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Nicole Seaman

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Learning objectives: Identify counterparty risk intermediaries including central counterparties (CCPs), derivative product companies (DPCs), special purpose vehicles (SPVs) and monoline insurance companies (monolines) and describe their roles. Describe the risk management process of a CCP and explain the loss waterfall structure of a CCP. Compare bilateral and centrally cleared over-the-counter (OTC) derivative markets. Assess the capital requirements for a qualifying CCP and discuss the advantages and disadvantages of CCPs. Discuss the impact of central clearing on credit value adjustment (CVA), funding value adjustment (FVA), capital value adjustment (KVA) and margin value adjustment (MVA)

Questions:

913.1. The history of various methods of counterparty risk mitigation via intermediation includes special purpose vehicles (SPVs), derivative product companies (DPCs), monolines, and credit derivative product companies (CDPC). Which of the following statements about the lessons learned is TRUE?

a. The best way to mitigate counterparty risk is to rely on a default-remote entity
b. Mitigating counterparty risk with mechanisms that create legal risk is a dangerous process
c. An advantage of the bilateral over the counter (OTC) derivatives market is an efficient close-out process in the event of a major default
d. Reliance on external credit ratings, especially single-A ratings or better, historically has been an effective way to manage counterparty risk


913.2. Acme Financial Corporation, a prominent member of a large central counterparty (CCP), has defaulted. Which of the following remedies is LEAST LIKELY to be true?

a. If Acme's own default fund (plus its initial margin) are exhausted, the CCP will fail unless it can secure external liquidity support
b. After Acme's contributions to the CCP have been exhausted, the other members' default fund (via loss mutualization) will absorb additional losses
c. When Acme defaults, the CCP will swiftly terminate financial relations by replacing Acme with other members as the counterparty on each trade
d. Due to daily (and possibly even intradaily) collateral calls coupled with full authority over all calculations, the margin period of risk is reduced


913.3. If a financial institution shifts a set of derivative trades from bilateral over the counter (OTC) to central clearing via a well-capitalized central counterparty (CCP), which of the following impact is most likely on their xVA (where xVA = CVA/DVA, ColVA, FVA, MVA, and/or KVA)?

a. No impact on the CVA
b. Eliminate the regulatory capital charges
c. Reduce the CVA (and KVA) to zero or very little
d. Reduce the FVA and MVA to zero or very little

Answers here:
 
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