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FRM Part I · FRM Exam Part I · Swaps

A bank has a USD 100 million pay-fixed swap with a client and an offsetting USD 100 million receive-fixed swap with another dealer, both with the same terms. After the swaps are cleared through a central counterparty (CCP), which statement is most accurate?

Clearing replaces the bank's bilateral exposures with exposure to the CCP through novation, and positions are margined daily. Counterparty risk is mitigated, not removed, because the CCP relies on margin and a default fund. The notional is never posted, and market risk is not transferred.

  1. AThe bank's exposure to each original counterparty is replaced by exposure to the CCP, and positions are margined dailyCorrect
  2. BThe bank's counterparty risk is eliminated entirely because the CCP guarantees performance without any margin
  3. CThe bank must pay the full notional to the CCP at inception as collateral
  4. DThe CCP assumes the bank's market risk, leaving the bank with no interest rate exposure

Explanation

Novation makes the CCP the counterparty to each side, and variation and initial margin protect it. Margin is not eliminated, notional is not posted, and market risk stays with the bank except that the two swaps offset each other.

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