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Explanation:
Central clearing can contribute to increased liquidity in the underlying markets due to the standardization and mutualization of risk. The presence of the CCP adds predictability and confidence in the market, encouraging participation and, hence, potentially increasing liquidity.
A is incorrect. While bilateral clearing allows for tailored credit terms, it may not necessarily enhance liquidity compared to the predictability provided by a CCP.
C is incorrect. Bilateral clearing can tie up capital due to varying margin requirements based on bilateral negotiations, which can potentially dampen liquidity.
D is incorrect. Central clearing is not viewed as restricting market liquidity overall, as standardized practices instill market confidence and can facilitate more efficient trading.
Things to Remember
Q.6105 In bilateral clearing, parties directly negotiate the terms of their trades and bear the risk of counterparty default themselves. Conversely, central clearing introduces a Central Counterparty (CCP) that assumes the risk for both sides of the trade. How does this fundamental difference affect the liquidity of underlying markets?
A
Bilateral clearing enhances market liquidity by allowing counterparties to directly negotiate credit terms tailored to their needs.
B
Central clearing standardizes and mutualizes risk, which can help increase the liquidity of the underlying markets through greater predictability and confidence.
C
Bilateral clearing inherently provides greater market liquidity as there are no standard margin requirements tying up capital, unlike in central clearing.
D
Central clearing restricts market liquidity due to the complex and rigid structures imposed by the CCP that cannot quickly adapt to market changes.
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