Question

An option is simply a derivative security, where price depends on the price of other securities or assets

a. true
b. false

Answer 1

The statement is **true**.

An option is a type of derivative security whose value is derived from the value of an underlying asset, such as stocks, bonds, commodities, or market indices. The price of an option is intrinsically linked to the price movement of the underlying asset.

Options grant the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price (strike price) within a specified period (until expiration) in exchange for a premium paid upfront. The value of the option is influenced by various factors, including the price of the underlying asset, time to expiration, volatility, interest rates, and dividend payments.

As a derivative, an option's price is directly impacted by changes in the price of the underlying asset. Therefore, the statement accurately describes an option as a derivative security whose price depends on the price movement of other securities or assets.

Answer 2

True, an option is a derivative security with a price that depends on other assets or securities. They are complex instruments that can serve for hedging or speculation and are used in various financial strategies, but can cause financial distress if not managed carefully.

Step-by-step explanation:

True, an option is indeed a type of derivative security whose price is dependent on the value of other assets or securities. Derivatives include a broad category of financial instruments such as options, futures, and swaps. The value of these instruments is derived from the price movements of the underlying assets, which can be stocks, bonds, commodities, market indices, currencies, or interest rates. Options give the holder the right, but not the obligation, to buy or sell the underlying asset at a predetermined price within a specified timeframe. They are complex financial instruments that can be used for hedging risk or for speculative purposes.

For example, if we consider mortgage-backed securities, which are a type of derivative, they derive their value from mortgage payments and housing prices. As observed during the financial crisis, when thousands of mortgages failed, the derivatives tied to those mortgages also saw a significant impact on their valuations. Derivatives like these can be instruments for risk management; however, if not understood properly, they can lead to substantial financial turmoil.