FRM Part I · FRM Exam Part I · Central Clearing
A regulator requires that standardized OTC derivatives be cleared through a central counterparty (CCP). Which of the following best describes the primary risk-reduction objective of this reform?
The reform aims to replace many bilateral counterparty exposures with exposure to one collateralized CCP, limiting contagion if a major dealer defaults. It does not remove market risk or prevent member defaults, and it relies on margin and default resources rather than eliminating them.
- AEliminating market risk on cleared positions for all clearing members
- BReplacing a web of bilateral credit exposures with exposures to a single, collateralized counterparty, reducing contagion from a dealer defaultCorrect
- CGuaranteeing that no clearing member can ever default
- DRemoving the need for any initial margin on standardized contracts
Explanation
Central clearing novates trades to the CCP, so bilateral counterparty exposures are replaced by exposures to the CCP, which is supported by margin and default resources. This limits contagion when a dealer fails. It does not remove market risk, prevent defaults, or eliminate margin, which is central to the CCP model.
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