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FRM Part I · FRM Exam Part I · Introduction to Derivatives

Which statement about exchange-traded versus OTC derivatives is correct?

Exchange-traded positions are normally closed by entering an offsetting trade because the clearing house stands behind every contract, whereas OTC contracts are bilateral and are usually terminated or unwound through negotiation with the original counterparty. The other statements reverse standard features of the two markets.

  1. AExchange-traded contracts are typically closed out before maturity by taking an offsetting position, whereas OTC contracts are usually terminated by negotiation with the original counterpartyCorrect
  2. BOTC derivatives are always settled through a clearing house that guarantees performance
  3. CExchange-traded derivatives have contract terms negotiated individually by the two parties
  4. DExchange-traded derivatives expose each party to the other's default risk directly, with no margin

Explanation

On an exchange, a position is closed by entering an opposite trade, since the clearing house is the counterparty. OTC contracts are bilateral, so early termination generally requires agreement with the original counterparty. The other options describe features that are reversed or incorrect.

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