Explanation:
Systemic risk in the context of OTC markets can be triggered by the default of a large market participant who has multiple and sizable positions in the market. The default can spark a chain reaction in the entire financial market. Such a spark could be the failure of a player considered "too big to fail." Therefore, OTC markets use different risk mitigation methods such as margins and capital requirements to mitigate systemic risk.
Option A is incorrect. refers to liquidity risk - the risk related to the early settlement by a large market participant that will absorb the liquidity from the entire financial market.
Option B is incorrect. refers to market risk - risk related to the unfavorable movement in the underlying which can trigger the early settlement of the contract by the counterparty.
Option C is incorrect. The complexity and negotiability of OTC contracts increase credit risk.
Ultimate access to all questions.
No comments yet.
Q.6 Over the years, over-the-counter markets have outgrown exchanges because of more flexible regulations and customized transactions. Nevertheless, this flexibility does not come without a cost. Over-the-counter markets are more exposed to systemic risk than exchanges. From the following, choose the most accurate explanation of systemic risk in the context of over-the-counter markets.
A
The risk related to the early settlement by a large market participant, a move that could absorb the liquidity from the entire financial market.
B
The risk related to an unfavorable movement in the underlying, which can trigger early settlement of the contract by the counterparty.
C
The risk related to the complexity and negotiability of OTC contracts, making it difficult for market participants to price the risk correctly.
D
The risk related to a large market participant's default creates a chain reaction of defaults in the entire financial system.