Skip to content

FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Which feature of the over-the-counter credit default swap market most clearly increased systemic risk during the 2007-2009 crisis, as illustrated by the near-failure of AIG?

The key feature was concentrated, bilateral protection selling with little collateral, as with AIG. When the reference assets fell and AIG was downgraded, large collateral calls arose and counterparties faced potential losses, so the failure of one seller threatened many institutions at once.

  1. AConcentrated, bilateral protection selling with little collateral posting, creating large counterparty exposuresCorrect
  2. BMandatory central clearing that concentrated margin calls on a clearing house
  3. CStrict position limits that forced dealers to close out contracts early
  4. DExchange trading that revealed prices and caused panic selling

Explanation

AIG sold large volumes of protection bilaterally without adequate collateral or reserves. When ratings fell and the mortgage assets declined, collateral calls exploded and counterparties faced potential losses. Central clearing and position limits were not in place at that time, and CDS were traded OTC, not on exchanges.

Did you get it right without looking?

One question tells you little. A timed set on Anatomy of the Great Financial Crisis of 2007-2009 shows your real accuracy, how long you take and where you lose marks.

Practise Anatomy of the Great Financial Crisis of 2007-2009Free diagnostic mock

More Anatomy of the Great Financial Crisis of 2007-2009 questions