Financial Accounting and Reporting-CPA Practice Exam

Which of the following is NOT a common type of derivative?

1. Options Contract

2. Stock Contract

3. Futures Contract

4. Swap Contract

The correct answer is: Stock Contract

In the realm of financial derivatives, common types include options contracts, futures contracts, and swap contracts. Each of these serves specific purposes in risk management and investment strategies. An options contract provides the purchaser the right, but not the obligation, to buy or sell an underlying asset at a predetermined price before a certain date. This flexibility allows investors to hedge or speculate based on anticipated price movements. A futures contract obligates the parties to buy or sell an asset at a predetermined future date and price. Futures are standardized and traded on exchanges, allowing for liquidity and effective price discovery. A swap contract involves the exchange of cash flows or liabilities between two parties, typically related to interest rates, currency, or commodities. Swaps are often used to manage exposure to fluctuations in interest rates and currencies. In contrast, a stock contract is not a standard derivative type. While one can create contracts based on stocks, such as options on stock or futures on stock indexes, stock contracts themselves do not represent a derivative financial instrument with specific underlying mechanisms like the recognized categories mentioned. This distinction is significant in financial reporting and accounting, as derivatives must meet specific definitions and characteristics as defined by accounting standards.