Derivatives and Risk Management: CFA® Level III

It is 10–15% of the 2027 Level III exam. 25 learning outcomes across 3 learning modules.

32 practice questions and 7 formula cards on this topic in the app.

Options Strategies

• Show how a combination of options can reproduce the return profile of an underlying asset
• Explain a covered call: why an investor writes one, how it is built, its payoff and value at expiry, its risks and profit, the most it can gain or lose, and the underlying price at which it breaks even
• Explain a protective put: the objective it serves, how it is constructed, its expiry payoff and value, its profit and risks, the most it can gain or lose, and the underlying price at which it breaks even
• Contrast the deltas of a covered call and a protective put with that of an asset held long and hedged by a short forward
• Weigh buying a call against writing a put as ways to modify a short position in the underlying
• Explain, for bull and bear spreads, straddles and collars, the objective, structure, payoffs, risks, value and profit at expiry, maximum gain and loss, and the underlying price at which each breaks even
• Explain what calendar spreads are used for
• Interpret the volatility smile and skew
• Select and assess option strategies that fit a stated investment objective
• Show how options can be used to reach a chosen level of equity risk exposure

Swaps, Forwards, and Futures Strategies

• Show how interest rate futures, forwards and swaps can reshape the risk and return of a portfolio
• Illustrate how currency forwards, futures and swaps alter the risk and return of a portfolio
• Illustrate how equity futures, forwards and swaps can change a portfolio's return and risk profile
• Show how volatility derivatives, including variance swaps, are used in practice
• Show how derivatives can set a portfolio's equity and interest rate exposures at chosen targets
• Illustrate how derivatives serve in asset allocation and rebalancing and in extracting market expectations from prices

Currency Management: An Introduction

• Analyse how exchange rate changes affect the risk and return of a portfolio
• Explain the strategic decisions available in managing currency exposure
• Design a suitable currency management programme in light of market conditions and the portfolio's objectives and constraints
• Contrast active currency approaches that rely on fundamentals-based valuation, technical analysis, carry trades or trading volatility
• Explain how shifts in the drivers of active currency strategies alter tactical positioning
• Explain how hedge ratios are adjusted using currency forwards and foreign exchange swaps
• Explain techniques that cut the cost of hedging and alter the risk and return profile of a portfolio holding foreign-currency assets
• Explain the role of minimum-variance hedge ratios, macro-hedges and cross-hedges for portfolios exposed to several foreign currencies
• Explain the difficulties of managing currency exposure in emerging markets