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CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses

After a regulatory change, a large share of previously bilateral OTC swaps must be centrally cleared through a central counterparty (CCP). Compared with the prior bilateral arrangement, this change is most likely to:

Central clearing most likely concentrates default risk in the central counterparty. It replaces many bilateral credit exposures with a single exposure to the CCP, which reduces counterparty risk between the original parties. Margin and collateral are still required, so collateral is not eliminated.

  1. Aremove the need for any collateral posting
  2. Bconcentrate default risk in the central counterpartyCorrect
  3. Cincrease counterparty credit risk between the original parties

Explanation

Central clearing replaces many bilateral exposures with exposure to the CCP, lowering counterparty risk between the original parties but concentrating risk in the CCP. Collateral (initial and variation margin) is still required, so the other options are wrong.

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