Explanation:
The correct answer is A.
Frank Oliver is only correct regarding the first stage of the derivatives trade cycle. The execution stage, as he described, is indeed where parties agree to the legal obligation of buying or selling the underlying against a cash flow determined by a variable. This is the stage where the overall parameters of trading activities are established through a bilateral master agreement. This agreement is a document that sets out standard terms that apply to all the transactions entered into between parties. At this stage, the derivatives desk also conducts credit reviews to establish credit lines and trading limits. Therefore, Oliver's description of the execution stage is accurate.
Choice B is incorrect. Oliver's description of the clearing stage is not accurate. The clearing stage in a derivatives trade cycle involves the process of updating the accounts of the parties involved in a transaction, not exchanging underlying securities and cash. This step ensures that both parties have sufficient funds to meet their obligations and mitigates credit risk.
Choice C is incorrect. Oliver's explanation of the settlement stage is also inaccurate. Settlement refers to the actual exchange of money and securities between buyer and seller, not maintaining margins or fulfilling contract obligations.
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Q.844 Frank Oliver is the head of the derivatives trading unit of an investment company. Apart from looking after derivative investments, his job description also includes the supervision of a dozen derivatives traders. In a post-market review session, Oliver made the following points regarding the cycle of a derivatives trade:
I. The first stage is the execution, in which parties agree to the legal obligation of buying or selling the underlying against a cash flow determined by a variable
II. The second stage is the clearing stage, where the underlying securities and cash is exchanged
III. The third stage is the settlement, where the margins are maintained trade is settled, and the obligation of the contract is fulfilled
Determine if Oliver's comments are accurate.
A
He is only correct regarding the first stage of the derivatives trade cycle.
B
He is only correct regarding the second stage of the derivatives trade cycle.
C
He is only correct regarding the third stage of the derivatives trade cycle.
D
He is correct regarding all stages of the derivatives trade cycle.