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Answer: Forward contracts are linear derivatives that require one party to the contract to make the payment at the pre-specified price and the other to deliver the underlying asset.
C is correct. Forward contracts are linear derivatives because their payoff is linearly related to the value of the under-lying asset at maturity and both parties are obligated to fulfill terms of the contract. A is incorrect. The value of underlying determines the value of the derivative contract, not the other way around. B is incorrect. Options are an example of non-linear derivatives because the payoff is not linearly related to the stock price but is zero if the option is not exercised. D is incorrect. Forward contracts are linear derivatives whose value is determined only by the price of the underlying, interest rate and time, not volatility of underlying.
Author: LeetQuiz Editorial Team
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A junior analyst working at an investment firm is analyzing the characteristics and distinctions between two types of derivative contracts: options and forward contracts. Specifically, the analyst is aiming to understand the differences between linear derivatives, such as forward contracts, and non-linear derivatives, such as options. Which of the following statements is most likely accurate based on the analyst's investigation into derivative contracts?
A
The value of the underlying asset in a contract is determined by the value of the contract in both linear and non-linear derivatives.
B
Options are linear derivatives that give the holder the right but not the obligation to buy or sell the underlying asset.
C
Forward contracts are linear derivatives that require one party to the contract to make the payment at the pre-specified price and the other to deliver the underlying asset.
D
The value of a forward contract is determined by both the price of the underlying asset and the volatility of the price.
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