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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

Which statement about close-out netting is most accurate?

Close-out netting lowers credit exposure at default by offsetting positive and negative values, but trades still carry market risk before default. It never increases exposure above the gross amount, and it is a core feature of OTC derivative master agreements.

  1. AIt reduces credit exposure at default but does not remove market risk on the trades before defaultCorrect
  2. BIt eliminates credit exposure whenever trades have opposite signs
  3. CIt increases exposure when trades are of the same sign
  4. DIt applies only to exchange-traded futures and never to OTC contracts

Explanation

Netting reduces the claim in default by combining positive and negative values; it never exceeds gross exposure and cannot increase it. Trades remain subject to market movements until default, and netting is widely used for OTC derivatives. It only fully removes exposure if net value is non-positive.

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