Manag., December-2019 – Q81
0. Novation, a feature of future exchanges stipulates:
- Option : B
- Explanation : Novation: Novation means that the exchange becomes a counter-party for all trades. Thus if A buys a futures contract from B, the exchange replaces this transaction with two transactions. In one transaction, the exchange buys from B and in another transaction, the exchange sells to A. The advantage of this process is that now neither A nor B needs to know anything about each other as legally
speaking, they are not dealing with each other at all. Even if A defaults, the exchange has to fulfill its obligation to B and try and sell the asset in the market at whatever price it can procure.
The credit risk is thus intermediated by the exchange, just as in many forward markets the credit risk is intermediated by banks. As the exchange relies on sophisticated margining systems to manage the credit risk, it does not have to charge a large fee to cover the risk.
