ACCA Financial Management (F9) Certification Practice Exam

What distinguishes a Forward contract from a Futures contract?

1. Futures are standardized and traded on exchanges

2. Forwards are regulated by banking authorities

3. Futures contracts have unlimited risk

4. Forwards are agreements made over the counter

The correct answer is: Forwards are agreements made over the counter

A Forward contract is primarily distinguished from a Futures contract by its structure and trading venue. Forwards are customized agreements that are typically arranged directly between two parties, and they are traded over the counter (OTC). This OTC trading allows for more flexibility in terms of the contract specifications, such as the amount, delivery date, and underlying asset, which can be tailored to meet the specific needs of the counterparties involved. On the other hand, Futures contracts are standardized and traded on organized exchanges. This standardization of Futures increases market liquidity but reduces the flexibility of the contracts compared to Forwards. Additionally, Futures are subject to daily mark-to-market settlements and various regulatory frameworks designed to enhance market stability. The other options provide distinctions that are less accurate. While it is true that Futures can involve significant risks depending on market movements, this is not distinctly a characteristic that sets them apart from Forwards; both can indeed result in substantial risks for the parties involved. The statement regarding regulatory oversight is also not a defining characteristic since Forwards are typically not subject to the same level of regulation as Futures, which are organized and regulated by exchanges.