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FRM Part II · FRM Exam Part II · Netting, Close-out and Related Aspects

A risk manager reviews a CSA under which cash collateral is posted daily, but the margin period of risk (MPOR) used for the counterparty exposure model is 10 business days. Which statement best explains why residual exposure remains despite daily variation margin?

Residual exposure remains because the portfolio value can change during the margin period of risk, which runs from the last successful margin exchange until the defaulted position is closed out and replaced. Collateral held then may not cover the new exposure, even with daily variation margin.

  1. ACollateral is only received after a default is declared and the close-out amount is calculated
  2. BVariation margin eliminates all market risk, so residual exposure arises only from legal risk
  3. CResidual exposure arises because the exposure can move during the time between the last successful margin call and the close-out and replacement of the positionCorrect
  4. DResidual exposure exists because the netting agreement is unenforceable

Explanation

The MPOR covers the period from the last margin exchange through default detection, grace period, close-out and re-hedging. Market values can change over this window, leaving uncollateralized exposure. Legal risk and unenforceability are separate issues, not the reason for MPOR-based gap exposure.

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