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

A risk manager is assessing the residual risk in a collateralised OTC derivatives relationship with daily margining. Which feature best explains why exposure can still arise even when variation margin is exchanged daily and no threshold applies?

Exposure remains because of the margin period of risk. Between the last margin exchange and the completion of close-out and replacement, the portfolio value can move against the bank, leaving a gap that collateral held does not cover, even with daily margining and zero threshold.

  1. AThe margin period of risk, during which the portfolio value can change between the last margin exchange and close-outCorrect
  2. BThe use of a master netting agreement, which increases gross exposure
  3. CThe existence of a two-way CSA, which removes the right to call margin
  4. DCash collateral being rehypothecated with certainty of return

Explanation

After a counterparty stops posting, the last successful margin call, then dispute, grace period and close-out and replacement take time. Market moves during this margin period of risk create uncollateralised exposure. Netting reduces, not increases, exposure; the other options are not sources of this residual risk.

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