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FRM Part I · FRM Exam Part I · Swaps

Which feature best distinguishes a centrally cleared interest rate swap from a bilaterally cleared OTC swap?

In central clearing the clearing house steps in as counterparty to both original parties through novation and collects initial and variation margin. This replaces bilateral credit exposure with exposure to the central counterparty, which manages default risk through margining and default funds.

  1. AThe clearing house becomes counterparty to both sides and collects initial and variation marginCorrect
  2. BThe two original parties retain direct credit exposure to each other with no margin
  3. CThe swap is exchange-traded with standardized contract sizes only
  4. DThe clearing house guarantees a fixed profit to each party

Explanation

In central clearing, novation replaces the original bilateral contract with two contracts facing the central counterparty, which collects initial and variation margin. The other options describe uncollateralized bilateral exposure, exchange trading, or something that does not exist.

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