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FRM Part II · FRM Exam Part II · Central Clearing

A bank trades a swap with a counterparty under a bilateral agreement with daily variation margin and no initial margin. It later moves the trade to a CCP that requires initial margin and daily variation margin. Which statement best describes the effect on the bank's exposure and funding?

Counterparty exposure falls because initial margin covers potential losses during close-out, but funding costs rise because the bank must post liquid collateral. Exposure is not eliminated, since losses can exceed margin and default fund resources, and the added initial margin is a real liquidity burden.

  1. ACounterparty exposure falls because initial margin covers close-out risk, but funding costs rise from the margin postedCorrect
  2. BCounterparty exposure rises because the CCP cannot net positions, and funding costs fall
  3. CBoth exposure and funding costs are unchanged because variation margin is identical
  4. DExposure is eliminated entirely because the CCP guarantees performance beyond its default waterfall

Explanation

Initial margin covers potential losses over the close-out period, so residual exposure to the CCP is reduced. Posting it ties up liquid assets, raising funding and liquidity costs. Exposure is not fully eliminated, since losses can exceed margin and the default fund, and CCPs generally net more, not less.

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