answer is prob right elena and u guys can ignore all this oops)Government securities: secondary market is a decentralized, OTC market mediated by dealers.-Direct settlement: no netting - counterparties using the same clearing bankcan have the trade settled internally by the bank, reducing transactions costs; bilateral netting between dealers can occur (for the same security) but usually trades are cleared one at a time on Fedwire-GSCC clears and settles non-same-day trades, uses comparison and multilateral netting, no depository since book-entry form, settlement over FedwireStock: markets are both exchange and OTC-gross netting in some markets settles each trade individually-multilateral multi-issue netting is done by most markets, reduces costs but increases settlement time to ensure a sufficient volume to optimize netting(and reduce liquidity problems)-settlement is usually done with a third party (the market) that guarantees trades10. Shortening the settlement period involves trade-offs. Explain the effect on replacement risk, liquidity risk, and principal risk. How can the trade-off be improved?-Shortening settlement period decreases replacement risk, increases liquidity risk, decreases principal risk-Same as Elena’s answer below for replacement & liquidity risk -> maybe decrease principal risk because there’s no delay between settlement and delivery and therefore less risk that one party will fail A longer settlement period means parties in the transaction have longer to come up with their part of the bargain. This reduces liquidity risk as it is more likely that
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both will be able to pay on time. However, the longer period increases replacement risk because there is more time for something to go wrong and result in one party not fulfilling their side of the agreement. There has been a movement toward shorter settlement periods to reduce replacement risk. Settlement period doesn’t affect principal risk because no money changes hands until the actual transaction takes place.How can the trade-off be improved?Substituting the credit of a third party can reduce both liquidity and replacement risk in the futures market by having each party conduct their exchange with the third party, in the stock market a third party only protects during settlement. -Third party would guarantee both ends of deal, addresses all three risks -Delivery against payment; simultaneous trades take away all risks -However not every party has access to electronic payments systemand securities are not linked on a real-time basis to the payments systemCould also improve liquidity with credit and securities lending Replacement risk would be improved if there is a use of a central counterparty. Higher availability of credit in markets means settlement can be much shorter because it is easier for traders to borrow if they lack the liquidity to complete a trade. This allows both replacement and liquidity risk to be reduced.
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