C. An investor in the Baywhite Structured Note assumes the credit risk of Baywhite Financial LLC for 100% of the note’s face value, while an investor entering into the SIXV derivative on a stand-alo
C. An investor in the Baywhite Structured Note assumes the credit risk of Baywhite Financial LLC for 100% of the note’s face value, while an investor entering into the SIXV derivative on a stand-alone basis assumes the counterparty credit risk of an exchange and its clearinghouse.
Here’s why:
Structured Note: Even if part of the structured note is “principal protected,” the entire payoff—principal and derivative-linked return—is contingent on the issuer (Baywhite) not defaulting. Thus, the investor is exposed to 100% credit risk of Baywhite.
Exchange-Traded Derivative (SIXV): If the embedded derivative is replicated through a stand-alone exchange-traded instrument (like a futures or listed option), the counterparty risk is absorbed by the exchange’s clearinghouse, which is significantly lower due to margining, daily settlement, and regulatory oversight.
This contrast is fundamental when advising clients on credit exposure and counterparty risk.
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This reply was modified 5 months ago by
Madhusudan Chandarasekaran, CFA, FRM.
Madhusudan Chandarasekaran, CFA, FRM