Which statement about futures contracts is true?

• A. They are customized OTC instruments with counterparty risk.
• B. They are settled only at expiration.
• C. They are standardized, exchange-traded with daily settlement, reducing counterparty risk.
• D. They are never cleared by a central counterparty

Answer: (C)

Futures reduce counterparty risk mainly because they’re standardized, exchange-traded contracts that are settled daily through a clearinghouse. The standard terms mean lots of participants can trade them easily, creating liquidity. The clearinghouse acts as the middleman and guarantees performance, so no single counterparty’s credit state endangers the other side.

Daily settlement, or mark-to-market, means gains and losses are realized each day and margin (collateral) is adjusted accordingly. This prevents a large, sudden payment at expiration and continually collateralizes the exposure, which is the key reason counterparty risk is much lower than with many OTC agreements that settle only at maturity.

In contrast, a forwards-like, customized OTC contract lacks that daily settlement and CCP guarantee, which is why it carries higher counterparty risk. Futures are not settled only at expiration, and they are typically cleared by a central counterparty, not left to private counterparties.

So the statement that best describes futures contracts is that they are standardized, exchange-traded with daily settlement, reducing counterparty risk.