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FRM Part II · FRM Exam Part II · Solvency, Liquidity and Other Regulation After the Global Financial Crisis

A bank must hold margin on non-centrally cleared derivatives with a financial counterparty under the uncleared margin rules. A risk manager explains the distinction between initial margin (IM) and variation margin (VM). Which statement is correct?

Variation margin reflects current mark-to-market exposure and is exchanged regularly, while initial margin covers potential future exposure during the close-out period after default and is held segregated, not freely rehypothecated. The wrong options reverse these roles or permit free reuse of initial margin.

  1. AVM reflects current mark-to-market exposure and is exchanged regularly, while IM protects against potential future exposure during the close-out period and is segregatedCorrect
  2. BIM is exchanged daily to reflect mark-to-market changes, while VM is posted once at inception
  3. CBoth IM and VM are rehypothecated freely by the receiving party
  4. DVM covers potential future exposure over the margin period of risk, while IM covers current exposure

Explanation

Variation margin tracks changes in current market value and is exchanged frequently, removing current exposure. Initial margin covers potential future exposure from price moves during the close-out period after a default, and under the rules it is segregated and not rehypothecated. The other options reverse the roles or wrongly allow free rehypothecation.

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