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FRM Part II · FRM Exam Part II · Credit Risk Management

A bank holds a long-dated receive-fixed interest rate swap with a client that has no collateral agreement. Compared with a similar swap that is covered by a daily-margined CSA, which change is most likely to the swap's exposure profile?

The uncollateralized swap has higher potential future exposure. Without margin, mark-to-market gains can accumulate across the full life of the trade, whereas daily margining limits uncovered exposure to market moves during the margin period of risk.

  1. AHigher potential future exposure, because without margin the exposure can grow with market moves over the whole lifeCorrect
  2. BLower expected exposure, because uncollateralized trades are netted automatically
  3. CIdentical exposure, because collateral affects only recovery rates
  4. DLower potential future exposure, because the client's credit spread is wider

Explanation

Without collateral, exposure is not reset by margin calls, so market moves accumulate and PFE is larger over the horizon. A daily-margined CSA limits exposure to movement over the margin period of risk. Collateral reduces exposure, not just recovery.

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