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FRM Part I · FRM Exam Part I · Introduction to Derivatives

Which statement best describes why a firm that uses forwards to hedge may still face a risk that an exchange-traded futures hedger faces differently?

A forward hedger bears the counterparty's default risk because the contract is bilateral and settles only at maturity, whereas futures are marked to market daily and guaranteed by a clearing house, which greatly reduces credit risk.

  1. AThe forward hedger bears counterparty credit risk, while exchange-traded futures are marked to market daily with a clearing house standing behind themCorrect
  2. BThe forward hedger faces daily margin calls, while futures hedgers do not
  3. CThe forward hedger cannot customize the maturity or amount, while futures can be fully customized
  4. DThe forward hedger is exposed to basis risk only, while futures hedgers are not exposed to it

Explanation

Forwards are OTC bilateral contracts settled at maturity, so each party bears the risk the counterparty defaults. Futures are standardized, margined daily and guaranteed by the clearing house. The other options reverse the actual features.

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