Skip to content

FRM Part I · FRM Exam Part I · Learning From Financial Disasters

A corporation hedged long-term fixed-price energy supply commitments with short-dated futures that were rolled forward. When prices fell, margin calls created a severe cash drain even though the long-term contracts were profitable on paper. What was the main flaw in the hedging strategy?

The main flaw was a maturity and funding liquidity mismatch. Short-dated rolled futures produced immediate margin calls when prices fell, while the offsetting gains on long-term contracts were unrealized and could not fund them. A hedge can be economically sound yet fail because of cash flow demands.

  1. ABasis and funding liquidity mismatch from using short-dated instruments against long-dated obligationsCorrect
  2. BUse of options rather than futures, which removes all margin requirements
  3. CInsufficient diversification across currency exposures
  4. DHedging at a ratio below one that left the firm net short

Explanation

Rolling short-dated futures to hedge long-dated commitments leaves a maturity mismatch. Price declines generate immediate margin outflows while offsetting gains on the long-term contracts are unrealized and illiquid. The problem is funding liquidity, not currency exposure or option use.

Did you get it right without looking?

One question tells you little. A timed set on Learning From Financial Disasters shows your real accuracy, how long you take and where you lose marks.

Practise Learning From Financial DisastersFree diagnostic mock

More Learning From Financial Disasters questions