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

During a stressed market, a bank finds that disputes over valuations of illiquid derivatives with a client are delaying variation margin receipts by several days. Which is the most direct effect on the bank's counterparty risk measurement?

Valuation disputes lengthen the effective margin period of risk, because collateral is received later after the last good exchange. The bank's exposure can therefore move further before close-out, increasing potential uncollateralised exposure and the related CVA and capital measures.

  1. AThe effective margin period of risk lengthens, raising potential exposure not covered by collateralCorrect
  2. BThe current mark-to-market of the portfolio falls to zero
  3. CInitial margin requirements are automatically waived
  4. DThe counterparty's probability of default becomes risk-neutral

Explanation

Disputes and delays extend the time between the last successful margin exchange and effective close-out, lengthening the margin period of risk. Exposure can then move further uncollateralised. Disputes do not change the portfolio's value or waive initial margin.

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