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February 21, 2025
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Although derivatives are a small part of the CFA® Level I exam, it’s present at all three levels so it’s important for you to gain a solid understanding of the fundamental concepts at this stage of your candidacy.
Derivative Markets and Instruments
Forward Commitment and Contingent Claim Features and Instruments
Derivative Benefits, Risks, and Issuer and Investor Uses
Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
Pricing and Valuation of Forward Contracts and for an Underlying with Varying Maturities
Pricing and Valuation of Futures Contracts
Pricing and Valuation of Interest Rates and Other Swaps
Pricing and Valuation of Options
Option Replication Using Put-Call Parity
Valuing a Derivative Using a One-Period Binomial Modal
Derivatives can be an abstract topic if it's not something you’ve studied or experienced before. Each LOS reading for derivatives is relatively short compared to the rest of the CFA curriculum. It’s also weighted low on the exam alongside Portfolio Management and Alternative Investments.
Take each reading in turn and focus on understanding the concepts and terminology used, making sure you’re happy with the differences between the different types of derivatives.
Learning Outcome Statements while studying for a CFA exam refer to specific skills and concepts you should possess within an exam topic whereas exam topics describe the broader body of knowledge you should have. For example, the Derivatives exam topic at Level I has lots of LOSs that you’ll need to learn.
An example of a CFA LOS for Derivatives is “describe the basic features of derivative markets, and contrast over-the-counter and exchange-traded derivative markets.”
Learn about important Derivative concepts covered on CFA exams.
Alongside Alternative Investments, the Derivatives topic introduces investment possibilities to candidates beyond the typical Equity and Fixed Income markets. This may be an area you have been exposed to already in your career, but if not, it’s likely to be something you come across later on. It is present at all three levels of the CFAI curriculum and will help your broader understanding.
The Derivatives topic represents 5%-8% of the Level I exam, meaning approximately 9-15 questions. It is tested in the afternoon session, within the Assets Functional Area, alongside Equity Investments, and Fixed Income.
The level and quantity of technical content tested at Level I for Derivatives is a lot less than for Topics such as Fixed Income. However, if it is something you have no prior knowledge or experience with, then many candidates do find Derivatives challenging to start with, as it can feel quite abstract in nature.
Focus on understanding the different types of derivatives and the key terminology which will be crucial for the exam. Remember the small weighting and try not to get too bogged down in the calculations which will only form a very small part of your exam.
Derivatives is a standalone topic, so it can be studied at any point. Some candidates like to study Derivatives alongside the other topics it is tested on exam day:
This helps understand the differences (and similarities) between the different assets. Make sure you study Derivatives after Quantitative Methods as the Binomial Model techniques will be mentioned again here.
Below are overviews of each Level I Derivatives readings and what you are expected to learn.
A derivative is a security that derives its value from the value of another security or a variable (such as an interest rate). This reading introduces us to key terminology used within this Topic, alongside the differences between over-the-counter and exchange-traded derivative markets.
This reading begins by defining the four key types of derivatives. It covers how to calculate the value and profit/loss on a call or put option, and compares forward commitments to contingent claims (such as options).
The four key types of derivatives included in the CFA syllabus are:
Forwards
Futures
Options
Swaps
What attracts investors to derivatives? This reading looks at the benefits and risks of derivatives compared to traditional investments, and how different issuers and investors use them.
This is an important reading which introduces two key terms - the concept of arbitrage (or more specifically, the fact that the valuation of derivatives is based on ‘no-arbitrage’), and replication. You will also learn about how the cost of carry accounts for some of the difference between spot and expected future prices.
The first of four readings focus on specific derivatives. This is where you will learn how to calculate the value and price of a forward contract at initiation, during its life, and at expiration.
Pay particular attention to the difference between the definitions of value and price. This reading also covers how to determine a forward rate, given various other spot and forward rates.
The focus again here is on the calculation of the value and price of a futures contract at various points in its life and comparing and contrasting this with forward prices.
Swaps can be described as a series of forward contracts, and this reading looks at this in more detail as well as considering the value and price of a swap (although not in as much detail as in the Forwards reading).
The final pricing and valuation reading looks at options and various terminology used such as exercise value and moneyness. It looks in detail at the factors which affect the value of an option (such as the volatility of the underlying asset), as well as brings in the arbitrage and replication concepts introduced earlier.
Building on the replication from the previous reading, you will learn some formulae here to help answer put-call parity questions in the exam. This is then expanded to introduce the put-call forward parity formula which can also be examined.
A somewhat standalone reading to end the Topic, you are introduced here to the binomial model which is used to value a derivative. This model was introduced in Quantitative Methods so may be familiar, and will be used in more detail at Level II.
There are no specific calculation functions to learn for Derivatives but do make sure you spend the time practicing and familiarizing yourself with the various formulae throughout this Topic (paying particular attention to the addition and subtraction signs.)
Learn about the TI BAII Plus, including how to set it up, store and retrieve results, do combination and permutation and calculations, calculate the time value of money, and more.
Answer these five questions to test your readiness for the Level I Exam.
The Derivatives topic is a similar size on the Level II exam as the Level I exam. The focus for Level II is on pricing and valuing forward commitments and contingent claims, which were briefly introduced at Level I.
We would recommend starting off by reading the Schweser CFA Level I SchweserNotes for Derivatives, which also provide illustrative examples and Module Quizzes for you to test your understanding. Once you have covered the material, you should cover as many other questions as possible from our range of resources such as the Schweser CFA Level I QBank.
Looking for more guidance on how to prepare for Derivatives? Enroll in one of our CFA Level I Premium study packages to receive expert instruction, CFA Program study materials, and more. Give yourself the best chance to prepare, practice, and perform on the CFA exam.
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