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FRM Part II · FRM Exam Part II · Central Clearing

A risk manager is assessing the moral hazard created by a CCP's default fund mutualisation. Which statement best describes this risk?

Mutualised default funds create moral hazard because members share losses from a defaulter beyond its own margin. Each member therefore has less incentive to monitor or restrain the risk-taking of other members, since part of the cost falls on the group rather than on the risk-taker.

  1. AClearing members that expect losses to be shared may have weaker incentives to monitor the risk taken by other membersCorrect
  2. BClearing members are forced to post higher initial margin than the risk requires, reducing trading
  3. CMutualisation lets the CCP avoid marking positions to market
  4. DMutualisation increases bilateral exposure between clearing members because they cease to net

Explanation

When default losses beyond the defaulter's resources are shared through the default fund, each member bears part of others' losses, which can weaken incentives to monitor or limit counterparties' risk. The other options misdescribe margin, valuation, or netting. Mutualisation does not stop daily mark-to-market or netting.

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