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

A bank and a hedge fund trade an uncleared OTC derivative under a CSA. The bank's net exposure moves daily as market values change. Which collateral flow is designed to reset the current mark-to-market exposure back to approximately zero on a regular basis?

Variation margin is the collateral flow that resets current mark-to-market exposure toward zero. It is exchanged as portfolio value changes, whereas initial margin covers potential future moves during the close-out period rather than the current exposure.

  1. AInitial margin posted to a segregated account at trade inception
  2. BVariation margin exchanged to reflect changes in the portfolio's mark-to-market valueCorrect
  3. CA rating-based upfront fee paid to the counterparty
  4. DDefault fund contribution to a central counterparty

Explanation

Variation margin is called or returned as the portfolio's mark-to-market changes, so the current exposure is largely collateralised. Initial margin covers potential future exposure during close-out and is not recalculated to offset daily value changes. Default fund contributions relate to central clearing, not bilateral CSAs.

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