9 Derivatives Interview Questions (With Sample Answers)

Updated 19 March 2023

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Interviews let hiring managers assess your applicable skills, technical expertise and personality to determine whether you are suitable for the role. If you want to pursue a career in finance, you are most likely to require clearing a formal interview process and proving your expertise. Learning more about the type of questions employers might ask about financial instruments, such as derivatives, can help you prepare for your interview. In this article, we share derivatives interview questions, discuss why interviewers might ask them and also provide sample answers to help you draft your own.

9 Derivatives Interview Questions With Sample Answers

Here are a few derivatives interview questions that interviewers might expect you to answer:

1. What do you understand by the term derivatives?

Interviewers might ask this question if they want to gauge whether you possess a basic understanding of the subject. Give a concise response to show that you understand the subject. Consider providing an example to show your knowledge.

Example answer: Usually regarded as financial contracts, derivatives are a crucial financial instrument which derives their value from their underlying spot price. For instance, a restaurant owner may agree on a price for ingredients or kitchen appliances in a contract with their respective suppliers to reduce the chance of prices rising in the future. This sort of contract takes place through the forward or futures market, which forms a major part of the derivative market.

2. How is a forward contract useful?

Hiring managers might question you about the forward contracts to assess your familiarity with the many sorts of contracts. Your response might also reflect how you think and make judgements, which can impact the decisions you might make for the business or the advice you give to clients. Explain the use cases for the forward contracts after outlining them at the outset of your response.

Example answer: A forward contract is an agreement between two parties to perform services or exchange goods or money at a future date for a particular amount and price. While the parties agree on the agreements, they exchange no products or money until the predetermined date. When speculating on possible pricing, this type of contract might be advantageous. For instance, if you possess data that suggests the cost of a specific commodity may rise in the future, using a forward contract to lock in the present, a more reasonable price for your exchange might be useful.

3. What are some common problems that affect forward markets?

Hiring managers can enquire about concerns that influence forward markets to assess how well you know the various market types. Being aware of the potential risks associated with particular markets can help you make wiser financial decisions, which can prove beneficial to future employers or clients. In your response, mention a few challenges with the forward markets and also consider describing how you resolved them.

Example answer: Several factors, such as a lack of liquidity and trading centralisation, may affect forward markets. But I believe that one of the main issues with the future markets is the length of some forward contracts' open periods, which may lead to counterparty risk. Longer-term forward contracts can cause fluctuation in prices, which can cause higher pricing and unfavourable outcomes. I always conduct an in-depth study into pricing trends and aim to establish forward contracts that are fairly brief to prevent this risk.

4. What is a futures contract and how is it useful?

Interviewers might test your knowledge about a futures contract by asking you this question. Provide a brief answer that helps them understand your expertise on the subject. Consider adding how futures contracts address the issues in the forward contracts.

Example answer: Futures markets try to resolve all three of the issues with the forward markets. In terms of fundamental economics, futures markets are identical to forward markets. But in futures contracts, agreements are standard and stock exchanges serve as the major hub for trade. The establishment of a clearing house, which acts as a counter-party to both sides of each transaction and guarantees the deal, eliminates counter-party risk. Contrary to the forward markets, the counterparty risk does not grow as the time to expiration gets closer. Comparatively speaking to the forward markets, the futures markets are very liquid.

5. What is the best time to trade in derivatives?

Prospective employers may ask about the most appropriate time, circumstances where one might invest or reasons for trading in derivatives to evaluate your aptitude for making informed decisions. Your response can reveal your approach to a client or the choices you may eventually make on the company's behalf. Consider preparing a response that includes futures and options trading.

Example answer: There is no best time to trade in derivatives, it depends entirely on the reason you want to invest. If futures trading appeals to you, it might be advantageous if you are considering investing or hedging or are attempting to leverage your efforts to maximise your profits. Options trading may be beneficial if you want to engage in the market without buying a lot of stock or trade, secure your portfolio with a lesser premium payment or both. Both can be helpful if you are cautious about liquidity, transaction costs or making money with less risk capital.

6. Can you name the types of derivative instruments traded at the National Stock Exchange of India (NSE)?

Interviewers might ask this question to determine whether you possess a basic knowledge about derivatives. In your response, mention the types of derivatives instruments traded at the NSE. You might also consider explaining the terms briefly.

Example answer: There are two types of derivatives that we can trade at the NSE, futures and options. The NSE settles both futures and options contracts in cash. A futures contract is a deal between two parties to buy or sell an asset at a specific price and time in the future. An option is a contract that grants the right, but not the obligation, to purchase or sell the underlying at a specified time and price.

7. What do you mean by an expiration day?

A hiring manager might ask you this question to make sure you are familiar with essential financial principles. Explain the meaning of an expiration date. Consider including any significant restrictions that might impact an expiration date.

Example answer: A contract's expiration date is the day on which the contract ends. Indian stock exchange has fixed Thursdays as the expiration day to prevent any confusion amongst traders. Monthly contracts for futures and options expire on the final Thursday of the month, whereas weekly contracts generally expire on that week's Thursday. For instance, if a contract ends in August 2022 and that month's end falls on the 31st, which is a Wednesday and a holiday, the expiration date for August falls on the 25th of that month, a Thursday.

Holidays, too, may affect expiration dates. The expiration day is the day before the trading day if there is a non-trading day or another holiday.

8. Explain the difference between at-the-money, in-the-money and out-of-the-money, in relation to options.

Interviewers might ask you to compare the distinctions between at-the-money, in-the-money and out-of-the-money options to assess your knowledge of various kinds of options. Your response can show how different options impact cash flow. Consider including a definition for each term and, if possible, an example of each kind of option.

Example answer: An at-the-money option offers no real cash flow if exercised instantly. This might happen if the price of an option is equal to its strike price. An out-of-the-money option is one that, if immediately exercised, results in a negative cash flow. A put option may be out-of-the-money if it is trading above the strike price, whereas a call option may be out of the money if it is currently trading below the strike price.

An in-the-money option produces a positive cash flow if executed right away. If the current price of a call option exceeds the strike price, the option may be the in-the-money option. If the spot price of a put option is lower than the strike price, the option may be out-of-the-money.

9. Why is considering interest rates essential when determining the price of options so crucial?

Interviewers might ask this question to evaluate your technical expertise. Keep your answer relevant and brief. Your response might show how well you understand the inter-relation between option pricing and interest rates.

Example answer: Interest rates are an important factor to consider when calculating the cost of options. This is because, when all else is equal, an increase in interest rates often decreases call option values. This follows the net present value concept.

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