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Answer: In the cleared market, CCPs want initial margin that covers a 5-day 99.0% price value at risk (VaR)
**Correct answer: D.** CCPs generally set initial margin to cover potential losses over a short liquidation horizon at a high confidence level, and a common benchmark is a **5-day 99% VaR**. - **A** is false: CCPs are generally designed to be highly regulated and centrally supervised. - **B** is false: OTC CCPs tend to rely more heavily on valuation models than exchange-traded CCPs because OTC products are typically less standardized and less transparent. - **C** is false: CCP member defaults are more likely to be **positively** correlated in stressed markets, not negatively correlated. Therefore, the true statement is that CCPs want initial margin covering a 5-day 99.0% VaR.
Author: Manit Arora
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Q-21.11.2. Derivatives can be cleared through a central counterparty (CCP) or they can be cleared bilaterally; i.e., uncleared transactions are cleared bilaterally. If the derivatives are cleared through a CCP, they can be either exchange-traded or over-the-market (OTC). In this way, we distinguish between the exchange and the clearinghouse (which may be owned by an exchange). While exchanges operate CCPs, we can also refer to the emergent OTC CCPs. In regard to central counterparties (CCPs), which of the following statements is TRUE?
A
Banks are easier to regulate than both OTC CCP and exchange CCP
B
An exchange CCP is more dependent on valuation models than an OTC CCP
C
CCP member defaults are negatively correlated such that CCPs are counter-cyclical
D
In the cleared market, CCPs want initial margin that covers a 5-day 99.0% price value at risk (VaR)
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