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FRM Part I · FRM Exam Part I · Futures Markets

In a futures market with a clearinghouse, after a trade is executed between a buyer and a seller, what is the legal relationship between the two original parties and the clearinghouse?

The clearinghouse becomes the seller to the buyer and the buyer to the seller through novation. Each side then faces the clearinghouse instead of each other, which removes direct bilateral counterparty risk between the original traders.

  1. AThe clearinghouse becomes the seller to the original buyer and the buyer to the original sellerCorrect
  2. BThe clearinghouse guarantees only the buyer's side of the contract and leaves the seller's obligation bilateral
  3. CThe original parties remain directly bound to each other, and the clearinghouse only records the trade
  4. DThe clearinghouse takes a share of the position's profit in exchange for monitoring the parties

Explanation

Through novation, the clearinghouse interposes itself so that it is the counterparty to each original party. Each clearing member therefore faces the clearinghouse rather than the other trader. The option saying the parties stay bound to each other describes bilateral OTC trading, not central clearing.

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