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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, which serves as a classic example of a cash flow mismatch due to margin calls. The company had entered into futures contracts to hedge its exposure to commodity prices, but as the contracts approached expiration, the prices diverged from the expected levels, leading to significant margin calls and ultimately causing a liquidity crisis. This case highlights the importance of understanding the risks associated with hedging strategies and the potential for cash flow mismatches when using futures contracts.
Author: LeetQuiz Editorial Team
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A risk manager at a banking institution aims to improve their understanding of recent notable cases involving liquidity risk failures. By reviewing various real-world scenarios, they seek to identify key lessons. Which of the following lessons is most accurately exemplified 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.
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