What type of settlement occurs in futures markets according to standard practice?

• A. Physical delivery of the underlying asset
• B. Daily cash settlements of gains and losses
• C. Quarterly performance reviews
• D. Annualized cash flow analysis

Answer: (B)

In futures markets, the standard practice involves daily cash settlements of gains and losses. This process is known as marking to market. Each day, the profits or losses from open positions are calculated and settled, meaning that gains are credited to a trader’s account while losses are deducted. This daily settlement helps to manage credit risk significantly, as it ensures that all parties are regularly updating their margin accounts based on market fluctuations, thus limiting the accumulation of unpaid losses.

The use of cash settlements helps maintain liquidity and facilitates continuous trading, as traders have a clear understanding of their positions and available funds on a day-to-day basis. This approach contrasts with physical delivery, which can occur in certain contracts but is not the standard practice in daily futures trading. While the other options suggest important processes relevant in broader finance, they do not accurately reflect the standard mechanics of futures markets.