FRM Part II · FRM Exam Part II · Derivatives
A risk manager reviews a bilateral CSA with daily margin calls. Even with daily variation margin, the bank still faces potential losses if the counterparty defaults. Which feature of the process best explains the residual exposure?
The residual exposure arises from the margin period of risk. Between the last margin call that was met and the completion of close-out and replacement, the portfolio value can move against the bank, leaving exposure that collateral already held does not cover, even with daily margining.
- AThe margin period of risk, during which the portfolio value can change between the last margin exchange and close-outCorrect
- BThe use of cash rather than securities as collateral
- CThe existence of a master netting agreement across products
- DThe requirement that collateral be re-hypothecated
Explanation
After the last successful margin call, the counterparty stops posting, and the bank needs time to declare default, close out and replace trades. Market moves in that window create uncollateralised exposure. Netting reduces exposure rather than creating residual risk, and cash collateral is the least risky form.
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