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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against forex risk

A company sells sterling futures to hedge a US dollar payable. Margin is required. Which is the main cash-flow consequence of using futures rather than a forward contract?

Daily marking to market creates variation margin flows during the life of the hedge. Losses must be funded in cash as they arise and gains are credited, so cash moves before the underlying payment date. Forward contracts do not have this feature, and futures leave residual basis risk.

  1. ADaily marking to market creates variation margin cash flows before the underlying payment dateCorrect
  2. BPremium is paid upfront and lost if the option is not exercised
  3. CThere is no cash flow until the contract expires
  4. DThe exchange rate is fixed with certainty for any exposure date and amount

Explanation

Futures are marked to market daily, so losses require variation margin payments and gains are received, giving cash flows before settlement. Premiums apply to options, not futures. Forwards have no interim cash flows, and futures cannot fix the rate exactly.

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