Credit risk is present to the long position in an options contract - this is fact.
So why would a forward conversion with options, where you are selling calls and buying puts, avoid any counterparty risk? If the price falls you will sell your stock in the option and be exposed.
It wouldn’t, that’s why the answer is A
Galli I just want to alert you that you are incorrect as to why the answer is A.
From answer key:
Adams’s statement about the short sale against the box is correct because it creates a riskless position. Although the forward conversion with options avoids counterparty risk, the equity forward sale and the total return equity swap use a derivative s dealer and thus include counterparty ri
Maybe because it’s assumed to be performed via an exchange?
IMO the PM version of the CFA MCQ are just miserable.
Here we go:
"With respect to an OTC derivative, the investor incurs the credit risk of the single counterparty that he or she contracts with. With respect to exchange-traded instruments, because a clearinghouse (that is typically owned and jointly and severally backed by all its members) is the counterparty and guarantees the instrument, the investor incurs significantly less counterparty credit risk.
(Institute 169) Institute, CFA. 2015 CFA Level III Volume 2 Behavioral Finance, Individual Investors, and Institutional Investors. Wiley Global Finance, 2014-07-14. VitalBook file. The citation provided is a guideline. Please check each citation for accuracy before use."
That’s because put and call are finalized through clearing house, no OTC here.