Nicole Seaman

Director of FRM Operations
Staff member
Subscriber
Learning objectives: Provide examples of the mechanics of a central counterparty (CCP). Describe the role of CCPs and distinguish between bilateral and centralized clearing ... Identify and explain the types of risks faced by CCPs. Identify and distinguish between the risks to clearing members and to non-members

Questions:

21.11.1. In comparison to a bilateral transaction, which of the following statements is TRUE as an advantage of a central counterparty (CCP)?

a. It is easier to exit a CCP position
b. There are no margin requirements for a CCP position
c. The CCP transactions legally mutate into uncleared transactions which reduces systemic risk
d. The exposures on a CCP are more concentrated and therefore their credit risk is better understood than bilateral transactions


21.11.2. Derivatives can be cleared through a central counterparty (CCP) or they can be cleared bilaterally; i.e., uncleared transactions are cleared bilaterally. If the derivatives are cleared through a CCP, they can be either exchange-traded or over-the-market (OTC). In this way, we distinguish between the exchange and the clearinghouse (which may be owned by an exchange). While exchanges operate CCPs, we can also refer to the emergent OTC CCPs. In regard to central counterparties (CCPs), which of the following statements is TRUE?

a. Banks are easier to regulate than both OTC CCP and exchange CCP
b. An exchange CCP is more dependent on valuation models than an OTC CCP
c. CCP member defaults are negatively correlated such that CCPs are counter-cyclical
d. In the cleared market, CCPs want an initial margin that covers a 5-day 99.0% price value at risk (VaR)


21.11.3. Acme FinCorp (A), Bitarion Inc (B), and Congrezo LLC (C) have entered into many derivative transactions. When transactions between A and B are netted, the net value to A is -12; the net value to B is +12. When transactions between B and C are netted, the net value to B is -9; the net value to C is +9. When transactions between A and C are netted, the net value to A is +17; the net value to C is -17. Symbolically, in the direction of positive exposure:
  • A -> B = +12
  • B -> C = +9
  • C -> A = +17
The total credit exposure of all three parties is equal to 12 + 9 + 17 = 38. Suppose that all transactions are cleared through a central counterparty (CCP) rather than bilaterally. After clearing through the CCP, what is the total credit exposure of all three (A + B + C) parties?

a. Zero
b. +2
c. +8
d. +27

Answers here:
 
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