Risk Management — ACCA Practice Question 14

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.

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?

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Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 4

More questions from this exam

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?

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA FM — Financial Management Practice Exam 4

More questions from this exam

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?