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P1.T3.600. Central clearing (Gregory)

Nicole Seaman

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Learning objectives: Explain the characteristics of bilateral OTC derivatives trading and the role they may have played in the recent financial crisis. Identify the regulatory changes implemented after the financial crisis. Describe the basic characteristics of central clearing and central counterparties (CCP), identifying potential benefits as well as drawbacks.


600.1. Each is true EXCEPT which is false?

a. CCPs both reduce and increase systemic risk
b. CCPs essentially reallocate default losses via a variety of methods including netting, margining and loss mutualisation.
c. In the wake of the global financial crisis (GFC), policymakers have generally encouraged and/or mandated a shift toward central clearing
d. CCPs cannot transform risk but they do reduce overall risk because they are the only way to achieve netting, margining and transparency

600.2. Which of the following reduces counterparty risk but is expensive especially because it typically cannot be rehypothecated ?

a. Initial margin required by CCP
b. Centralized auction process in a CCP
c. Bilateral netting in a bilateral OTC contract
d. Variation margin required in a bilateral OTC contract

600.3. Gregory cites three possible drawbacks to central counterparties (CCPs). Each of the following is a drawback EXCEPT which is not accurately stated?

a. Loss mutualization tends to homogenize credit risk of members
b. Increase in liquid margin will introduce costs and potential instabilities
c. CCP are likely to become systemically important, potentially creating moral hazard
d. Variation margin confers an adverse selection advantage to members with better credit

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