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Answer: In distinguishing from an arbitrage or a hedge, the key feature of a speculation is the use of high leverage
**Correct answer: B** Speculation is primarily identified by the intent to profit from expected price movements, and it often involves **high leverage** because derivatives can create large gains or losses relative to the initial cash outlay. Why the other choices are not the best answer: - **A** describes a characteristic of a hedge with no basis risk, not speculation. - **C** is false because call options can be used for both speculation and hedging depending on the investor’s objective. - **D** is a general pricing assumption in derivatives theory, but it does not identify whether a specific position is speculation. Therefore, the feature most indicative of speculation is **high leverage**.
Author: Manit Arora
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Question 707.1. PlanetZim Financial Bank just entered a position in a derivatives contract. Which of the following features of the derivative position is MOST likely to indicate the trade is a case of SPECULATION, in contrast to a case of a hedge, arbitrage, or market-making?
A
If a hedge has no basis risk, then the hedged outcome is always superior to the unhedged outcome
B
In distinguishing from an arbitrage or a hedge, the key feature of a speculation is the use of high leverage
C
Although put options can be used as a hedge or insurance, a position in call options implies the investor is speculating rather than hedging
D
In Hull, the theoretical price of futures contracts and stock options (per Black-Scholes Merton) depend on the assumption that no riskless arbitrage opportunities exist
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