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

During a market stress episode, a bank that has rehypothecated received collateral is asked by a counterparty to return securities, while its own funding sources are drying up. Which risk is most directly highlighted?

The scenario shows collateral liquidity risk. Rehypothecating received collateral leaves the bank obliged to return equivalent assets on demand, and in stressed markets with weak funding it may be unable to obtain them, creating a liquidity squeeze and possible knock-on effects.

  1. ACollateral liquidity risk arising from reuse of collateral and the need to source returned assets in stressed marketsCorrect
  2. BBasis risk between the collateral and the hedged exposure
  3. CModel risk in the exposure calculation
  4. DSovereign transfer risk

Explanation

Reusing collateral creates an obligation to return equivalent assets on demand; if markets are stressed or the bank's funding is impaired, sourcing those assets can be costly or impossible, producing liquidity strain. The other risks are not what the scenario describes.

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