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Answer: A derivative contract allows a transfer of risks that is beneficial to both parties in the contract.
## Explanation **A is correct.** Derivative contracts allow risks to be transferred from one party to another in ways that benefit both sides. For example, a hedger can transfer price risk to a speculator who is willing to bear that risk for potential profit. **B is incorrect.** There are speculators and hedgers in both exchange-traded and over-the-counter markets. The distinction is not based on the type of market participant but rather on the structure and standardization of the contracts. **C is incorrect.** Complex derivatives created with mortgages (such as mortgage-backed securities and CDOs) actually increased the availability of mortgages and led to an increase in housing demand, which contributed to the severity of the 2007-2009 financial crisis rather than limiting it. **D is incorrect.** While forwards and futures have linear payoff functions, options have non-linear payoff functions. Options provide the right but not the obligation to buy or sell, creating asymmetric payoff profiles that are non-linear in nature. **Learning Objective:** Define derivatives, describe features and uses of derivatives, and compare linear and non-linear derivatives.
Author: LeetQuiz .
A risk manager at a bank is presenting at a seminar on derivative contracts to a group of newly hired junior analysts. The manager focuses on the features and uses of derivative contracts traded by financial market participants. Which of the following statements, if made by the manager, would be correct regarding these derivative contracts?
A
A derivative contract allows a transfer of risks that is beneficial to both parties in the contract.
B
Speculators use derivative contracts traded on exchanges, while hedgers use contracts traded in over-the-counter markets.
C
Complex derivatives created with mortgages by banks in the years leading up to the 2007 – 2009 global financial crisis limited demand for housing and reduced the severity of the crisis.
D
Derivative contracts such as forwards, futures, or options have linear payoff functions that depend on the value of the underlying asset.
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