FRM Part II · FRM Exam Part II · Central Clearing
A risk manager reviews a dealer's portfolio of 5 counterparties, each trading bilaterally with each of the other 4 dealers and with no CCP. If all trades are moved to a single CCP through novation, how does the number of bilateral counterparty relationships among the 5 participants change?
The network shrinks from 10 bilateral links (5 times 4 divided by 2) to 5 links, one between each participant and the CCP. Novation replaces the web of pairwise exposures with a hub-and-spoke structure centred on the CCP.
- AFrom 10 bilateral relationships to 5 relationships, each with the CCPCorrect
- BFrom 20 bilateral relationships to 5 relationships, each with the CCP
- CFrom 10 bilateral relationships to 1 relationship with the CCP
- DIt stays at 10 because novation does not alter the network structure
Explanation
Fully connected bilateral network of 5 participants has 5x4/2 = 10 links. With a CCP each participant has one link to it, giving 5. Counting 20 double counts links; 1 ignores that each member faces the CCP separately.
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