FRM Part I · FRM Exam Part I · Central Clearing
A corporate treasurer enters a bilateral interest rate swap with a dealer under an ISDA Master Agreement but with no CSA. Compared with an otherwise identical swap that is covered by a two-way CSA with zero threshold, which outcome is most likely for the dealer?
The dealer faces higher counterparty credit exposure, which grows with the swap's positive mark-to-market because no variation margin is exchanged. Dealers typically reflect this in the price through a credit valuation adjustment. Netting alone does not eliminate the exposure, and capital is still required.
- ALower counterparty credit exposure, since uncollateralized trades are settled daily
- BHigher counterparty credit exposure that builds up with the swap's mark-to-market, which the dealer typically prices through a credit valuation adjustmentCorrect
- CNo change in credit exposure, since ISDA netting removes all credit risk
- DLower funding cost, since the dealer must hold no capital against uncollateralized trades
Explanation
Without a CSA, no variation margin is exchanged, so the dealer's exposure follows the positive mark-to-market of the swap and can grow. Dealers compensate by charging a CVA in the price. Netting reduces but does not eliminate exposure, and uncollateralized trades are not settled daily. Capital is still required against uncollateralized exposure.
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
- A CCP's default waterfall is being reviewed after a clearing member defaults. Which ordering of loss absorption is standard, from first loss…
- In a bilateral over-the-counter derivatives market without central clearing, which feature most directly exposes a dealer to the risk that a…
- Which of the following is a recognized moral hazard concern associated with central clearing?
- A CCP's default waterfall has these resources: defaulter's initial margin 400 million, defaulter's default fund contribution 100 million, CC…
- A regulator requires that standardized OTC derivatives be cleared through a central counterparty (CCP). Which of the following best describe…
- Bank A and Bank B agree an OTC interest rate swap that is later submitted to a central counterparty (CCP) for clearing. After the CCP accept…