FRM Part II · FRM Exam Part II · Central Clearing
A bank and a hedge fund agree an interest rate swap that is then accepted by a central counterparty (CCP) through novation. Which describes the legal result of novation?
Novation replaces the original bilateral trade with two new contracts, one between the CCP and each original party. The CCP becomes buyer to every seller and seller to every buyer, so the original contract is extinguished rather than merely guaranteed.
- AThe original bilateral contract stays in force and the CCP only guarantees it
- BThe original contract is replaced by two contracts, with the CCP as buyer to the seller and seller to the buyerCorrect
- CThe CCP becomes a third party that nets the swap against the parties' other bilateral trades outside the CCP
- DThe contract is transferred wholly to the clearing member, which becomes the sole counterparty to both parties
Explanation
Novation extinguishes the original bilateral contract and replaces it with two new contracts in which the CCP is the counterparty to each original party. The guarantee option is wrong because the original contract does not survive. Netting only occurs among trades cleared at the CCP, not outside it.
Did you get it right without looking?
One question tells you little. A timed set on Central Clearing shows your real accuracy, how long you take and where you lose marks.
More Central Clearing questions
- Under standard practice at a CCP, which statement about initial margin versus the default fund and the defaulter-pays principle is most accu…
- Which statement best describes a key difference between a bilateral OTC derivatives relationship under a CSA and a centrally cleared relatio…
- A clearing member of a central counterparty (CCP) holds a cleared interest rate swap position that has gained value over the day. Which desc…
- A CCP's default waterfall has the following layers in order after a clearing member defaults: defaulter's initial margin, defaulter's defaul…
- A CCP's default waterfall is being reviewed after a clearing member defaults. Which ordering of loss absorption is the standard sequence use…
- During a sharp market sell-off, a CCP's risk model recalibrates and raises initial margin requirements on all members within days, forcing l…