In relation to credit risk, which of the following is true?Question 1Select one:Since they are traded on organised exchanges, futures contracts involve considerable credit risk because you never know the identity of the counter party.Futures contracts have virtually no credit risk since the exchange clearing house guarantees delivery of the contract.Forward contracts are traded over the counter at banks and large financial institutions, so there is virtually no credit risk.
Question
In relation to credit risk, which of the following is true?Question 1Select one:Since they are traded on organised exchanges, futures contracts involve considerable credit risk because you never know the identity of the counter party.Futures contracts have virtually no credit risk since the exchange clearing house guarantees delivery of the contract.Forward contracts are traded over the counter at banks and large financial institutions, so there is virtually no credit risk.
Solution
The correct answer is: "Futures contracts have virtually no credit risk since the exchange clearing house guarantees delivery of the contract."
Here's why:
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Futures contracts are standardized and traded on organized exchanges. The exchange's clearinghouse acts as the counterparty to both parties in the contract and guarantees the terms of the contract, thus eliminating the credit risk.
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The first statement is incorrect because, while it's true that futures contracts are traded on organized exchanges, they do not involve considerable credit risk. The credit risk is mitigated by the presence of the exchange's clearinghouse.
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The third statement is also incorrect. Forward contracts, unlike futures contracts, are traded over-the-counter (OTC), not on organized exchanges. This means they are negotiated directly between two parties, without going through an exchange or other intermediary. This can actually increase credit risk, as there is no clearinghouse to guarantee the contract. The credit risk in forward contracts depends on the creditworthiness of the counterparty.
Similar Questions
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