Each of the following is true about termination and walkaway features in credit contracts except?
A. Termination events give an institution the right to terminate a trade prior to their counterparty's credit-worthiness deteriorating to the point of bankruptcy.
B. A break clause - a.k.a. liquidity put - is an agreement to terminate a transaction at pre-specified dates in the future at market rates.
C. Break clause are often linked to additional termination events which are not in the standardized ISDA documentation and therefore are a result of negotiations.
D. Walkaway features are parts of the standardized ISDA documentation and "should be utilized in almost all transactions" as they mitigate counterparty risk.?
Answer:D
Walkaway feature are not part of the standardized documentation. walkaway features are rather unpleasant and should be avoided for the following reasons:
• They create an additional cost for a counterparty in the event of default.
• They create moral hazard since an institution is given the incentive to contribute to their counterparty default due to the financial gain they can make.
• A walkaway feature may be "priced in" to a transaction. The possible gains in counterparty default will then offset the negative component due to potential losses that may ultimately "hide" some of the risk.