Question

Which of the following is a risk associated with the use of forward contracts?

A. Equity risk.

B. Commodity risk.

C. Interest rate risk.

D. Credit risk.

E. Governance risk.

What is the obligation of the buyer of a forward contract?

A. To take delivery of the underlying asset on the specified date.

B. To pay for a specified quantity of the underlying asset at a set price on a specified date.

C. To pay the seller the difference between the set price and current market price on the underlying asset.

D. To sell a specified quantity of the underlying asset at a set price on a specified date.

E. To receive payment from the seller equal to the difference between the market price on the underlying asset and the forward price.

The feature of a futures contract by which gains and losses are realized on a daily basis is called _________.

A. Gain/loss realization.

B. Equalizing.

C. Marking-to-market.

D. Profit-taking.

E. Accelerating amortization.

Which of the following is NOT a source of financial risk?

A. Commodity price fluctuations.

B. Equity price fluctuations.

C. Exchange rate fluctuations.

D. Liquidity fluctuations.

E. Interest rate fluctuations.

When we draw a graph showing that the value of Air Canada decreases as the price of oil increases, this is an example of a ________.

A. Risk profile.

B. Risk frontier.

C. Risk map.

D. Volatility map.

E. Volatility index.

The payoff profile resulting from a perfect hedge with a forward contract is _________.

A. A downward-sloping curve.

B. An upward-sloping curve.

C. A downward-sloping straight line.

D, A horizontal straight line.

E, An upward-sloping straight line.

Answer 1

1. Answer: Credit risk.
2. Answer: B. To pay for a specified quantity of the underlying asset at a set price on a specified date.
3. Answer: Marking-to-market.

Explanations for 1,2 and 3:
Forward contracts are over the counter contracts and not exchange-traded. They are "NOT settled in a mark to mark process." They are settled single time on a predetermined settlement date as per the set rates. Depending upon the rates prevailing on the settlement date, there can be a counterparty default risk.

So it can create a credit risk.

However the
The futures contracts are settled in a mark to mark process on a daily basis. Hence eliminating the counterparty risk because profits and losses are realised on a daily basis.