ACCA Financial Management (F9) Certification Practice Exam

In which circumstance would a Futures contract be typically utilized?

1. To hedge existing risks in the underlying asset

2. To speculate with long-term investments

3. To guarantee a return on savings accounts

4. To provide immediate cash flows

The correct answer is: To hedge existing risks in the underlying asset

A Futures contract is primarily utilized in scenarios where there is a need to hedge against existing risks in the underlying asset. Hedging is a risk management strategy used by investors or companies to offset potential losses in their investments or operations. By entering into a Futures contract, parties agree to buy or sell an asset at a predetermined price on a specified date in the future. This is commonly used by businesses to lock in prices for commodities, currencies, or financial instruments to mitigate the risk of price fluctuations that could adversely affect their profitability. In contrast, speculation typically involves seeking to profit from anticipated future price movements, which is more characteristic of trading strategies rather than risk management. Using Futures contracts to speculate with long-term investments does not align well with the purpose of these contracts, as they are generally more suitable for short- to medium-term positions. Additionally, Futures contracts do not guarantee a return on savings accounts, as that pertains to different financial products and investment strategies focusing on interest rather than futures prices. Lastly, while Futures can provide liquidity and facilitate cash flows in the market, they are not designed specifically to create immediate cash flows; rather, they are primarily instrumented for risk management purposes.