Question
Which of the following statement(s) is/are true? (Select the correct answer from the options below the statements) (1) Forward contracts are binding (2) Forward contracts are flexible and can be renegotiated or cancelled at any time before the date of settlement (3) Forward contracts are prone to counterparty risks (1) only (1) and (2) (1) and (3) (1), (2) and (3)
Answer
4.3
(320 Votes)
Louis
Professional · Tutor for 6 years
Answer
Option (1) and (3) are correct.Statement (1): "Forward contracts are binding" and statement (3): "Forward contracts are prone to counterparty risks" are True.Statement (2): "Forward contracts are flexible and can be renegotiated or cancelled at any time before contract settlement" is False.
Explanation
Before addressing each statement, let's understand what a forward contract is.## Understanding Forward ContractsA forward contract is a private and customized agreement between two parties to buy or sell an asset at a specified price on a future date. Given this, we can now evaluate the statements:## Evaluation of Statements:### Statement 1: "Forward contracts are binding" Forward contracts are obligatory. Once set, both parties are obliged to abide by the terms of the contract and cannot unilaterally alter them unless they mutually agree to change it. **This statement is True.**### Statement 2: "Forward contracts are flexible and can be renegotiated or cancelled at any time before the date of settlement" This statement is finding whether forward contracts are negotiable before the settlement date. But the truth is, although forward contracts are customizable according to the needs of the contracting parties when the contract is being established, they become a binding obligation that cannot be changed or cancelled at will once the contract has been concluded, they do not typically afford the parties that way either party is free to change or terminate them at will. **This statement is False.**### Statement 3: "Forward contracts are prone to counterparty risks" Counterparty risk refers to the risk that the counterparty will default on their contractual obligation to complete the transaction as agreed. As forward contracts are not exchange-traded but are instead private agreements between two parties without a clearinghouse guarantee and associated daily margining, they're exposed to counterparty risk.**This statement is True.**After examining all three statements, we find that statements 1 and 3 are true, which corresponds to option C.