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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

Which statement best explains why a firm might prefer exchange-traded futures over a customized OTC forward to hedge a commodity exposure?

Exchange-traded futures reduce counterparty credit risk because a clearinghouse and daily margining stand behind them. The trade-off is standardization, which can leave basis risk and quantity or maturity mismatches that a customized OTC forward could avoid.

  1. AFutures eliminate basis risk because contracts are standardized
  2. BFutures offer lower counterparty credit risk through daily margining and clearing, at the cost of imperfect tailoringCorrect
  3. CFutures allow exact matching of the hedged quantity and maturity date
  4. DFutures involve no cash flows before maturity

Explanation

Exchange clearing and daily mark-to-market margin reduce counterparty credit risk, but standardization creates basis and quantity mismatch. Standardization increases rather than eliminates basis risk, and futures generate interim margin cash flows.

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