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

Compared with an exchange-traded futures position, a bilaterally settled OTC forward position typically exposes a hedger to greater liquidity risk in unwinding the trade. What is the main reason?

Because OTC forwards are tailored, there is no deep secondary market, so unwinding generally requires negotiating with the original counterparty or finding a replacement. Standardized futures can be offset on the exchange with an opposite trade, making exit easier.

  1. AForward contracts are tailored, so closing out generally requires negotiating with the original counterparty or finding a new oneCorrect
  2. BExchanges prohibit offsetting trades before expiry
  3. COTC forwards are marked to market daily, draining cash
  4. DFutures contracts cannot be closed before maturity

Explanation

Customized forwards lack a liquid secondary market, so exiting usually means agreeing terms with the original dealer or arranging a replacement. Futures are standardized and can be offset easily with an opposite trade on the exchange.

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