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Quizzes > Business & Management

Applied Derivative Strategies Quiz

Free Practice Quiz & Exam Preparation

Difficulty: Moderate
Questions: 15
Study OutcomesAdditional Reading
3D voxel art showcasing the course Applied Derivative Strategies

Boost your command of complex financial concepts with our Applied Derivative Strategies practice quiz, designed for students eager to master volatility trading and advanced derivatives techniques. This engaging quiz covers key topics such as the CBOE VIX product, OTC variance swaps, risk parity, risk premia capture, alternative risk premia, and volatility targeting, helping you solidify your skills and prepare for success in the dynamic world of derivatives trading.

What does the CBOE VIX index represent?
The market's expectation of near-term volatility derived from S&P 500 options
The market capitalization of blue-chip companies
The current trading volume of the S&P 500 index
The average dividend yield of S&P 500 stocks
The CBOE VIX is widely recognized as a gauge of market expectations for near-term volatility, computed from S&P 500 options. It serves as an important sentiment indicator, especially during market stress.
Which instrument is primarily traded over-the-counter (OTC) to capture realized variance?
Interest rate swap
Futures contract
Variance swap
Credit default swap
Variance swaps are OTC derivatives that allow market participants to trade future realized variance against a fixed strike. They provide exposure to volatility without the complexities of delta hedging associated with traditional options.
What does volatility targeting refer to in risk management?
Adjusting a portfolio's exposure to maintain a predetermined level of volatility
Holding fixed positions regardless of market volatility changes
Using options to completely eliminate volatility risk
Investing only in low-volatility stocks
Volatility targeting involves dynamically adjusting a portfolio's exposure so that overall volatility remains close to a predetermined level. This method helps manage risk and can improve risk-adjusted returns over varying market conditions.
Which strategy uses derivatives to reduce portfolio volatility while maintaining risk exposure?
Risk parity
Momentum trading
Buy and hold
High-frequency trading
Risk parity is a strategy that allocates risk equally across various asset classes rather than simply balancing capital. This approach typically uses derivatives among other instruments to manage and hedge risks while preserving desired exposures.
Which of the following best describes risk premia capture strategies?
Systematic extraction of return from various sources of risk
Hedging against price changes exclusively with options
Speculating solely on interest rate movements
Investing only in fixed income securities
Risk premia capture strategies are designed to systematically earn returns by taking advantage of various risk factors that are not captured by traditional market beta. They involve diversifying exposures to gain premium from sources like volatility, value, momentum, and others.
In an OTC variance swap, which parameter is directly exchanged between counterparties?
Interest rate exposure
Implied volatility
Realized variance
Time decay
Variance swaps settle based on the difference between the realized variance and a predetermined strike price. The focus is on capturing the actual variance observed over the life of the swap, making realized variance the key parameter.
Which of the following best describes the purpose of risk parity strategies in portfolio construction?
Focusing exclusively on equity returns
Balancing risk contributions from various asset classes
Concentrating risk in a single asset class for higher returns
Maximizing short-term gains from high volatility assets
Risk parity aims to balance the risk contributions from all components of a portfolio, not just the allocation of capital. This strategy leads to more diversified portfolios that manage volatility more effectively.
In volatility trading, what is the primary reason for using listed products across multiple asset classes?
To replicate market index performance exactly
To eliminate transaction costs entirely
To concentrate exposure in a single asset class
To diversify and hedge against market-specific volatility risks
Utilizing listed products across various asset classes allows for diversification, which is essential in hedging against risks unique to a single market. This approach enhances overall portfolio resilience by balancing different sources of volatility.
How does a volatility swap differ from traditional options trading?
It requires the physical delivery of the underlying asset
It involves trading the underlying asset instead of its derivative
It allows trading of volatility directly without taking a directional view on the underlying asset
It is available only for commodity markets
Volatility swaps enable traders to gain exposure solely to volatility, decoupling the trade from directional moves in the underlying asset. This feature distinguishes them from traditional options, which combine volatility and directional risk.
Alternative risk premia strategies typically involve which of the following?
Relying only on technical analysis for trade decisions
Speculative trading based solely on macroeconomic news
Systematic strategies that capture risk premia beyond traditional market exposures
Investing exclusively in government bonds
Alternative risk premia strategies focus on capturing returns from factors that are not associated with the traditional market beta. They use systematic approaches to harness risks like value, momentum, or carry, which often exhibit low correlation with the broader market.
What is one of the primary benefits of employing variance swaps in volatility trading?
They remove the need for any margin requirements
They completely eliminate all forms of market risk
They allow for pure exposure to volatility without the directional (delta) risk
They guarantee profits regardless of market conditions
Variance swaps offer a way to gain exposure solely to volatility, isolating it from directional risk associated with the underlying asset. This purity makes them attractive for strategies focused on volatility trading, though they do not eliminate all market risks.
Which risk management practice is inherently associated with volatility targeting?
Increasing leverage during periods of high volatility
Adjusting portfolio positions to maintain a set level of volatility
Relying solely on historical returns for risk assessment
Disregarding volatility trends when making investment decisions
Volatility targeting involves continuously adjusting a portfolio's exposure to ensure that overall volatility remains within predetermined limits. This method is used to mitigate risk, by reducing exposure in turbulent times and increasing it in calmer periods.
In constructing a volatility trading strategy using listed products, which factor is most critical?
Analyst recommendations
Liquidity of the instruments
Past performance of the instruments
Company earnings reports
Liquidity is crucial in volatility trading as it ensures that positions can be entered and exited efficiently with minimal transaction costs and slippage. Listed products must offer sufficient liquidity to allow for quick adjustments in response to market changes.
Why is implied volatility, as derived from option prices, not a perfect predictor of future realized volatility?
Because it is generally lower than realized volatility
Because it is strictly based on historical data
Because it ignores market uncertainty completely
Because it reflects market sentiment and includes a risk premium, not an unbiased forecast
Implied volatility incorporates market expectations, sentiment, and a risk premium, which means it does not solely represent a forecast of realized volatility. The inclusion of these elements makes it an imperfect predictor of future volatility levels.
Which of the following best explains the concept of 'volatility trading'?
Taking positions to profit from changes in volatility rather than price direction
Avoiding any exposure to market volatility
Investing solely based on dividend yields
Betting exclusively on rising stock prices
Volatility trading focuses on capitalizing on shifts in market volatility as opposed to relying on the directional movement of asset prices. This approach can provide opportunities during periods of market stress or uncertainty, by directly targeting changes in volatility.
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Study Outcomes

