CFA Level 1 · Free topic practice

CFA Level 1 Derivatives: notes and free practice

CFA Level 1 Derivatives distinguishes forwards, futures, swaps and options by their obligations and payoffs. Start with the long or short position, then separate the payoff at expiration from profit after the initial cost.

The key ideas, at a glance

Level 1 · Visual study guide Study illustration of an analyzed worksheet, calculator and checked answer.

Identify what was promised

Read the visual, then follow the worked example below. Use the stated case assumptions.

Illustrative worked case

The long forward gains as the ending price rises

$ payoff per unit

60: -10
65: -5
70: 0
76: 6
80: 10

Delivery price is $70. At an ending price of $76, payoff is $6 before other costs.

Key methods and mistakes for CFA Level 1 Derivatives
Concept	Rule or decision	Common mistake
Identify what was promised	Long forward payoff = spot at expiry - delivery price	The agreed delivery price is not the same as the contract’s current value.
Separate payoff from profit	Call payoff = max(S - K, 0); put payoff = max(K - S, 0)	An in-the-money option can still produce a loss after the premium.
Use matching cash-flow packages	European call + PV(strike) = stock + European put	Parity does not directly apply to a mismatched expiry or an omitted dividend cash flow.
Offset the exposure	Underlying loss → offsetting derivative gain	A hedge can reduce an exposure without eliminating every source of uncertainty.

01Identify what was promised
Long forward payoff = spot at expiry - delivery price
Watch for: The agreed delivery price is not the same as the contract’s current value.
02Separate payoff from profit
Call payoff = max(S - K, 0); put payoff = max(K - S, 0)
Watch for: An in-the-money option can still produce a loss after the premium.
03Use matching cash-flow packages
European call + PV(strike) = stock + European put
Watch for: Parity does not directly apply to a mismatched expiry or an omitted dividend cash flow.
04Offset the exposure
Underlying loss → offsetting derivative gain
Watch for: A hedge can reduce an exposure without eliminating every source of uncertainty.

Selected 2026 study concepts. Match your preparation to your registered exam-year curriculum. These notes are not complete curriculum coverage.

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CFA Level I: 20 practice MCQs

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Put the method to work

One worked example, from facts to answer

Given
A long forward fixes purchase at $70; the asset ends at $76.
Method
76 - 70.
Answer and interpretation
The long’s expiration payoff is $6 per unit before other costs.

Original independent teaching example. Assumptions are stated above; this is not an official exam question or scoring key.

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10 free Derivatives questions

Choose an answer, check the reasoning, then use ‘Review the method’ to revisit the exact idea. Selected practice, not a complete syllabus or pass prediction.

