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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 makes them better suited than exchange-traded futures for this hedge?

OTC forwards can be customized to the exact amount and date of the exposure, which exchange-traded futures cannot do because they have standardized contract sizes and delivery months. This makes forwards better for hedging a specific 7.3 million euro payment due in 143 days.

  1. AThey can be customized to the exact amount and settlement dateCorrect
  2. BThey eliminate counterparty credit risk through daily margining by an exchange
  3. CThey are always more liquid and easier to close out before maturity
  4. DThey are standardized in contract size and maturity dates

Explanation

OTC contracts are bilaterally negotiated, so the amount and delivery date can be tailored to match the exposure. Exchange-traded futures have standardized sizes and dates, creating basis and rounding mismatch. The option claiming no credit risk describes exchange clearing, not bilateral OTC forwards.

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