Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which type of contract is generally more liquid?

1. Forwards contracts

2. Futures contracts

3. Both are equally liquid

4. Swaps contracts

The correct answer is: Futures contracts

Futures contracts are generally considered more liquid than forwards and swaps contracts for several reasons. They are standardized agreements traded on organized exchanges, which facilitates a significant volume of trading and easier entry and exit from positions. The standardization of terms (like contract size and expiration dates) and a centralized clearinghouse reduce counterparty risk and build greater trust among investors, attracting more participants. Additionally, because futures contracts are exchange-traded, they benefit from the presence of market makers and a continuous trading environment, which enhances liquidity. The ability to easily find buyers and sellers means that futures contracts can be traded quickly without significant price changes, which is a crucial characteristic for liquidity. In contrast, forwards are customized agreements negotiated directly between two parties, which can lead to greater difficulty in finding a counterparty and lower overall trading volumes. Swaps contracts typically entail complex agreements tailored to the needs of the parties involved and are not traded on an exchange, further reducing their liquidity compared to futures.