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FRM Part II · FRM Exam Part II · Central Clearing

A CCP sets initial margin for a portfolio using a 99% one-tailed confidence level and a 5-day margin period of risk. The 1-day 99% loss estimate for the portfolio is USD 4 million, and price changes are assumed independent and identically distributed with zero mean. Using the square-root-of-time rule, what is the initial margin?

Initial margin is about USD 8.94 million. Under the square-root-of-time rule with independent, zero-mean returns, the 1-day 99% loss of USD 4 million is multiplied by the square root of 5, about 2.236, to reflect the 5-day margin period of risk.

  1. AUSD 20.00 million
  2. BUSD 8.94 millionCorrect
  3. CUSD 4.00 million
  4. DUSD 2.00 million

Explanation

Scale by the square root of time: 4 × √5 = 4 × 2.236 = 8.94 million. Multiplying by 5 (USD 20 million) wrongly scales linearly and ignores diffusion of risk. Dividing or leaving unscaled ignores the longer horizon.

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