NISM Series V-D · Unit 6 of 12 · about 10% of the paper
Basics of derivatives and understanding index: NISM Series V-D notes and practice questions
What derivatives are, who uses them, the types of contracts and how stock indices are built.
What to know in Unit 6
- Hedgers, speculators, arbitrageurs.
- Forwards, futures, options, swaps.
- Index construction.
Key terms, examples and exam traps
Derivative
A derivative is a contract whose value is derived from an underlying asset such as a share, index, currency or interest rate.
Example. An index future derives its value from the index.
Exam trap. This statement is false: A derivative has a value independent of any underlying.
Hedger
A hedger uses derivatives to reduce an existing risk.
Example. A fund holding shares sells index futures to protect against a fall.
Exam trap. This statement is false: A hedger takes derivative positions to increase risk.
Speculator
A speculator takes a view on price movements and accepts risk in hope of profit.
Example. A trader buys futures expecting the index to rise.
Exam trap. This statement is false: A speculator uses derivatives to remove risk.
Arbitrageur
An arbitrageur exploits price differences between related markets to earn riskless profit.
Example. A trader buys in the cash market and sells in the futures market when they are mispriced.
Exam trap. This statement is false: An arbitrageur depends on the market direction.
Types of derivatives
The main types are forwards, futures, options and swaps.
Example. A fund uses futures and options on an index.
Exam trap. This statement is false: Shares and bonds are derivatives.
Exchange-traded and OTC
Exchange-traded derivatives are standardised and cleared through a clearing corporation, while OTC derivatives are customised and privately negotiated.
Example. Index futures trade on an exchange.
Exam trap. This statement is false: OTC derivatives are traded on exchange with standard terms.
Underlying
The underlying is the asset, rate or index from which the derivative gets its value.
Example. An option on the Nifty has the Nifty index as the underlying.
Exam trap. This statement is false: The underlying is the derivative contract itself.
Stock index
A stock index measures the value of a basket of shares to show the market's movement.
Example. The Nifty 50 tracks 50 large stocks.
Exam trap. This statement is false: An index tracks a single stock.
Free-float market capitalisation
Index weights are commonly based on free-float market capitalisation, which counts only the shares available for public trading.
Example. A company with a large promoter holding gets a lower weight than its full market cap.
Exam trap. This statement is false: Free-float counts shares held by promoters.
Index uses
Indices are used as benchmarks, for index funds and ETFs and as the underlying for futures and options.
Example. A fund compares itself with its benchmark index.
Exam trap. This statement is false: Indices cannot be used for investing.
Systematic and unsystematic risk
Systematic risk affects the whole market and cannot be diversified away, while unsystematic risk is specific to a company and can be diversified.
Example. An index future hedges market risk.
Exam trap. This statement is false: Index futures hedge company-specific risk completely.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which term is described here? A derivative is a contract whose value is derived from an underlying asset such as a share, index, currency or interest rate.
- Long-short use
- Gross exposure cap
- Derivative
- Equity Long-Short
Q2. Which statement best describes “Systematic and unsystematic risk”?
- The hedge ratio gives the number of futures contracts needed to offset the portfolio's interest rate sensitivity, using the PV01 of the portfolio and the future.
- Systematic risk affects the whole market and cannot be diversified away, while unsystematic risk is specific to a company and can be diversified.
- AMCs pay trail commission to distributors for regular plans and this must be disclosed to investors.
- A long-short equity fund buys stocks expected to rise and uses futures or options to short those expected to fall, reducing market exposure.
Q3. Which term is described here? A hedger uses derivatives to reduce an existing risk.
- Standard deviation
- Hedger
- Basis risk in IRF
- Mark-to-market in IRF
Q4. Which statement best describes “Underlying”?
- An arbitrageur exploits price differences between related markets to earn riskless profit.
- Systematic risk affects the whole market and cannot be diversified away, while unsystematic risk is specific to a company and can be diversified.
- The main types are forwards, futures, options and swaps.
- The underlying is the asset, rate or index from which the derivative gets its value.
Q5. Which statement best describes “Index uses”?
- A SIF is a SEBI-regulated investment product launched by an AMC for investors who want more sophisticated strategies than regular mutual funds, with a higher minimum investment.
- Investors must complete KYC with proof of identity and address and PAN before investing in funds.
- Indices are used as benchmarks, for index funds and ETFs and as the underlying for futures and options.
- The riskometer shows a scheme's risk on six levels from low to very high and must be shown on scheme documents.
Q6. Which statement best describes “Speculator”?
- Equity arbitrage funds exploit price differences between cash and futures markets, with the futures sold against the shares bought.
- AMFI is the industry body of AMCs that promotes standards, sets code of conduct for distributors and registers them with an ARN.
- Investors can complain to the AMC, then to SEBI's complaint system and use online dispute resolution if unresolved.
- A speculator takes a view on price movements and accepts risk in hope of profit.
Frequently asked questions
How much of NISM Series V-D comes from Unit 6?
Unit 6 (Basics of derivatives and understanding index) usually carries about 10% of the questions. The whole exam has 150 questions and the pass mark is 60%.
What should I study in NISM Series V-D Unit 6?
Hedgers, speculators, arbitrageurs. Forwards, futures, options, swaps. Index construction.
Are these NISM Series V-D practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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