Best method to reduce credit risk previous, multiple, posting

Carson

This is from one of the questions in previous exams.

Q) what is the best method to reduce OTC credit risk.

A) posting margin
B) Marking to markert/ netting
C) limit exposure to one counter party( not sure about the wording) but it meant, diversify your transactions with multiple parties

The correct answer is C.

Can anyone justify why it is better than posting margin.

Darien

When your entire exposure is with a single party and if that party's credit quality (ability and willingness to pay) deteriorate then it will lead to default and your realisation will be negligible. However, on the contrary, if the exposure is spread among various individual and distinct parties, then it is very less likely that all of them will default simultaneously.


Viks

bodhisattva

it is ok
limiting the total exposure to a given counterparty is primary method
it is stated in the book , I think the reason is low cost and diversification

Zestt

...



Edited 1 time(s). Last edit at Tuesday, May 31, 2011 at 11:51PM by goodman2011.

Windjam

my mistake, did not post the question exactly the way it was asked. 2009.

) In keeping with industry standards, primary means of managing credit risk

choices are

Posting collateral
periodic marking to market
limiting the total exposure to a given counterparty

lcw77

mock ask most popular not best , 2009 or 2010 , check it ok?

zwjy

q) In keeping with industry standards, primary means of managing credit risk

choices are

Posting collateral
periodic marking to market
limiting the total exposure to a given counterparty



Edited 1 time(s). Last edit at Tuesday, May 31, 2011 at 11:44PM by lowonmemory.

mar350

having worked in collateral management for OTC derivatives, I can say from practice that you take collateral (i.e. not "margin" but the actual exposure of your derivatives portfolio with the other bank or HF) ONLY TO BE ABLE TO INCREASE YOUR EXPOSURE WITH THE COUNTERPARTY

even though we took cash or AAA rated sec from them, at a certain point there was a risk limit.

Thus, as a margin is not even close to getting your daily exposure t-2 (after settlement) in Cash USD or EUR, C) is in fact the best answer even and especially from a practical point of view

cityboy

I think the assumption here is that you have multiple OTC transactions each with their own default risk. So if I have 100 transactions and 100 different counterparties, I am exposed to much less default risk than I would be if my 100 transactions all had the same counterparty.

zwjy

That question sucks. The answer is pretty unclear and subjective.