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

A bank holds a bond as collateral with a market value of USD 50 million. The bond's daily price volatility is 1.0%, the bank estimates a 10-day liquidation period, and it sets the haircut at the 99% one-tailed confidence level (z = 2.33) using the square-root-of-time rule, ignoring drift. What is the collateral value credited after the haircut, to the nearest USD 0.1 million?

The credited collateral is about USD 46.3 million. Ten-day volatility is 1% times the square root of 10, or 3.16%; multiplied by 2.33 this gives a 7.37% haircut, which removes about USD 3.7 million from the USD 50 million market value.

  1. AUSD 46.3 millionCorrect
  2. BUSD 48.8 million
  3. CUSD 42.6 million
  4. DUSD 47.1 million

Explanation

10-day volatility = 1.0% x sqrt(10) = 3.162%. Haircut = 2.33 x 3.162% = 7.37%. Credited value = 50 x (1 - 0.0737) = 46.3 million. Using only 1-day volatility gives 48.8 million, which ignores the liquidation period.

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