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FRM Part II · FRM Exam Part II · Derivatives

A CCP requires members to post variation margin daily and initial margin calibrated to cover a 99% loss over a five-day liquidation period. Which risk is initial margin primarily designed to cover?

Initial margin covers the potential loss from adverse price moves during the period needed to close out or hedge a defaulting member's portfolio after its last variation margin payment. Variation margin handles current mark-to-market changes, so initial margin addresses future, not accumulated, exposure.

  1. ALosses on a defaulting member's positions arising between its last variation margin payment and the close-out of its portfolioCorrect
  2. BThe cumulative mark-to-market loss on the portfolio since inception
  3. CThe CCP's operational losses from system failure
  4. DLosses from the default of the CCP's own shareholders

Explanation

Variation margin settles current mark-to-market changes daily. Initial margin covers potential future exposure during the margin period of risk, i.e. price moves while the defaulter's positions are being closed out or hedged. It does not cover accumulated past losses, which variation margin handles.

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