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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

In an over-the-counter derivatives market that moves from bilateral clearing to clearing through a central counterparty (CCP), which feature of the CCP most directly reduces the counterparty credit risk faced by an individual clearing member?

Novation, under which the CCP becomes buyer to every seller and seller to every buyer, most directly reduces counterparty risk. Members face the CCP instead of each other, and the CCP manages default risk through margin and default fund resources. It does not guarantee profits, waive margin or set prices.

  1. AThe CCP becomes the buyer to every seller and the seller to every buyer through novationCorrect
  2. BThe CCP guarantees a fixed profit to each clearing member on every trade
  3. CThe CCP eliminates the need for any margin to be posted by members
  4. DThe CCP sets the price at which every trade must be executed

Explanation

Novation replaces the original bilateral contract with two contracts, each facing the CCP. Members then face the CCP rather than each other, and the CCP manages default risk with margin and a default fund. The other options describe things a CCP does not do: it does not guarantee profits, remove margin, or set trade prices.

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