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FRM Part I · FRM Exam Part I · Introduction to Derivatives

A corporate treasurer wants to hedge a highly specific exposure: a payment of 7.3 million euros due in 143 days. Which feature of over-the-counter (OTC) forward contracts, relative to exchange-traded futures, best explains why the treasurer would prefer an OTC forward?

The treasurer would prefer an OTC forward because it can be customized to the exact amount and maturity of the exposure. Exchange-traded futures come in standardized sizes and dates, so they would leave a basis mismatch, while clearing and daily margining are exchange features.

  1. ACustomization of amount and maturity date to match the exposure exactlyCorrect
  2. BElimination of counterparty credit risk through a clearing house
  3. CDaily marking to market of the position
  4. DStandardized contract sizes that improve secondary-market liquidity

Explanation

OTC contracts are bilateral and can be tailored to the exact notional and settlement date, which suits a unique exposure. Exchange-traded futures have standardized sizes and maturities. Daily margining and clearing house guarantees are features of exchange trading, not advantages of the OTC forward.

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