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FRM Part II · FRM Exam Part II · Margin (Collateral) and Settlement

A bank and a hedge fund have an uncollateralised OTC interest rate swap. They now sign a Credit Support Annex (CSA) with a zero threshold and a minimum transfer amount of USD 250,000. Which statement best describes the effect of a zero threshold?

A zero threshold means no exposure is left uncollateralised, so collateral is called for any positive mark-to-market exposure. The only friction is the minimum transfer amount, which stops very small transfers. The threshold is unrelated to independent amounts or rating triggers.

  1. ACollateral is called for any positive exposure, subject only to the minimum transfer amountCorrect
  2. BCollateral is called only when exposure exceeds the minimum transfer amount plus a buffer equal to the independent amount
  3. CNo variation margin is ever required because the threshold is nil
  4. DCollateral is called only when the counterparty's rating is downgraded

Explanation

The threshold is the amount of exposure that can remain uncollateralised. With a threshold of zero, any exposure above zero is collateralised, although transfers smaller than the minimum transfer amount are not made. The second option confuses threshold with independent amount. The third reverses the meaning of the threshold.

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