2025 CFA Program Curriculum Level III Core Volume 4: Derivatives and Risk Management
CONTENTS
How to Use the CFA Program Curriculum vii
CFA Institute Learning Ecosystem (LES) vii
Designing Your Personal Study Program vii
Errata viii
Other Feedback viii
Derivatives and Risk Management
Learning Module 1 Options Strategies 3
Introduction 4
Position Equivalencies 4
Synthetic Forward Position 5
Synthetic Put and Call 8
Covered Calls and Protective Puts 9
Investment Objectives of Covered Calls 10
Investment Objectives of Protective Puts 19
Loss Protection/Upside Preservation 20
Profit and Loss at Expiration 22
Equivalence to Long Asset/Short Forward Position 24
Writing Puts 25
Risk Reduction Using Covered Calls and Protective Puts 27
Covered Calls 27
Protective Puts 28
Buying Calls and Writing Puts on a Short Position 28
Spreads and Combinations 31
Bull Spreads and Bear Spreads 32
Straddle 40
Collars 43
Calendar Spread 46
Implied Volatility and Volatility Skew 48
Investment Objectives and Strategy Selection 52
The Necessity of Setting an Objective 52
Criteria for Identifying Appropriate Option Strategies 53
Options in Portfolio Management 55
Covered Call Writing 55
Put Writing 57
Long Straddle 59
Collar 61
Calendar Spread 61
Hedging an Expected Increase in Equity Market Volatility 64
Establishing or Modifying Equity Risk Exposure 66
Summary 69
Practice Problems 71
Solutions 78
Learning Module 2 Swaps, Forwards, and Futures Strategies 83
Managing Interest Rate Risk with Swaps 83
Changing Risk Exposures with Swaps, Futures, and Forwards 84
Managing Interest Rate Risk with Forwards and Futures 88
Fixed-Income Futures 90
Managing Currency Exposure 95
Currency Swaps 95
Currency Forwards and Futures 98
Managing Equity Risk 99
Equity Swaps 100
Equity Forwards and Futures 102
Cash Equitization 105
Volatility Derivatives: Futures and Options 105
Volatility Futures and Options 106
Volatility Derivatives: Variance Swaps 108
Using Derivatives in Asset Allocation 111
Solution: 112
Cash Equitization 112
Using Derivatives in Asset Allocation 113
Changing Allocations between Asset Classes Using Futures 113
Rebalancing an Asset Allocation Using Futures 116
Changing Allocations between Asset Classes Using Swaps 117
Using Derivatives to Infer Market Expectations 119
Using Fed Funds Futures to Infer the Expected Average Federal Funds Rate 120
Inferring Market Expectations 121
Summary 122
Practice Problems 124
Solutions 132
Learning Module 3 Currency Management: An Introduction 141
Introduction 141
Foreign Exchange Concepts 142
Spot Markets 143
Forward Markets 145
FX Swap Markets 147
Currency Options 148
Currency Risk and Portfolio Risk and Return 149
Return Decomposition 149
Volatility Decomposition 151
Strategic Decisions in Currency Management 154
The Investment Policy Statement 155
The Portfolio Optimization Problem 155
Choice of Currency Exposures 156
Spectrum of Currency Risk Management Strategies 160
Passive Hedging 160
Discretionary Hedging 160
Active Currency Management 16
Currency Overlay 161
Formulating a Currency Management Program 164
Economic Fundamentals, Technical Analysis and the Carry Trade 166
Active Currency Management Based on Economic Fundamentals 167
Active Currency Management Based on Technical Analysis 168
Active Currency Management Based on the Carry Trade 170
Volatility Trading 172
Forward Contracts, FX Swaps, and Currency Options 177
Forward Contracts 177
Currency Options 184
Currency Management Strategies 187
Over-/Under-Hedging Using Forward Contracts 188
Protective Put Using OTM Options 188
Risk Reversal (or Collar) 189
Put Spread 189
Seagull Spread 190
Exotic Options 191
Section Summary 192
Hedging Multiple Foreign Currencies 195
Cross Hedges and Macro Hedges 195
Minimum-Variance Hedge Ratio 198
Basis Risk 198
Currency Management Tools and Strategies: A Summary 201
Currency Management for Emerging Market Currencies 205
Special Considerations in Managing Emerging Market Currency Exposures 206
Non-Deliverable Forwards 207
Summary 208
References 212
Practice Problems 213
Solutions 225
Glossary G-1