Vol 1 Chapter 4

Question 1

explains clearing and settlement

Answer 1

After the trade is executed, the record is submitted to the clearing agency, which matches the buyer and seller record and confirms that the counterparts agree to all the terms. The agency reports discrepancies (差異) to traders in case the reports do not match, who then try and resolve them. After the clearing process is performed, through settlement, agencies fulfill the delivery requirements of the securities object of a trade. The settlement agency receives cash from buyers and securities from sellers and, at the end of the process, gives the securities to the buyers and the cash to the seller. Agencies perform an important function in case a trader is not trustworthy or creditworthy

Question 2

Specific risks arising in clearing and settlement. (7)

Answer 2

Credit risk
Replacement cost risk
Principal risk
Liquidity risk
Operational risk
Systematic risk
Errors risk

Question 3

Credit risk

Answer 3

transaction NEVER settle for full value

Failure caused by economic reasons

Question 4

Replacement cost risk

Answer 4

Asset value exchanged before, CHANGES between time of trade and settlement

Question 5

Principal risk

Answer 5

Risk of loss from one counterparty making a delivery

So between a transaction, one person can deliver but the other person fails to deliver

Question 6

Liquidity risk

Answer 6

Risk that trade will settle for the full value AFTER the agreed upon time
Failure to settle on time results in failed transactions

Question 7

Operational risk

Answer 7

Loss caused by technical issues

Such as hardware, software, communications or other physical aspects in clearing and settlement

Question 8

Systematic risk

Answer 8

One failure leads to other people failing to meet obligations as well

Question 9

Errors risk

Answer 9

accidental mess-up caused by easy mistakes

Such as buying instead of selling, trading wrong asset on the wrong amount of asset, trading at the wrong price, etc.

Question 10

Three methods used to mitigate these risks

Answer 10

Netting
Delivery vs. Payment
Margin

Question 11

Netting

Answer 11

in the event of failure, net amount of each asset or funds are transferred
▪ Bilateral netting
▪ Multilateral netting

Question 12

Delivery vs. Payment

Answer 12

Reducing difference between the trade time and settlement time
Reduces principal risk
Both parties pay at the same time

Question 13

Margin

Answer 13

Depositing money in case of default

This allows a cushion for settlement protection

Question 14

Specialized institutions involved in clearing and settlement that help reduce risks and lower costs:(5)

Answer 14

Registrars and transfer agents
Clearinghouses
Central depositories
Global custodians
Communication networks

Question 15

Registrars and transfer agents

Answer 15

Helps manage shareholder account
Registrar –issuer for stock and or bond issues and records transactions
Transfer agent- initiator for issuing new certificate and cancellation of old certificates

Question 16

Clearinghouses

Answer 16

Involved with clearing and settlement

Question 17

Central depositories

Answer 17

Accepts deposits of security and account for transferring the securities

Question 18

Global custodians

Answer 18

Makes sure everything is settled properly and correctly registered
◦ Protects ownership rights
Dividend, stock splits and voting

Question 19

Communication networks

Answer 19

Communicate to easily execute trades