issuers and Investors
  Uses of Derivatives by Issuers and Investors (CFA Level 1): Corporate Issuers: Managing Cash Flows, Interest Rate Swaps for Debt Management, and FX Forwards for Currency Exposure. Key definitions, formulas, and exam tips.
• Operational, Legal, and Liquidity Risks
  Operational, Legal, and Liquidity Risks (CFA Level 1): Operational Risk in the Derivatives Context, Settlement Failures and Payment Mismatches, and Mitigating Operational Risks. Key definitions, formulas, and exam tips.
• Regulatory Considerations for Risk Management
  Regulatory Considerations for Risk Management (CFA Level 1): Context and Rationale, Key Post-Crisis Reforms, and Mandatory Clearing Thresholds. Key definitions, formulas, and exam tips.
• Tax Implications of Derivative Transactions
  Tax Implications of Derivative Transactions (CFA Level 1): Classification of Gains and Losses, Capital Gains vs. Ordinary Income, and 60/40 Rule (U.S. Context). Key definitions, formulas, and exam tips.
• Collateralization and Funding Costs
  Collateralization and Funding Costs (CFA Level 1): Role of Collateral in Derivative Markets, Initial vs. Variation Margin, and Initial Margin. Key definitions, formulas, and exam tips.
• ESG Considerations and Sustainability Risk Hedging
  ESG Considerations and Sustainability Risk Hedging (CFA Level 1): Understanding ESG in Derivatives Markets, Green Derivatives: The “E” in ESG, and Carbon Emission Allowances and Their Role in Hedging. Key definitions, formulas, and exam tips.
• Case Studies of Derivative Disasters
  Case Studies of Derivative Disasters (CFA Level 1): Barings Bank Collapse (1995), Long-Term Capital Management (LTCM) (1998), and Société Générale Rogue Trading (2008). Key definitions, formulas, and exam tips.
• Hedge Accounting Considerations
  Hedge Accounting Considerations (CFA Level 1): Purpose of Hedge Accounting, Types of Hedges, and Fair Value Hedge. Key definitions, formulas, and exam tips.
• Reporting and Disclosure of Derivative Positions
  Reporting and Disclosure of Derivative Positions (CFA Level 1): Financial Statement Footnotes, Regulatory Filings and Large Position Disclosures, and Fair Value Hierarchy Under IFRS and U.S. GAAP. Key definitions, formulas, and exam tips.
• Internal Controls for Derivative Operations
  Internal Controls for Derivative Operations (CFA Level 1): Key Components of Internal Controls in Derivative Operations, Segregation of Duties, and Limit Management. Key definitions, formulas, and exam tips.
• Cybersecurity Risks in Derivative Markets
  Cybersecurity Risks in Derivative Markets (CFA Level 1): Evolving Threat Landscape, Electronic and Algorithmic Trading Platforms, and Data Security and Confidentiality. Key definitions, formulas, and exam tips.
• Role of Third-Party Custodians in Collateral Management
  Role of Third-Party Custodians in Collateral Management (CFA Level 1): Importance of Independent Custody, Tri-Party Repo Arrangements, and Collateral Verification and Eligibility. Key definitions, formulas, and exam tips.
• Uncleared Margin Requirements for OTC Derivatives
  Uncleared Margin Requirements for OTC Derivatives (CFA Level 1): Background and Regulatory Evolution, Key Components of Uncleared Margin Requirements, and Variation Margin vs. Initial Margin. Key definitions, formulas, and exam tips.
• Post-Trade Processing, Settlement, and Collateral Optimization
  Post-Trade Processing, Settlement, and Collateral Optimization (CFA Level 1): Affirmation and Confirmation, Clearing and Settlement, and Collateral Optimization Tools. Key definitions, formulas, and exam tips.
• Risk Parity Strategies and Derivatives
  Risk Parity Strategies and Derivatives (CFA Level 1): Understanding Risk Parity, Key Idea: Equal Risk Contribution, and Role of Derivatives in Risk Parity. Key definitions, formulas, and exam tips.
• Combinations and Overlays in Portfolio Management
  Combinations and Overlays in Portfolio Management (CFA Level 1): Fundamental Ideas and Definitions, Overlay Management, and Why Not Just Restructure the Core Portfolio?. Key definitions, formulas, and exam tips.
• Real-Time Risk Management and Intraday Margin Calls
  Real-Time Risk Management and Intraday Margin Calls (CFA Level 1): Monitoring Market Volatility in Real-Time, Why Volatility Matters So Much, and Intraday Margin Calls: Key Concepts. Key definitions, formulas, and exam tips.
• Cross-Asset Volatility and Correlation Trading
  Cross-Asset Volatility and Correlation Trading (CFA Level 1): Creating Multi-Asset Portfolios Using Derivatives, Volatility Trading Across Asset Classes, and Variance Swaps. Key definitions, formulas, and exam tips.