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FRM Part II · FRM Exam Part II · Counterparty Risk and Beyond

A dealer is reviewing a CSA that allows the counterparty to post government bonds rather than cash. Compared with accepting cash in the same currency as the exposure, which risk should the dealer primarily address by applying a haircut to the bonds?

The haircut addresses the risk that the bonds' market value falls between the last margin call and their liquidation. By valuing the collateral below market price, the dealer ensures sale proceeds are still likely to cover the exposure after adverse price moves.

  1. APossible decline in the bonds' market value between the last margin call and liquidationCorrect
  2. BLoss of the netting benefit across trades
  3. CThe counterparty's right to terminate the trades early
  4. DInterest rate payable on cash collateral being too high

Explanation

Haircuts protect against collateral price volatility (and FX or liquidity effects) over the margin period of risk, so that sale proceeds still cover the exposure. They do not affect netting or termination rights, and cash interest is a separate matter.

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