Module: | MODULE B: RISK MANAGEMENT
Q401: Consider the following statements regarding the RBI Master Direction on Credit Default Swaps and the specific categorization of market participants:
1. Retail users are permitted to act as Protection Sellers in the Credit Default Swap market to generate consistent premium income.
2. Retail users are strictly restricted to buying Credit Default Swap protection exclusively for the purpose of hedging their underlying credit risk.
3. Non-Retail users, such as commercial banks, Non-Banking Financial Companies, and primary dealers, are permitted to act as both Protection Buyers and Protection Sellers.
Which of the statements given above is/are correct?
2. Retail users are strictly restricted to buying Credit Default Swap protection exclusively for the purpose of hedging their underlying credit risk.
3. Non-Retail users, such as commercial banks, Non-Banking Financial Companies, and primary dealers, are permitted to act as both Protection Buyers and Protection Sellers.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 2 is correct: Under the updated RBI Master Directions, Retail Users (which includes corporate clients and smaller entities not defined as market makers) are heavily regulated.
They are strictly permitted to buy CDS protection only if they hold the underlying reference asset, meaning they can only use CDS for pure hedging purposes, not speculation.
Statement 3 is correct: Non-Retail Users (commercial banks, primary dealers, large NBFCs, and mutual funds) function as the backbone of the derivative market.
They are permitted to act as both Protection Buyers and Protection Sellers, enabling liquidity and market-making.
Statement 1 is incorrect: Retail users are absolutely prohibited from acting as Protection Sellers.
Selling a CDS involves writing insurance and taking on massive, unhedged contingent liabilities, which the RBI deems too systemic a risk for retail entities to handle.
They are strictly permitted to buy CDS protection only if they hold the underlying reference asset, meaning they can only use CDS for pure hedging purposes, not speculation.
Statement 3 is correct: Non-Retail Users (commercial banks, primary dealers, large NBFCs, and mutual funds) function as the backbone of the derivative market.
They are permitted to act as both Protection Buyers and Protection Sellers, enabling liquidity and market-making.
Statement 1 is incorrect: Retail users are absolutely prohibited from acting as Protection Sellers.
Selling a CDS involves writing insurance and taking on massive, unhedged contingent liabilities, which the RBI deems too systemic a risk for retail entities to handle.