Hi,
Can someone please explain why option A is incorrect.
Question : A derivative is best described as financial instrument that derives its performance by:
A) passing through the returns of the underlying.
B) replicating the performance of the underlying.
C)transforming the performance of the underlying
Greetings friend! Think of it this way - derivatives allow folks to participate in the returns of some asset without actually needing to own that asset. In this manner, derivative products pass the returns of the underlying asset through to the derivative product owner.
Consider the following scenario: you purchase an at the money call option and sell an at the money put option on a certain stock. The 2 options together create a synthetic long position in the underlying stock. You don’t own the underlying, you just own options (which are derivatives). But this combination of options passes the underlying stock’s return to you as if you owned it. Since a derivative’s value is based on the underlying asset’s value, they pass the underlying asset’s returns to you they aren’t merely replicating it.
Cheers - good luck - you got this👍