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NISM Certifications · NISM-Series-XXI-A: Portfolio Management Services (PMS) Distributors · Derivatives

In an exchange-traded equity futures contract, which feature primarily protects the counterparties against default by the other side?

Novation to the clearing corporation protects counterparties. After a trade, the clearing corporation becomes the buyer to every seller and the seller to every buyer, guaranteeing performance and removing direct counterparty default risk, unlike bilateral over-the-counter contracts.

  1. ANovation of the trade to the clearing corporation, which becomes the counterparty to both sidesCorrect
  2. BFixing the contract size at a very large value
  3. CAllowing delivery only on the expiry date
  4. DUsing a bilateral agreement signed between buyer and seller

Explanation

On exchange-traded derivatives the clearing corporation steps in through novation and becomes the buyer to every seller and seller to every buyer, guaranteeing settlement. Bilateral agreements are characteristic of OTC contracts, which carry counterparty risk. Contract size and expiry-only delivery do not address default risk.

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