ExpertMedium2 marksMultiple Choice
ACCA · Question 14 · Risk Management
Section A
Which of the following is a primary disadvantage of using currency futures contracts compared to over-the-counter (OTC) forward contracts for hedging foreign exchange risk?
Section A
Which of the following is a primary disadvantage of using currency futures contracts compared to over-the-counter (OTC) forward contracts for hedging foreign exchange risk?
Answer options:
A.
Futures contracts are standardized in size and maturity, which can lead to basis risk and imperfect hedges.
B.
Futures contracts carry a higher risk of counterparty default than forward contracts.
C.
Futures contracts cannot be traded or closed out before their maturity date.
D.
Futures contracts require the payment of an upfront premium, similar to options.
How to approach this question
Compare the characteristics of exchange-traded derivatives (futures) with OTC derivatives (forwards). Focus on flexibility.
Full Answer
A.Futures contracts are standardized in size and maturity, which can lead to basis risk and imperfect hedges.✓ Correct
Currency futures are traded on organized exchanges and are highly standardized regarding contract size (e.g., £62,500 per contract) and delivery dates (e.g., end of March, June, September, December). This standardization often means a company cannot hedge its exact exposure amount or exact date, leading to an imperfect hedge (basis risk). Forwards are tailor-made OTC contracts.
Common mistakes
Believing futures have higher default risk. The clearinghouse mechanism actually eliminates counterparty risk in futures.
Practice the full ACCA FM — Financial Management Practice Exam 4
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