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FRM Part I · FRM Exam Part I · Central Clearing

A CCP's risk committee is reviewing why novation concentrates risk. Which statement about the CCP's exposure after novation is most accurate?

With a matched book, the CCP has no net market risk while members perform. Its risk arises when a member defaults and the CCP must close out or replace that member's positions, where adverse price moves could exceed the margin held.

  1. AThe CCP carries market risk on its matched book because it is long and short the same contracts, so it must hedge dynamically
  2. BThe CCP's matched book removes its net market risk when all members perform, but it faces losses if a member defaults and the position must be closed out at adverse pricesCorrect
  3. CThe CCP has no credit exposure because initial margin always covers any possible loss
  4. DThe CCP's risk rises with multilateral netting because gross notional of cleared trades increases

Explanation

Because the CCP is on both sides of every trade, its net market risk is zero while all members perform. Risk arises on default, when it must replace or close the defaulter's positions and prices may move beyond margin. Margin reduces but cannot eliminate this risk, and netting reduces rather than raises exposure.

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