A derivative financial instrument is one which:
A. Creates a contractual link between two entities such that the financial asset or equity item of one entity becomes the financial liability of the other entity and there is a transfer of risks and returns.
B. Creates rights and obligations that have the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument.
C. Creates a contractual link between a secondary financial instrument and a primary financial instrument such that there is an ultimate transfer of a financial asset between the contracting parties.
D. Creates rights and obligations that have the effect of transferring the financial returns inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument.
E. None of the given answers.

Question

Quizplus · Accepted Answer

A derivative financial instrument creates rights and obligations that have the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument. Option A is describing a form of securitization, while option C is describing an asset swap. Option D is not entirely accurate, as derivatives can transfer both risks and returns, not just returns.

A Derivative Financial Instrument Is One Which