Explanation:
In a niche, highly concentrated market with few dominant firms, expanding counterparties (Option B) is difficult or impossible. Acquiring credit derivatives (Option D) might introduce significant wrong-way risk and reliance on a third-party seller whose correlation to the niche market may be high. Cross-product netting (Option C) is beneficial but can only net positions up to the offsetting amounts, not necessarily reducing the exposure "near zero."
Requiring counterparties to provide ample high-quality collateral (Option A), such as cash or government securities, ensures that counterparty risk exposure is maximally mitigated, effectively collateralizing the gross exposure and bringing the residual uncollateralized exposure to near zero.
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Q.22 A trading firm specializes in derivatives linked to scarce commodities and, along with a few other dominant firms, holds substantial notional contracts in this niche market. The firm's management aims to significantly reduce its counterparty risk exposure, ideally to near zero. Which of the following strategies would be most effective in achieving this objective?
A
Requiring counterparties to provide ample high-quality collateral
B
Expanding the pool of counterparties
C
Implementing cross-product netting agreements with individual counterparties
D
Acquiring credit derivatives such as credit default swaps
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