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FRM Part I · FRM Exam Part I · Central Clearing

In a central counterparty (CCP) clearing structure, what is the primary purpose of the initial margin collected from a clearing member?

Initial margin protects the CCP against potential losses when closing out a defaulting member's positions after the last variation margin payment. It is a risk buffer, not a daily settlement of gains and losses, which is the role of variation margin.

  1. ATo cover the cost of daily profits owed to the other side of a trade
  2. BTo cover potential losses in closing out the member's positions if it defaults, after the last variation margin exchangeCorrect
  3. CTo pay the CCP's operating and technology expenses
  4. DTo replace the need for any default fund contributions from other members

Explanation

Initial margin is a buffer sized to cover potential adverse price moves over the close-out (margin period of risk) after a member defaults. Variation margin, not initial margin, settles daily gains and losses. Initial margin does not replace the default fund, which covers losses beyond the defaulter's margin.

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