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Question 1 of 10Level I topic sampleDerivativesMultiple choice
A long forward has a delivery price of $80 and the underlying is worth $86 at expiration. Ignoring costs, its payoff per unit is:
Answer and explanations
Long payoff equals expiry spot minus delivery price: $86 - $80 = $6.
Review the method
- A: -$6 is the short’s payoff, the opposite side of the contract.
- B - correct: Long payoff equals expiry spot minus delivery price: $86 - $80 = $6.
- C: $86 is the underlying’s value, not the net payoff after paying the delivery price.
Question 2 of 10Level I topic sampleDerivativesMultiple choice
A short forward commits to sell at $95; the asset is worth $88 at expiration. Its payoff per unit is:
Answer and explanations
Short payoff is delivery price minus spot: $95 - $88 = $7.
Review the method
- A - correct: Short payoff is delivery price minus spot: $95 - $88 = $7.
- B: -$7 belongs to the long position, not the short.
- C: The agreed delivery price is not the contract’s net payoff.
Question 3 of 10Level I topic sampleDerivativesMultiple choice
Which feature most directly distinguishes a futures contract from a typical forward contract?
Answer and explanations
Daily settlement is a defining futures feature and changes cash-flow timing relative to a typical forward.
Review the method
- A: A futures contract is a commitment, not an option held only by the buyer.
- B: A bilateral forward can expose each party to counterparty risk.
- C - correct: Daily settlement is a defining futures feature and changes cash-flow timing relative to a typical forward.
Question 4 of 10Level I topic sampleDerivativesMultiple choice
A call expires with stock price $63 and strike $55. The buyer paid a $4 premium. Ignoring financing, the buyer’s profit is:
Answer and explanations
Payoff is $63 - $55 = $8; subtract the $4 premium to obtain $4 profit.
Review the method
- A: $8 is exercise payoff before subtracting the premium.
- B - correct: Payoff is $63 - $55 = $8; subtract the $4 premium to obtain $4 profit.
- C: A loss equal to the premium would occur with zero exercise payoff, not the stated stock price.
Question 5 of 10Level I topic sampleDerivativesMultiple choice
A put has strike $45 and expires with the stock at $38. What is its exercise payoff per share, before premium?
Answer and explanations
A put pays max($45 - $38, 0) = $7 at expiration.
Review the method
- A - correct: A put pays max($45 - $38, 0) = $7 at expiration.
- B: The holder can exercise for a positive difference rather than accept a negative payoff.
- C: The put is in the money because the stock is below its strike.
Question 6 of 10Level I topic sampleDerivativesMultiple choice
An investor buys a call for $5. It expires out of the money. Ignoring financing and fees, the investor’s loss is:
Answer and explanations
Zero payoff minus the $5 premium produces a $5 loss.
Review the method
- A: An unexercised call has zero payoff, but the premium was paid.
- B: The call buyer’s maximum loss is the premium; unlimited upside in stock price does not create unlimited buyer loss.
- C - correct: Zero payoff minus the $5 premium produces a $5 loss.
Question 7 of 10Level I topic sampleDerivativesMultiple choice
A non-income-producing asset costs $100. With frictionless markets, no storage cost and a 5% annual funding rate, its one-year forward price is:
Answer and explanations
$100 × 1.05 = $105 under the stated no-income, no-storage, no-arbitrage assumptions.
Review the method
- A: $95.24 discounts spot, whereas funding ownership for one year increases the delivery price.
- B - correct: $100 × 1.05 = $105 under the stated no-income, no-storage, no-arbitrage assumptions.
- C: $100 ignores the positive cost of financing the asset for the year.
Question 8 of 10Level I topic sampleDerivativesMultiple choice
For matching European options on a non-dividend-paying stock, S = $50, call = $4 and PV(strike) = $48. Put-call parity implies a put price of:
Answer and explanations
Put = call + PV(strike) - stock = $4 + $48 - $50 = $2.
Review the method
- A - correct: Put = call + PV(strike) - stock = $4 + $48 - $50 = $2.
- B: $6 uses the wrong sign for the difference between stock and discounted strike.
- C: $98 adds stock and discounted strike without balancing the matching payoff packages.
Question 9 of 10Level I topic sampleDerivativesMultiple choice
A wheat producer expects to sell a known quantity at harvest and wants to reduce the risk of a lower reference price. The natural forward hedge is to:
Answer and explanations
A short forward gains when the reference price falls, offsetting the producer’s sale-price exposure if quantity and basis match.
Review the method
- A: A long forward gains when the reference price rises, which is not the producer’s adverse movement.
- B: More unhedged inventory increases exposure to falling prices.
- C - correct: A short forward gains when the reference price falls, offsetting the producer’s sale-price exposure if quantity and basis match.
Question 10 of 10Level I topic sampleDerivativesMultiple choice
A company hedges a local commodity price using a futures contract on a similar, but not identical, commodity. Which risk can remain?
Answer and explanations
The local and reference commodity prices may move differently, leaving basis risk despite the hedge.
Review the method
- A: A hedge does not guarantee zero losses or perfect offset in all circumstances.
- B - correct: The local and reference commodity prices may move differently, leaving basis risk despite the hedge.
- C: A shared asset-class label does not ensure identical price changes.

Four ideas to put to work

Find the method you need

Start with: Long versus short positions, present value and basic algebra.

METHOD 01

Identify what was promised

Long forward payoff = spot at expiry - delivery price

A forward commits both sides; an option gives its holder a choice.
Reverse the payoff sign when switching from long to short.
Futures use daily settlement, which changes the timing of cash flows.

