Explanation:
D is correct. The CCP’s net exposure is AUD 28 million under central clearing. We express the positions – through the process of novation and netting – and present the results shown both in the table and the explanations below (note that a negative net exposure means a zero exposure):
| Party | No Netting | Bilateral Netting | Central Clearing |
|---|---|---|---|
| Firm 1 | 90 + 12 = 102 | max(0, 90-60) + max(0, 12-70) = 30 + 0 = 30 | max(0, (90+12)-(60+70)) = max(0, 102-130) = 0 |
| Firm 2 | 60 + 57 = 117 | max(0, 60-90) + max(0, 57-0) = 0 + 57 = 57 | max(0, (60+57)-(90+0)) = max(0, 117-90) = 27 |
| Firm 3 | 70 | max(0, 70-12) + max(0, 0-57) = 58 + 0 = 58 | max(0, (70+0)-(12+57)) = max(0, 70-69) = 1 |
| CCP | -- | -- | 27 + 1 = 28 |
| Total | 289 | 145 | 56 |
A is incorrect. Firm 1 has a net exposure of AUD 30 million under bilateral netting as shown above.
B is incorrect. Firm 2 has a net exposure of AUD 57 million under bilateral netting as shown above.
C is incorrect. Firm 3 has a net exposure of AUD 1 million under central clearing as shown above.
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A junior risk analyst at a consulting firm is reviewing the operational arrangements of bilateral netting and central clearing of derivative trades. The analyst examines the following bilateral trades of three firms:
Which of the following statements is correct?
A
Under bilateral netting, Firm 1’s net exposure is AUD 28 million.
B
Under bilateral netting, Firm 2’s net exposure is AUD 27 million.
C
Under central clearing, Firm 3’s net exposure is AUD 0 million.
D
Under central clearing, the CCP’s net exposure is AUD 28 million.