The main tradeoff between forward and future contracts is
A) Design flexibility.
B) Credit risk.
C) Liquidity risk.
D) All of the above.
E) Choices a and b only

Question

Quizplus · Accepted Answer

Forward and futures contracts are both derivative contracts that allow investors to hedge against price risk. However, there are some key differences between the two types of contracts. Forward contracts are customized contracts that are traded over-the-counter (OTC), while futures contracts are standardized contracts that are traded on an exchange. This difference in trading venue leads to different levels of design flexibility and liquidity risk. Forward contracts offer more design flexibility because they can be customized to meet the specific needs of the parties involved. However, this flexibility also comes with increased liquidity risk, as there is no central exchange to facilitate trading. Futures contracts, on the other hand, are standardized contracts that are traded on an exchange. This standardization reduces design flexibility but also increases liquidity risk. In addition to design flexibility and liquidity risk, forward and futures contracts also differ in terms of credit risk. Forward contracts are not centrally cleared, which means that the parties to the contract are responsible for each other's performance. This can lead to increased credit risk, as there is no guarantee that the other party will be able to fulfill their obligations under the contract. Futures contracts, on the other hand, are centrally cleared, which means that a clearinghouse interposes itself between the parties to the contract and guarantees performance. This reduces credit risk, as the clearinghouse is responsible for ensuring that the parties to the contract fulfill their obligations.

The Main Tradeoff Between Forward and Future Contracts Is