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FRM Part I · FRM Exam Part I · Futures Markets

A short futures position in a stock index is held at a clearing member. Which statement best describes the effect of daily settlement on the counterparty credit risk of this position?

Daily settlement limits the accumulated unrealized loss to roughly one day's price movement, which reduces default exposure. Gains and losses are paid each day through the margin account. It does not eliminate risk, because a very large one-day move can still exceed the posted margin.

  1. AIt eliminates all risk of loss from default because the position is settled in full each day
  2. BIt limits the accumulated unrealized loss to roughly one day's price movement, thereby reducing default exposureCorrect
  3. CIt transfers the credit risk to the holder of the opposite position
  4. DIt increases default exposure because gains are paid out only at maturity

Explanation

Daily settlement realizes gains and losses each day, so potential unpaid exposure builds up over only about a day (or until a margin call is met). It does not remove risk entirely, since a large one-day move can exceed margin. Gains are paid daily, not at maturity.

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