Explanation:
Trade compression involves offsetting long and short positions in the same reference entity to reduce the notional exposure. By netting the long and short positions across all counterparties, we calculate the net exposure as follows:
Net long position = Notional position of Counterparty A + Notional position of Counterparty D = 300 + 50 = 350
Net short position = Notional position of Counterparty B + Notional position of Counterparty C = 100 + 150 = 250
Net notional exposure after compression = Net long position - Net short position = 350 - 250 = 100 Long
Since Counterparty A has the largest individual long position, after compression, Counterparty A will hold the net contract position.
B is incorrect because the net notional exposure is not short. After netting the long and short positions, the exposure is long, not short.
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Q.5511 Global Finance Bank (GFB) is undertaking a trade compression exercise to streamline its derivatives portfolio and reduce the notional exposure across its Credit Default Swap (CDS) positions. The risk management team has identified several offsetting positions with different counterparties that are candidates for compression. The positions are on the same reference entity and have the same maturity date but involve different notional amounts and counterparties. The team needs to calculate the net notional exposure after compression and identify which counterparty will hold the net contract position. The following are the details of the trades identified for compression:
| Reference Entity | Notional Position | Position | Counterparty |
|---|---|---|---|
| XYZ Index | 300 | Long | Counterparty A |
| XYZ Index | 100 | Short | Counterparty B |
| XYZ Index | 150 | Short | Counterparty C |
| XYZ Index | 50 | Long | Counterparty D |
Considering the trade compression mechanics, what will be the net notional exposure and which counterparty will hold the net contract position?
A
Net notional exposure of 100 Long held by Counterparty A.
B
Net notional exposure of 100 Short held by Counterparty C.
C
Net notional exposure of 0 with no counterparty holding a net position.
D
Net notional exposure of 100 Long held by Counterparty D.