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

A firm hedges a commodity exposure with a futures contract that is settled daily. The futures price falls on each of three consecutive days by USD 2, USD 3 and USD 1 per unit, and the firm is long 5,000 units. Meanwhile an equivalent OTC forward with no collateral would settle only at maturity. Which statement is correct?

The firm pays USD 30,000 in variation margin: the total price fall is USD 6 per unit times 5,000 units. An uncollateralized OTC forward involves no such interim cash flow, since it settles only at maturity.

  1. AThe firm pays USD 30,000 in variation margin over the three days on the futures, and has no equivalent cash flow on the uncollateralized forward until maturityCorrect
  2. BThe firm receives USD 30,000 in variation margin over the three days on the futures
  3. CThe firm pays USD 6 in total on the futures because margin is per contract only
  4. DThe firm pays USD 30,000 on both the futures and the forward during the three days

Explanation

Cumulative fall is 2+3+1 = USD 6 per unit; with 5,000 units long, the loss is 6 × 5,000 = USD 30,000, paid as variation margin. An uncollateralized forward has no interim settlement. Receiving margin would require a price rise.

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