Advantages of using forward market hedge against using futures market hedge
As the underlying risk exposure is a transaction exposure to currency risk, forward market hedge and futures market hedge are options for dealing with the risk. However, using a forward market hedge to deal with the currency risk exposure would present to the company the following advantages as gainst using a futures market hedge to deal with the same:

Perfect hedge
As a typical over-the-counter arrangement, forward contracts can be tailored to the requirements of the company. The company can arrange for the exact quantity of the foreign currency it wants to hedge against and a contract maturity that matches the maturity of the underlying exposure. Thus, it is much easier to create a hedge that perfectly protects an underlying exposure when a forward contract is used. However, it is somewhat challenging to create a perfect hedge with a futures contract as futures contracts are standardised in terms of the underlying asset, the contract size, and contract maturity. Thus, it is common to have situations where an entity must manage with a contract underlying asset different from the asset that is exposed to risk, a number of contracts that either overcovers or undercovers the underlying exposure, and contract maturity that differs from the underlying exposure maturity date.

No margin requirements
Unlike futures contract arrangements, entering a forward contract does not typically require margin deposits against potential counterparty risk. Thus, the company will not have to deposit money or equivalent value in securities with a clearing house that could otherwise be used to finance operational or other needs.

Guaranteed outcome
In a typical forward contract, the forward price is set at the commencement of the contract, and it remains fixed over the contract maturity period. This feature guarantees the outcome of the forward as the proceeds or cost of the trade is known in advance. In the case of futures contract, the futures price is marked-to-the-market and so is permitted to vary as the underlying asset value varies in the spot market. This leaves the futures contract to an uncertain outcome.

(Marks allocation: a maximum of 2.5 marks for each of two advantages = 5)

• Forward contract are non-standardized but Futures contracts are standardized as to delivery date, quality and quantity
• Forward contracts are over the counter contracts but Futures contracts are traded on an organized exchange
• Forwards contract have no clearing houses but Futures contracts have clearing houses
• No margin requirement under Forward but margin requirement exist under Futures contract
• Credit risk is higher in Forward contracts but minimal on Futures contracts due to the margin requirements.

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ALTERNATIVE (Assuming the interest rates were understood to be for the specific tenor and not per annum as question was silent)

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A firm that engages in international business transactions faces transaction risk when it has contractual cash flows that are fixed in the foreign currency and the exchange rate might change over the contract period. For instance, transaction risk exists when value of imports and exports are fixed in the foreign currency and there is movement in the exchange rate between the invoice date and settlement date.
Translation risk is when an organisation will suffer exchange losses when the results of its foreign branches and subsidiaries are translated into the home currency.
Economic risk refers to the effect of exchange rate movement on the international competitiveness of an organisation. It refers to the present value of longer-term cash flows. It exists when an organisation faces competition from domestic producers/traders in the foreign country or local importers in the home country.
Analysis of AD Ventures case:
By engaging in the import transaction that will be settled in the future, AD Ventures faces contractual cash flow (here the obligation to pay EUR540,000). Moreover, the contractual cash flow is fixed in the foreign currency, the euro.
Conclusion on risk type:
With respect to the tomato import from Italy, AD Ventures is facing transaction exposure to currency risk.

• Contract size cannot be tailored to the exact requirements the investor. This means that the investor’s underlying exposure may not be covered effectively, resulting in hedge inefficiency.
• Contract maturity date cannot be tailored to synchronise with maturity date of underlying exposure. For instance, AD Ventures’ euro obligation falls due in January 2016 but the available contract matures in February 2016. This results in hedge inefficiency.
• Basis risk is inherent in futures hedge. There is the risk that the futures price may move by a different amount from the price of the underlying asset.
• Unlike options, the investor has an obligation to either trade the underlying asset or take an opposite position to close out. This means that the investor does not have the flexibility to take advantage of favourable price movements in the spot market.
• Unlike forwards, futures requires opening and maintenance of a margin account which involves deposit of cash or cash equivalent.

• Currency futures is a standardized contract whereas forward contracts are customized contracts.
• Currency futures contracts take place in regulated markets whereas forwards contracts are traded over the counter.
• Currency futures contract are in foreign currency whereas forwards contracts are in local currency.
• Currency futures have flexible closeout dates but forwards have fixed close out dates.
• Underlying transactions for currency futures take place at the spot rate but for forwards the underlying transactions take place at the forward rate.
• Currency futures are cheaper than forward contracts.