NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Understanding Derivatives
In the context of exchange-traded equity derivatives, what is the main purpose of the initial margin collected from a futures trader?
Initial margin is collected to cover potential losses from adverse price movements in a futures position. It acts as a performance guarantee for the clearing system, not as brokerage, option premium or full payment for the underlying shares.
- ATo cover potential losses from adverse price movement in the positionCorrect
- BTo pay the brokerage charged by the trading member
- CTo pay the premium to the counterparty
- DTo fund the final settlement of the underlying shares in full
Explanation
Initial margin is a performance guarantee collected upfront and is sized to cover the likely loss over the close-out period, often estimated using a value-at-risk approach. It is not a fee, a premium or full payment for the underlying. Futures involve no premium, so the premium option is wrong.
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