Learning Objectives: Discuss the risks faced by a CCP and the ways it manages its exposures. Provide examples of a loss waterfall. Explain the different methods of managing the default of one or more members of a CCP.
Questions:
24.30.1. RiskShield CCP is a central counterparty that clears a wide range of financial instruments, including interest rate swaps, credit default swaps, and futures contracts. Recently, one of its clearing members, BetalBank, defaulted on its obligations due to significant losses in its trading portfolio. RiskShield's risk management team must now handle the default while minimizing the impact on other clearing members and the broader financial system.
Which of the following actions should RiskShield prioritize to most effectively manage the default and mitigate potential losses?
a. Immediately liquidate BetalBank's entire portfolio to recover as much value as possible before market conditions deteriorate further.
b. Use BetalBank's initial margin and default fund contributions to cover the losses, and if necessary, allocate any remaining losses to other clearing members.
c. Employ macro-hedging techniques to reduce BetalBank's portfolio's market risk exposure and then auction the sub-portfolios to other clearing members.
d. Suspend all clearing activities for 24 hours to allow clearing members to assess their exposure and provide additional margin to cover potential losses.
24.30.2. A central counterparty (CCP) has the following loss waterfall structure in place:
a. $0 million
b. $40 million
c. $90 million
d. $140 million
24.30.3. A CCP has four clearing members: W, X, Y, and Z. The current positions and unrealized gains/losses are as follows:
a. $10 million
b. $20 million
c. $28 million
d. $35 million
Answers here:
Questions:
24.30.1. RiskShield CCP is a central counterparty that clears a wide range of financial instruments, including interest rate swaps, credit default swaps, and futures contracts. Recently, one of its clearing members, BetalBank, defaulted on its obligations due to significant losses in its trading portfolio. RiskShield's risk management team must now handle the default while minimizing the impact on other clearing members and the broader financial system.
Which of the following actions should RiskShield prioritize to most effectively manage the default and mitigate potential losses?
a. Immediately liquidate BetalBank's entire portfolio to recover as much value as possible before market conditions deteriorate further.
b. Use BetalBank's initial margin and default fund contributions to cover the losses, and if necessary, allocate any remaining losses to other clearing members.
c. Employ macro-hedging techniques to reduce BetalBank's portfolio's market risk exposure and then auction the sub-portfolios to other clearing members.
d. Suspend all clearing activities for 24 hours to allow clearing members to assess their exposure and provide additional margin to cover potential losses.
24.30.2. A central counterparty (CCP) has the following loss waterfall structure in place:
- Defaulter's Margin: $80 million
- Defaulter's Default Fund Contribution: $30 million
- CCP's Own Capital (Skin in the Game): $25 million
- Surviving Members' Default Fund Contributions: $200 million
- Assessment Calls: Up to $100 million
a. $0 million
b. $40 million
c. $90 million
d. $140 million
24.30.3. A CCP has four clearing members: W, X, Y, and Z. The current positions and unrealized gains/losses are as follows:
- Member W: Long position, unrealized gain of $80 million
- Member X: Short position, unrealized loss of $60 million
- Member Y: Long position, unrealized gain of $20 million
- Member Z: Short position, unrealized loss of $40 million
- Member X defaults, and the CCP closes out their position at a premium, resulting in a total loss of $90 million. The CCP's loss waterfall is as follows:
- Member X's initial margin: $30 million
- Member X's default fund contribution: $15 million
- CCP's own capital (skin-in-the-game): $10 million
a. $10 million
b. $20 million
c. $28 million
d. $35 million
Answers here:
