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© 2014 Pearson Canada Inc.$14.2 Forward Contracts and Markets
Forward contracts do not suffer from the problem of ____.
A) a lack of liquidity
B) a lack of flexibility
C) the difficulty of finding a counterparty
D) default risk
Answer: B
Diff: 1 Type: MC Page Ref: 325
Skill: Recall
Objective List: 14.1 Distinguish among forwards, futures, options, and swaps
What are the pros and cons of forward contracts?
Answer: The advantage of forward contracts is that they can be as flexible as the parties
involved want them to be. This means that an institution may be able to hedge completely the
interest-rate risk for the exact security it is holding in its portfolio.
There are two disadvantages of forward contracts. First, it may be very hard for an institution to
find another party which is called counterparty to make the contract with. The second problem
with forward contracts is that they are subject to default risk. The presence of default risk in
forward contracts means that parties to these contracts must check each other out to be sure that
the counterparty is both financially sound and likely to be honest and live up to its contractual
obligations.
Diff: 2 Type: SA Page Ref: 325
Skill: Recall
Objective List: 14.1 Distinguish among forwards, futures, options, and swaps