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FRM Part I · FRM Exam Part I · Futures Markets

Which statement best describes how a futures clearing house reduces counterparty risk between the buyer and the seller of an exchange-traded futures contract?

The clearing house becomes the buyer to every seller and the seller to every buyer, so the original parties do not bear each other's default risk. Margin and daily settlement support this arrangement, but it does not guarantee profits or mandate delivery.

  1. AIt becomes the counterparty to each side, so buyer and seller do not face each other directlyCorrect
  2. BIt guarantees profits to the side that holds the position until maturity
  3. CIt requires physical delivery on every contract so that no cash settlement occurs
  4. DIt sets the futures price each day so that no margin is needed

Explanation

Through novation, the clearing house stands between the two parties, acting as seller to every buyer and buyer to every seller. Margining supports this, and it does not remove the need for margin. Delivery is not required for all contracts, as many are closed out or cash settled.

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