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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 the bank receives collateral daily, but after a counterparty fails to post, the bank must wait for the dispute process, then close out positions. Which feature of collateral modeling is the main reason exposure on a collateralised netting set is not zero even with zero threshold and zero MTA?

Residual exposure arises from the margin period of risk: the time between the last collateral exchange and the completed close-out and replacement of trades. Market values can move during this window, so the bank can be under-collateralised even with zero threshold and zero minimum transfer amount.

  1. AThe margin period of risk, during which exposure can change before collateral is received and positions are closed outCorrect
  2. BThe legal enforceability of netting, which always removes residual exposure
  3. CThe use of cash collateral, which carries wrapper-free zero risk
  4. DThe ISDA definition of close-out, which prevents any further valuation

Explanation

Even with zero threshold and MTA, there is a lag between the last successful collateral receipt and the close-out and replacement of the portfolio, the margin period of risk. Market moves in this window create exposure. Netting enforceability reduces exposure but does not explain residual collateralised exposure.

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