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P2.T6.903. The International Swaps and Derivatives Association (ISDA) Master Agreement (Gregory Ch.4)

Nicole Seaman

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Learning objectives: Explain the purpose of an ISDA master agreement. Summarize netting and close-out procedures (including multilateral netting), explain their advantages and disadvantages, and describe how they fit into the framework of the ISDA master agreement.


903.1. Becky's firm, Zapstreet International, is analyzing an opportunity to enter into a set of significant over the counter (OTC) derivative trades with a single institution (aka, the Counterparty). The Counterparty has proposed that the trades be governed by the bilateral framework of an International Swaps and Derivatives Association (ISDA) Master Agreement; see https://www.isda.org/. As Becky evaluates the proposal, which of the following statements is TRUE?

a. Although the ISDA Master Agreement will mitigate legal risk, it cannot be expected to mitigate counterparty risk
b. If an individual transaction produces a trade confirmation, then the trade confirmation will nullify the Master Agreement
c. A key drawback of the ISDA Master Agreement is that its terms are "hard-wired" and not adjustable even if Zapstreet and the Counterparty both agree
d. The Master Agreement will include contractual terms regarding the posting of collateral, transactions referenced into single netting set(s), close-out process mechanics, and definitions of events of default

903.2. Acme Financial has a position in five derivative contracts with its counterparty. The current mark-to-market values of the positions are the following: +12, -9, +20, -6, and +8. The five positions are all included in a single netting set. Let's define the "netting benefit" as the reduction in current exposure due to netting; that is, the difference between the total current exposure with netting and the current exposure "as if" netting did not apply. What is the netting benefit in this set?

a. Zero
b. 3
c. 15
d. 25

903.3. In regard to netting, each of the following statements is true EXCEPT which is false?

a. The best approach to determining the close-out amount is the Product Coverage Method
b. Payment netting reduces settlement risk by netting, in general, cash flows or obligations
c. Close-out netting reduces pre-settlement risk by netting, in general, mark-to-market values
d. Set-off rights involve the potential to offset or net obligations between two parties across different product types

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