Product Overview

When Prime Broking defaulted on its equity derivative positions at the National Stock Exchange, the central counterparty (CCP) suffered substantial losses, although there was no significant movement in the relevant market prices. This revealed hidden risks arising from collateral, liquidity and concentration, wrong-way risks and operational risks in the default management process, even when the market risk environment is benign. The CCP ends up with risks it is not designed to handle and similar to those faced by a bank. The CCP suffered massive losses, even though its market risk models functioned flawlessly.

Learning Objectives

To appreciate the role of CCP for the efficient functioning of the financial market. To discuss the factors affecting risk management of CCP and more specifically: a. Collateral requirement for different exposures, especially for deep-in-the-money positions. b. Characteristics of an effective collateral policy (liquidity and concentration risks). c. Operational risks in the default management process To discuss the use of box spreads to create synthetic loan transactions using equity index options.