CFA Level I · CFA Level I Exam · Derivative Instrument and Derivative Market Features
After a regulatory reform, many standardized OTC swaps must be submitted to a central counterparty (CCP). Compared with the earlier bilateral arrangement, the change most likely:
Central clearing most likely reduces bilateral counterparty credit risk. The CCP steps in between the parties through novation and collects margin, so one party's default affects the other less. Credit risk becomes concentrated in the CCP rather than disappearing.
- Aincreases the exposure of each party to the other's default
- Blets each party customize every term without any margin
- Creduces bilateral counterparty credit risk through novation and margin requirementsCorrect
Explanation
Central clearing replaces the original bilateral contract with contracts against the CCP (novation), which collects margin and mutualizes losses. This lowers bilateral credit exposure, though risk concentrates in the CCP. It does not eliminate margin or allow unlimited customization.
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