Future Business Leaders of America (FBLA) Securities and Investments Practice Test

What defines an option in finance?

1. A share of equity with guaranteed dividends

2. A derivative allowing the purchase or sale of an asset at a set price

3. A method for businesses to obtain loans

4. A fixed return investment over a specific period

The correct answer is: A derivative allowing the purchase or sale of an asset at a set price

An option in finance is defined as a derivative that provides the holder with the right, but not the obligation, to purchase or sell an underlying asset at a predetermined price, known as the strike price, within a specified time frame or on a specific expiration date. This characteristic makes options versatile financial instruments that can be used for speculation, hedging, or increasing exposure to changes in the price of an underlying asset. In this context, derivatives are financial contracts whose value derives from the performance of an underlying entity, such as stocks, bonds, currencies, or commodities. Options are a specific type of derivative, distinguishing them from other financial instruments like loans or fixed-return investments, which have different structures and purposes. The other options do not meet the definition of an option. Options do not guarantee dividends or represent shares of equity; they instead give the right to buy or sell those shares. They are also not a method for businesses to secure loans or related directly to fixed-return investments, which typically provide regular interest payments without offering the flexibility or rights granted by an option. Therefore, the core concept of an option relates specifically to the rights to trade an asset at a designated price, making the correct answer clear.