(TCO E & F) A forward contract is marked to market. has significant default risk. is...

(TCO E & F) A forward contract is

marked to market.

has significant default risk.

is standardized.

is traded over the counter.

is highly liquid.

Solutions

Expert Solution

A forward contract is basically entered into by two parties to exchange a pre decided sum of money or an underlying asset on a predecided date in the future. No amount of money exchanges hands at the time of getting into the contract, but the contract is an obligation on both the parties unlike in the case of another derivative instrument called options. A Forward is similar to Future in some respects but different in other respects as explained in the below points, but essentially they are obligatory to both parties and have similar nature of contract.

Marked to market: This is false and is one of the reasons why the default risk is high for the forward contracts. Marking to market is the process of netting each day's profits and losses to bring down the stakes so that in case of default, the expected loss is low. This feature more aking to Futures contract and not Forward Contracts
has significant default risk: This is true for Forward contracts due to the lack of a clearing house in between which becomes the counterparty in each contract. Clearing house feature is available in Futures contract. Clearing house is basically an exchange, which guarantees that the contract will be met.
is standardized: This is false, one of the reasons why forward contracts are popular is because they are tailor made, suiting to the needs of the parties getting into them and therefore it is harder to find a suitable counterparty.Standardisation feature is more aking to Futures contract and not Forward Contracts
is traded over the counter: As mentioned earlier, there is no clearinghouse or an exchange which is the counterparty as in case of Futures contract and further the contracts are customized having high default risk. All these point us to the fact that Forward contracts are traded over the counter, so this is true
is highly liquid: As explained in the above points, it is difficult to find a suitable counterparty to these contracts due to the customization they undergo, this makes them less liquid. Further due to being traded OTC and not on an exchange, these have lower liquidity. So this point is false

jeff jeffy answered 1 year ago

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