Best Derivative for Risk Management in Commodities

Very Hard Derivative Markets And Instruments Derivative Risks

A trader is considering the use of derivatives to hedge against the volatility of a specific commodity, which has shown significant fluctuations due to geopolitical tensions and seasonal factors. The trader can choose from three derivative instruments: a futures contract, an options contract, or a swap agreement. Each instrument comes with its own risk profile and effectiveness in mitigating different kinds of risks.

The trader needs to understand not only the intrinsic properties of each derivative but also the specific types of risks they are exposed to, including market risk, credit risk, and liquidity risk. In this scenario, which derivative would best manage the risks associated with potential adverse price movements in the commodity while minimizing costs?

Futures contract, as it locks in a price and prevents losses from price increases.

Options contract, as it provides the right but not the obligation to buy or sell, thereby limiting potential losses.

Swap agreement, as it allows the trader to exchange cash flows and hedge against price movements.

Hint

Submitted2.9K

Correct1.5K

% Correct54%