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FRM Part II · FRM Exam Part II · Derivatives

A CCP calls variation margin daily and holds initial margin sized to cover a 5-day close-out period. A clearing member defaults on Monday after the previous day's variation margin was paid. Which of the following best explains why the CCP still faces potential loss?

The CCP is still exposed because prices can move during the period between the last margin payment and the completed close-out of the defaulter's portfolio. If those moves exceed the defaulter's initial margin, the CCP suffers a residual loss that must be covered by other resources.

  1. AVariation margin is only paid at the end of each month, leaving unrealised gains uncollected
  2. BMarket prices can move between the last margin call and the close-out of the defaulter's portfolio, and losses may exceed initial marginCorrect
  3. CInitial margin is returned to the defaulter immediately on default
  4. DNovation transfers the defaulter's losses to non-defaulting members automatically without any default fund

Explanation

Variation margin resets exposure to current market value, but the CCP must still hedge or auction the portfolio over the close-out period. Price moves during that margin period of risk can exceed initial margin, creating residual loss. Initial margin is retained, not returned, and the default fund is used only after the defaulter's resources.

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