In hedging transactions, derivatives typically have the following advantages over cash instruments:

In hedging transactions, derivatives typically have the following advantages over cash instruments:

I. Lower credit risk

II. Lower funding requirements

III. Lower dealing costs

IV. Lower capital charges
A . I, II
B . I, III
C . II, IV
D . I, II, III, IV

View Answer

Answer: D

Explanation:

Derivatives have several advantages over cash instruments in hedging transactions. These include:

Lower Credit Risk:

Derivatives, especially exchange-traded ones, often have lower credit risk because the clearinghouse guarantees the performance of the contract.

Lower Funding Requirements:

Derivatives typically require lower upfront capital than buying or selling the underlying cash instruments directly. This is due to the leverage they offer, where only a margin is required instead of the full value of the position.

Lower Dealing Costs:

Trading derivatives can be cheaper in terms of transaction costs compared to trading the underlying cash instruments. This is especially true for large positions or frequent trading.

Lower Capital Charges:

Regulatory capital requirements for derivatives can be lower compared to cash instruments because derivatives can be used to hedge and reduce overall portfolio risk, thereby reducing capital charges under regulatory frameworks.

References Source: How Finance Works?