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FRM Part II · FRM Exam Part II · Margin (Collateral) and Settlement

A firm's collateral agreement allows cash or government bonds, and the firm posts the cheapest-to-deliver asset. In a market stress, many counterparties simultaneously demand more collateral and the firm must sell assets to raise it. Which risk does this chiefly represent?

This is collateral liquidity risk. In stress, margin calls arrive together and require the firm to find cash or eligible securities quickly, possibly selling assets at depressed prices, which worsens losses and can intensify market-wide funding pressure.

  1. ACollateral liquidity risk, where margin calls create funding needs that can be met only by selling assets at depressed pricesCorrect
  2. BNetting risk, because offsetting trades are being cancelled
  3. CModel risk arising from the use of a normal distribution for haircuts
  4. DLegal risk because the agreement is unenforceable

Explanation

Simultaneous margin calls in stress create sudden demands for liquid assets, forcing fire sales and amplifying losses. This is liquidity risk linked to collateral. Nothing in the scenario suggests netting failure, model error or unenforceability.

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