CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
A firm buys a forward contract to lock in the price of a commodity it will need in six months. The derivative benefit this use best illustrates is:
The use best illustrates risk management through risk transfer. By fixing today the price of a purchase in six months, the firm passes commodity price uncertainty to the forward counterparty. It is a hedge, not an arbitrage or a leveraged speculative position.
- Arisk management through risk transferCorrect
- Bmarket completion through arbitrage
- Cspeculation through embedded leverage
Explanation
Locking a future purchase price transfers price risk from the firm to the counterparty, which is risk management. The firm is not exploiting a mispricing, so arbitrage does not apply, and the purpose is hedging rather than leveraged speculation.
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