CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
A corporate treasurer buys a customized interest rate option from a bank because no listed contract matches the firm's loan reset dates. Relative to using an exchange-traded option, the treasurer has most likely accepted greater:
The treasurer has most likely accepted greater exposure to the bank's credit risk and lower liquidity. A customized OTC option matches the loan dates exactly, but it lacks a clearinghouse guarantee and is difficult to offset, unlike a standardized exchange-traded option.
- Aexposure to the bank's credit risk and lower liquidity.Correct
- Bprice transparency and lower exposure to default.
- Cstandardization of terms and daily margin requirements.
Explanation
A customized OTC option fits the exact hedging need but is not guaranteed by a clearinghouse, so the buyer bears the bank's credit risk. It is also harder to resell or offset, so liquidity is lower. The other choices describe exchange-traded features.
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