  1. Understand volatility trading principles and their applications to various asset classes.
  2. Analyze the pricing dynamics of CBOE VIX products and OTC variance swaps.
  3. Apply advanced options and derivatives strategies such as risk parity and alternative risk premia capture.
  4. Evaluate volatility targeting approaches within structured derivative portfolios.

Applied Derivative Strategies Additional Reading

Ready to dive into the world of applied derivative strategies? Here are some top-notch academic resources to enhance your understanding:

  1. Alternative Risk Premia: What Do We Know? This comprehensive paper delves into the concept of alternative risk premia, exploring systematic risk factors like carry and momentum across various asset classes. A must-read for grasping the nuances of risk premia in modern finance.
  2. Risk Premia: Asymmetric Tail Risks and Excess Returns This study investigates the relationship between risk premia and tail-risk skewness, offering insights into the Sharpe ratios of various strategies and their negative skewness. It's a fascinating read for understanding the risk-return dynamics in derivative strategies.
  3. Risk Parity Portfolios with Skewness Risk: An Application to Factor Investing and Alternative Risk Premia This article presents a model incorporating skewness risk into risk parity portfolios, providing analytical formulas and practical applications. It's particularly useful for those interested in portfolio optimization techniques.
  4. Second-order Risk of Alternative Risk Parity Strategies This paper analyzes the estimation risk in alternative risk parity strategies, offering both theoretical and empirical insights. It's essential for understanding the complexities of portfolio construction in the presence of model uncertainty.
  5. Incorporating Alternative Risk Premia into Balanced Portfolios: Is There Any Added Value? This study evaluates the impact of adding alternative risk premia products to traditional equity/bond portfolios, providing valuable insights for portfolio diversification strategies.
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