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Answer: Taking physical delivery of commodities can involve warehousing costs and storage costs, so traders usually prefer using futures for financial purposes and not for consumption.
**D is correct.** Very few futures contracts lead to the delivery of an underlying asset because traders usually prefer to close out contracts before the delivery period. Taking physical delivery involves additional costs like warehousing and storage, which financial traders typically want to avoid. **A is incorrect.** Regulators do not prefer cash settlement because it makes futures contracts seem like gambling. They actually prefer physical settlements whenever possible. **B is incorrect.** Forward contracts trade OTC (over-the-counter) and are subject to higher credit risks than futures contracts, which trade on exchanges with clearinghouses that mitigate counterparty risk. **C is incorrect.** The exact underlying asset, delivery location, and delivery time are specified in futures contracts, so these are not sources of uncertainty or risk.
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A first-year analyst on the commodity futures trading desk of a bank is assessing the desk's current portfolio and its typical trading patterns. The analyst examines why a large majority of the trades made by the desk are cash-settled and reviews the delivery mechanics of cash-settled and physically settled futures contracts. Which of the following observations is the most likely for the analyst to make?
A
Regulators prefer that cash settlements take place whenever possible due to the inconvenient delivery process involved in physically settling futures contracts.
B
The bank should trade physically delivered commodities using forward contracts since they provide a similar payoff to futures contracts, but unlike futures, they trade on exchanges and are less prone to credit risks.
C
It is risky for the bank to take physical delivery of commodities due to uncertainty about the exact underlying asset, delivery location, and delivery timeframe.
D
Taking physical delivery of commodities can involve warehousing costs and storage costs, so traders usually prefer using futures for financial purposes and not for consumption.