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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

A bank's netting set with a counterparty has a mark-to-market of +USD 40 million at the last margin call. The counterparty has posted USD 30 million of collateral, and defaults. The margin period of risk is 10 days, over which the net portfolio value rises to USD 52 million. Ignoring thresholds, minimum transfer amounts, and collateral haircuts, what is the bank's loss before recoveries and how does it differ from the exposure at the last margin call?

The loss before recovery is USD 22 million: the close-out value of USD 52 million less USD 30 million collateral. Exposure at the last margin call was only USD 10 million, so the 10-day margin period of risk, during which value rose USD 12 million, increased the loss by USD 12 million.

  1. AUSD 22 million; the loss is USD 12 million larger than the USD 10 million exposure at the callCorrect
  2. BUSD 12 million; the loss is USD 2 million larger than the exposure at the call
  3. CUSD 22 million; the loss is USD 12 million smaller than the exposure at the call
  4. DUSD 10 million; the loss is unchanged because collateral covers moves in value

Explanation

Exposure at the last call = 40 - 30 = 10 million. Close-out value after the margin period is 52, so the loss before recovery = 52 - 30 = 22 million. This is 12 million above the call-date exposure, which equals the value increase (52 - 40). Choice D ignores the margin period of risk.

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