CFA Practice Question

CFA Practice Question

Which of the following is (are) true about swaps and futures markets?

I. The swap market is generally more illiquid than a futures market.
II. Early termination of standard swaps requires special negotiations whereas futures can be closed out at any time.
III. The default risk in the swap market is lower than that in the futures market.
A. I and II.
B. I and III.
C. I, II and III.
Explanation: Futures are exchange traded instruments while swaps, for the most part, are traded only on the OTC market. Due to this, futures are standardized products and have a highly liquid market for most underlyings. On the other hand, since swaps are specifically tailored to individual counterparties, the secondary market for them is quite illiquid and any changes to the contract require negotiation between the two counterparties. Further, futures are guaranteed by the exchange clearinghouse and default is significantly reduced due to features like daily mark-to-market. Swaps have a much higher credit risk since they are OTC products.

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