Documentation & Clearing Infrastructure Flashcards

A Central Counterparty (CCP) reduces systemic counterparty risk in derivatives markets primarily by:

Answer: Interposing itself as buyer to every seller and seller to every buyer via novation

Through novation, a CCP becomes the buyer to every seller and seller to every buyer, mutualizing counterparty credit risk and reducing bilateral exposure across the market.

In the correct order of a CCP's 'default waterfall,' which resources are used first when a clearing member defaults?

Answer: The defaulting member's initial margin and default fund contribution

The default waterfall uses the defaulter's own initial margin and default fund contribution first, before touching CCP capital or surviving members' funds, to minimize mutualization of losses.

'T+1' settlement in derivatives markets refers to:

Answer: Settlement occurring one business day after the trade date

T+1 means settlement completes one business day after the trade date (T), with T+2 and T+3 being common for other asset classes.

'Delivery versus Payment' (DvP) in derivatives settlement is designed to eliminate:

Answer: Principal risk by ensuring asset delivery and cash payment occur simultaneously

DvP links asset transfer and cash payment so both legs settle simultaneously, eliminating the principal risk that one party delivers without receiving payment.

In exchange-traded derivatives markets, 'open interest' represents:

Answer: The total number of outstanding contracts not yet settled, closed, or expired

Open interest measures the total number of active, outstanding derivative contracts that remain open and have not been offset, exercised, or expired.

For a physically settled commodity futures contract, 'final settlement' involves:

Answer: Actual delivery of the underlying commodity in exchange for the contract price

Physical settlement requires the short to deliver the actual commodity and the long to pay the contract price, distinguishing it from cash-settled contracts.

Portfolio 'compression' of OTC derivatives (e.g., via TriOptima or LCH SwapClear) achieves which primary goal?

Answer: Reduces gross notional outstanding and trade count without changing net risk exposure

Compression eliminates offsetting trades and reduces gross notional and line items while preserving the net risk position, lowering capital consumption and operational complexity.