FRM Part I · FRM Exam Part I · Central Clearing
A dealer has an uncollateralized OTC derivative with a client. The exposure is USD 50 million today. Two-way margining is introduced with a zero threshold, daily variation margin, and a 10-day margin period of risk. Which statement best describes the residual credit exposure?
Residual exposure equals the possible movement in portfolio value during the 10-day margin period of risk. Variation margin sharply reduces exposure but does not eliminate it, because the value can change between the last margin exchange and the close-out and replacement of the trades.
- AExposure falls to the potential change in portfolio value over the margin period of risk, not to zeroCorrect
- BExposure falls exactly to zero because collateral is posted daily
- CExposure is unchanged because collateral cannot reduce credit risk
- DExposure rises because collateral creates wrong-way risk by definition
Explanation
After the last margin call and before close-out, the portfolio value can move during the margin period of risk (here 10 days), leaving a residual gap. So exposure is reduced but not eliminated. Daily margining does not remove it, and collateral does reduce exposure.
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