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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

A corporate treasurer must hedge a EUR 7.3 million receivable due in 11 months, which does not match any listed futures expiry or contract size. Which is the strongest reason to prefer an OTC forward over an exchange-traded futures contract?

The OTC forward is preferable because it can be tailored to the exact EUR 7.3 million amount and the 11-month date, avoiding the mismatch of standardized futures. It does not remove credit risk and is generally less liquid than futures.

  1. AThe OTC forward eliminates all counterparty credit risk
  2. BThe OTC forward can be tailored to the exact amount and date, reducing basis and rounding mismatchCorrect
  3. CThe OTC forward is marked to market daily, removing liquidity needs
  4. DThe OTC forward is always more liquid and easier to unwind before maturity

Explanation

OTC forwards can be customized in notional and maturity, matching the exposure exactly. They do not remove credit risk (they add it, absent collateral), are not necessarily marked to market daily, and are typically less liquid than futures.

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