Association for Financial Professionals (AFP) Practice Exam

Disable ads (and more) with a membership for a one time $2.99 payment

Prepare for the Association for Financial Professionals Exam. Utilize flashcards and multiple-choice questions with hints and explanations. Ace your exam!

Each practice test/flash card set has 50 randomly selected questions from a bank of over 500. You'll get a new set of questions each time!

Practice this question and more.

Which type of derivatives contract requires the holder to pay a premium to the writer?

Forwards
Swaps
Futures
Options

The correct answer is: Options

In the context of derivatives, options are unique because they give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price within a certain timeframe. To obtain this right, the holder must pay a premium to the writer (or seller) of the option. This premium compensates the writer for the potential risk associated with the position they are taking on. In contrast, forwards, swaps, and futures contracts do not involve a premium payment. Forwards are agreements between two parties to buy or sell an asset at a future date for a price agreed upon today, without any upfront payment. Swaps involve exchanging cash flows between parties, typically based on interest rates or currencies, and they too do not require an initial premium. Futures contracts obligate the buyer to purchase, and the seller to sell, an asset at a predetermined future date and price, again without any upfront payment. Therefore, the defining characteristic of options requiring payment of a premium makes them distinct from the other types of derivatives mentioned.