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FRM Part I · FRM Exam Part I · Exchanges and OTC Markets

A bank has a bilateral OTC portfolio with a counterparty under an enforceable netting agreement. Trade A has a mark-to-market value of +USD 18 million to the bank, Trade B has +USD 7 million, and Trade C has -USD 21 million. Variation margin is exchanged daily with zero threshold and zero minimum transfer amount. Ignoring initial margin and intraday moves, what variation margin does the bank receive, and what is the benefit of netting relative to gross positive exposure?

The bank receives USD 4 million of variation margin because the net mark-to-market is 18 plus 7 minus 21, which is plus 4 million. Without netting, exposure is the sum of positive values, USD 25 million, so netting reduces it from 25 million to 4 million.

  1. AReceives USD 4 million; netting reduces exposure from USD 25 million to USD 4 millionCorrect
  2. BReceives USD 25 million; netting increases exposure by USD 21 million
  3. CReceives USD 4 million; netting reduces exposure from USD 46 million to USD 4 million
  4. DReceives USD 21 million; netting reduces exposure from USD 25 million to USD 21 million

Explanation

Net value = 18 + 7 - 21 = +4 million, so the counterparty posts USD 4 million. Without netting the bank's exposure is the sum of positive values, 18 + 7 = 25 million (Trade C is not offset). Netting cuts exposure from 25 to 4 million. Using 46 wrongly adds the absolute value of the negative trade.

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