Worked example

Given: A long forward fixes purchase at $70; the asset ends at $76.
Calculate / decide: 76 - 70.
Result: The long’s expiration payoff is $6 per unit before other costs.

Watch for: The agreed delivery price is not the same as the contract’s current value.

Practise this idea

METHOD 02

Separate payoff from profit

Call payoff = max(S - K, 0); put payoff = max(K - S, 0)

Calculate exercise value before incorporating the premium.
Subtract the premium to find the buyer’s profit when financing is ignored.
The buyer’s limited loss does not imply the writer has the same risk limit.

Worked example

Given: A call has strike $40, expiry stock price $47 and premium $3; ignore financing.
Calculate / decide: Payoff = 47 - 40 = 7; profit = 7 - 3.
Result: Payoff is $7 and buyer profit is $4 per share.

Watch for: An in-the-money option can still produce a loss after the premium.

Practise this idea

METHOD 03

Use matching cash-flow packages

European call + PV(strike) = stock + European put

Use the same underlying, strike and expiry in parity comparisons.
With no income or storage costs, forward price = spot × (1 + annual funding rate)^years.
A pricing relationship is not a forecast of the eventual spot price.

Worked example

Given: Stock $60, European call $5 and present value of strike $58; no dividends.
Calculate / decide: Put = call + PV(strike) - stock = 5 + 58 - 60.
Result: Put value is $3 under the matching-contract assumptions.

Watch for: Parity does not directly apply to a mismatched expiry or an omitted dividend cash flow.

Practise this idea

METHOD 04

Offset the exposure

Underlying loss → offsetting derivative gain

State which price movement harms the business or investor.
Choose a derivative direction that offsets that movement.
Keep basis, quantity, liquidity and counterparty risks visible.

Worked example

Given: A producer will sell a crop later and worries about a lower sale price.
Calculate / decide: A short forward gains when the reference price falls.
Result: Selling forward can offset price risk; quantity and basis mismatches may remain.

Watch for: A hedge can reduce an exposure without eliminating every source of uncertainty.

Practise this idea

Questions about this topic

How does an option differ from a forward obligation?: A plain long option gives a right to exercise according to its terms, while a forward creates an obligation to transact at the agreed terms. The payoff and initial-cost structure differ, so identify the contract first.
Is payoff the same as profit?: No. An option payoff at expiry does not deduct the initial premium or account for its financing. A profit calculation must include the relevant cost under the question’s assumptions.
Why does a long or short label matter?: It determines the direction of the contractual exposure. The same change in an underlying value can have opposite effects on otherwise matching long and short positions.

Sources and curriculum scope

Official outlines establish curriculum scope. The explanations and worked examples are independent teaching material; the sources do not verify or endorse them.

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One worked example, from facts to answer

Given

Method

Answer and interpretation

10 free Derivatives questions

A long forward has a delivery price of $80 and the underlying is worth $86 at expiration. Ignoring costs, its payoff per unit is:

A short forward commits to sell at $95; the asset is worth $88 at expiration. Its payoff per unit is:

Which feature most directly distinguishes a futures contract from a typical forward contract?

A call expires with stock price $63 and strike $55. The buyer paid a $4 premium. Ignoring financing, the buyer’s profit is:

A put has strike $45 and expires with the stock at $38. What is its exercise payoff per share, before premium?

An investor buys a call for $5. It expires out of the money. Ignoring financing and fees, the investor’s loss is:

A non-income-producing asset costs $100. With frictionless markets, no storage cost and a 5% annual funding rate, its one-year forward price is:

For matching European options on a non-dividend-paying stock, S = $50, call = $4 and PV(strike) = $48. Put-call parity implies a put price of:

A wheat producer expects to sell a known quantity at harvest and wants to reduce the risk of a lower reference price. The natural forward hedge is to:

A company hedges a local commodity price using a futures contract on a similar, but not identical, commodity. Which risk can remain?

Find the method you need

Identify what was promised

Worked example

Separate payoff from profit

Worked example

Use matching cash-flow packages

Worked example

Offset the exposure

Worked example

Questions about this topic

Sources and curriculum scope