A replicating portfolio for a derivative security is
A) A portfolio consisting of long and short positions in the derivative.
B) A portfolio that has the same payoffs as the derivative.
C) A portfolio that has payoffs at least as great as, and in some states greater than, the payoffs from the derivative.
D) A portfolio that combines the derivative with another derivative on the same underlying so as to make the portfolio riskless.

Question

A replicating portfolio for a derivative security is 
A) A portfolio consisting of long and short positions in the derivative.
B) A portfolio that has the same payoffs as the derivative.
C) A portfolio that has payoffs at least as great as, and in some states greater than, the payoffs from the derivative.
D) A portfolio that combines the derivative with another derivative on the same underlying so as to make the portfolio riskless.

Quizplus · Accepted Answer

A replicating portfolio for a derivative security is a portfolio that can generate the same payoffs as the derivative security. Therefore, option B is the correct choice. Option A refers to a combination of long and short positions, which may not necessarily replicate the derivative security. Option C implies the possibility of better payoffs, which is not necessarily true for a replicating portfolio. Option D refers to a riskless portfolio created by combining the derivative with another derivative, which is not necessary to replicate the derivative security.

A Replicating Portfolio for a Derivative Security Is