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P2.T6.912. The impact of collateral on counterparty risk and funding (Gregory Ch.7)

Nicole Seaman

Director of FRM Operations
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Learning objectives: Explain the impact of collateralization on exposure, and assess the risk associated with the remargining period, threshold, and minimum transfer amount. Assess the impact of collateral on counterparty risk and funding, with and without segregation or rehypothecation.

Questions:

912.1. Suppose the current mark-to-market (MTM) value of a portfolio is +$30.0 million and $27.0 million of variation margin is held. Also, $8.0 million of segregated initial margin was posted bilaterally. What are, respectively, the current counterparty risk (CCR) exposure and the funding exposure?

a. CCR Exposure = Zero; and Funding exposure = $11.0 million
b. CCR Exposure = $3.0 million; and Funding exposure = Zero
c. CCR Exposure = $3.0 million; and Funding exposure = $3.0 million
d. CCR Exposure = $11.0 million; and Funding exposure = $19.0 million


912.2. Suppose the mark-to-market (MTM) value of a portfolio is -$36.0 and -$40.0 of variation margin has been posted. Also, $3.0 million of initial margin was posted bilaterally. What are, respectively, the current counterparty risk (CCR) exposure and the funding exposure?

a. CCR Exposure = zero; and Funding exposure = zero
b. CCR Exposure = zero; and Funding exposure = $3.0 million
c: CCR Exposure = $1.0 million; and Funding exposure = $7.0 million
d. CCR Exposure = $3.0 million; and Funding exposure = $33.0 million


912.3. In a certain credit portfolio, Acme Bank holds four large over the counter (OTC) derivative positions, each with a different counterparty. As it happens, the mark-to-market value of each position is significantly positive (i.e., above the threshold) and consequently, Acme Bank holds collateral for each position. However, the type of collateral for each position is different. The collateral types are as follows:

I. Cash that does not need to be segregated
II. Securities that can be rehypothecated
III. Cash/securities that must be segregated; i.e., cannot be rehypothecated
IV. The Counterparty is posting own bonds, and they can be rehypothecated

Gregory explains the distinction between held collateral that provides a counterparty risk reduction benefit and held collateral that provides a funding benefit. In regard to these four examples (i.e., I., II., III. and IV), which of the following statements is TRUE?

a. All four provide counterparty risk reduction and funding benefits
b. I. and II. provide both counterparty risk reduction and funding benefits; III. provides only counterparty risk reduction benefits; and IV. provides only funding benefit
c. I. provides both counterparty risk reduction and funding benefits; II. and III. provide only funding benefit; and IV. provides only counterparty risk reduction benefit
d. None except I. provide EITHER counterparty risk reduction OR funding benefit

(Source: Jon Gregory, The xVA Challenge: Counterparty Credit Risk, Funding, Collateral, and Capital, 3rd edition (West Sussex, UK: John Wiley & Sons, 2015))

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