Skip to content

FRM Part I · FRM Exam Part I · Using Futures for Hedging

Which statement best explains why tailing the hedge reduces the number of futures contracts when the futures price exceeds the spot price?

Tailing reduces contracts because futures are marked to market daily, so gains and losses are realized and can be reinvested or financed before the hedge horizon. The hedge therefore needs a smaller notional than a forward would, roughly scaled by spot over futures value.

  1. AFutures are settled daily, so gains and losses accrue before the hedge horizon and can earn interest, so a smaller notional sufficesCorrect
  2. BFutures prices exceed spot prices, so basis risk is eliminated and fewer contracts are required
  3. CMargin requirements reduce the number of contracts a firm may legally hold
  4. DThe minimum-variance hedge ratio always falls below one when the futures market is in contango

Explanation

Daily settlement means cash flows from the hedge occur immediately, not at maturity, so the exposure is adjusted by roughly the ratio of spot to futures value. Basis risk is not eliminated by tailing, and the hedge ratio depends on correlation and volatilities, not on contango.

Did you get it right without looking?

One question tells you little. A timed set on Using Futures for Hedging shows your real accuracy, how long you take and where you lose marks.

Practise Using Futures for HedgingFree diagnostic mock

More Using Futures for Hedging questions