CFA Level I · CFA Level I Exam · Derivative Instrument and Derivative Market Features
A trader enters an over-the-counter forward contract with a bank, and later the forward's value to the trader is positive. The trader's main additional risk relative to an exchange-traded futures position is most likely:
The main added risk is counterparty default risk. An OTC forward is a private bilateral agreement without a clearinghouse guarantee, so a trader holding a positive-value position may not be paid if the bank defaults. Customization is a benefit, not a risk.
- Acounterparty default risk on the bankCorrect
- Bdaily mark-to-market settlement
- Closs of the contract's customization
Explanation
OTC contracts are bilateral without a clearinghouse guarantee, so a party with a positive value faces the risk the counterparty defaults. Daily mark-to-market is a futures feature, and customization is a benefit of OTC contracts, not a risk.
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