Answer-first summary for fast verification
Answer: Hedging liabilities by rolling forward futures contracts may create cash flow mismatches.
The correct answer is C: "Hedging liabilities by rolling forward futures contracts may create cash flow mismatches." This is illustrated by the case of Metallgesellschaft in 1993, a classic example of a cash flow mismatch due to margin calls. The company had engaged in a strategy of hedging its long-term oil and gas contracts by using short-term futures contracts. However, as the futures contracts approached expiration, they had to be rolled over into new contracts. This created a situation where the company faced margin calls and potential liquidity issues as the short-term futures contracts did not align with the long-term cash flows of the underlying assets. This case highlights the importance of understanding the risks associated with hedging strategies and the potential for cash flow mismatches when using futures contracts to hedge liabilities.
Author: LeetQuiz Editorial Team
Ultimate access to all questions.
A banking institution's risk manager aims to enhance their understanding of liquidity risk incidents by analyzing historical real-life examples. In reviewing various cases, they seek to determine which scenario best illustrates critical lessons in liquidity risk management. Specifically, which of the following lessons is most vividly demonstrated by the case of Metallgesellschaft in 1993?
A
Negative public perception of emergency borrowing from the central bank can cause a bank run.
B
Positive feedback trading in illiquid instruments can cause excessive losses
C
Hedging liabilities by rolling forward futures contracts may create cash flow mismatches.
D
Futures provide a better effective hedge for hedging commodities exposure than forwards.
No comments yet.