NISM Series XXI-B · Unit 4 of 12 · about 8% of the paper
Derivatives and mutual funds: NISM Series XXI-B notes and practice questions
Futures and options, how portfolio managers use them, and mutual funds as a comparison and a building block.
What to know in Unit 4
- Futures and options.
- Hedging uses.
- Mutual fund structure and measures.
Key terms, examples and exam traps
Derivative
A derivative is a contract whose value is derived from an underlying asset, index or rate.
Example. A futures contract on an index.
Exam trap. This statement is false: A derivative has its own value independent of any underlying.
Futures contract
A futures contract is a standardised agreement to buy or sell an asset at a set price on a future date, with daily settlement.
Example. A manager sells index futures to cover a falling market.
Exam trap. This statement is false: A futures contract gives only the right, not the obligation, to trade.
Option
An option gives the buyer the right but not the obligation to buy or sell at a strike price, for a premium paid to the seller.
Example. A put option protects a holding against a fall.
Exam trap. This statement is false: The option buyer must always exercise.
Hedging
Hedging uses derivatives to reduce an existing risk, such as selling futures against a stock portfolio.
Example. A manager hedges a portfolio before an election.
Exam trap. This statement is false: Hedging always raises expected return.
Protective put
A protective put combines a long stock holding with a bought put to set a floor on loss.
Example. A holder buys puts and limits downside.
Exam trap. This statement is false: A protective put removes the cost of insurance.
Covered call
A covered call is a long stock holding with a call sold against it, earning premium but capping upside.
Example. A holder writes calls to earn extra income.
Exam trap. This statement is false: A covered call has unlimited upside.
Margin
Exchange-traded derivatives require margin as a deposit that covers possible losses, and it is adjusted with price moves.
Example. A trader posts margin when buying futures.
Exam trap. This statement is false: Margin is a fee that is never refunded.
Mutual fund structure
A mutual fund is a trust that pools investor money, run by an AMC, with a trustee and a custodian providing oversight and safekeeping.
Example. Investors hold units in a pooled trust.
Exam trap. This statement is false: A mutual fund is a company owned by its AMC.
NAV
NAV is the value of a fund's assets less liabilities divided by the units outstanding.
Example. A fund with ₹100 crore of net assets and 10 crore units has NAV of ₹10.
Exam trap. This statement is false: NAV is set by the fund's demand in the market.
Expense ratio
The expense ratio is the annual cost of running a fund, charged as a percentage of assets and reducing returns.
Example. A fund charges 1% a year.
Exam trap. This statement is false: Expenses are charged only when the fund makes a profit.
Derivatives in portfolios
Portfolio managers may use derivatives for hedging, portfolio rebalancing and as permitted by the agreement and regulations, with disclosure of the approach.
Example. A manager discloses a hedging approach to clients.
Exam trap. This statement is false: Derivatives may be used freely without disclosure.
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 statement best describes “Derivatives in portfolios”?
- A return objective states the return a portfolio needs, taking in the client's goals, inflation and the risk the client can accept.
- Overconfidence is overestimating one's own skill and information, which can lead to excess trading.
- Portfolio managers may use derivatives for hedging, portfolio rebalancing and as permitted by the agreement and regulations, with disclosure of the approach.
- DCF values a business as the present value of its expected future cash flows, discounted at a rate reflecting risk.
Q2. Which term is described here? A mutual fund is a trust that pools investor money, run by an AMC, with a trustee and a custodian providing oversight and safekeeping.
- Diversification
- Risk tolerance and ability
- Investment constraints
- Mutual fund structure
Q3. Which term is described here? Exchange-traded derivatives require margin as a deposit that covers possible losses, and it is adjusted with price moves.
- Primary market
- Clearing and settlement
- Margin
- Coupon and face value
Q4. Which statement best describes “Option”?
- Client funds and securities must be kept separate from the manager's own, with separate bank and demat accounts for clients.
- A protective put combines a long stock holding with a bought put to set a floor on loss.
- The manager must act in clients' best interest, disclose conflicts and treat clients fairly in allocating trades.
- An option gives the buyer the right but not the obligation to buy or sell at a strike price, for a premium paid to the seller.
Q5. Which term is described here? A covered call is a long stock holding with a call sold against it, earning premium but capping upside.
- Equity ownership
- Covered call
- Portfolio return
- Market intermediaries
Q6. Which statement best describes “Derivative”?
- The SML plots expected return against beta, and securities above the line are undervalued.
- A derivative is a contract whose value is derived from an underlying asset, index or rate.
- Rebalancing creates transaction costs and may create tax, which must be weighed against the benefit of risk control.
- A portfolio manager must be registered with SEBI and must meet the eligibility, capital and fit and proper requirements.
Frequently asked questions
How much of NISM Series XXI-B comes from Unit 4?
Unit 4 (Derivatives and mutual funds) usually carries about 8% of the questions. The whole exam has 120 questions and the pass mark is 60%.
What should I study in NISM Series XXI-B Unit 4?
Futures and options. Hedging uses. Mutual fund structure and measures.
Are these NISM Series XXI-B practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
Next
UpperCrust Academy is independent study material from UpperCrust Wealth. It is not affiliated with NISM, SEBI or AMFI. For education only. Not investment advice. Always confirm the latest syllabus and rules on the official NISM website.