Learning Objectives: Describe the implementation of a margining process and explain the determinants of and calculate initial and variation margin requirements. Describe the process of buying stock on margin without using CCP and calculate margin requirements. Describe the role of collateralization in the over-the-counter market and compare it to the margining system.
Questions:
24.3.1. Emma, a risk manager, is assessing the margining processes in exchange-traded and OTC derivatives markets. Her goal is to ensure her firm understands and complies with margin requirements, utilizing the different advantages of each market type.
Emma examines a trade in the exchange-traded corn futures market (5,000 bushels at $4.00 per bushel) to explain the margining process to her team. She wants to illustrate how initial and variation margins are calculated and compare these practices with those in OTC markets.
Given this scenario, select the option that best explains the complete margining process and the differences between the two types of markets.:
a. Initial Margin: $1,000; Variation Margin: $750 if corn price drops to $3.85 per bushel, reflecting a predictable margining process typical of exchange-traded markets.
b. Initial Margin: $1,000; Variation Margin: $750, applicable when price drops to $3.85 per bushel, which showcases precise and fixed margin calculations typical of exchange-traded markets.
c. Initial Margin: $1,000; Variation Margin: Incorrectly assumes no variation margin is required unless there is a significant drop, such as $0.50 per bushel, underestimating the sensitivity of margin calls to smaller market movements.
d. Initial Margin: $1,000; Variation Margin: $750 for a price drop to $3.85 per bushel, emphasizing the contrast with OTC markets where margin terms can be negotiated and are not strictly based on market price movements.
24.3.2. A trader purchases 1,000 shares at $60 per share using a margin account, where the initial margin requirement is 50%, and the maintenance margin is set at 25%. After some market fluctuations, the share price drops to $12 per share. The trader's margin account now shows a significant loss.
What is the amount the trader needs to deposit to meet the maintenance margin if the share price drops to $12 per share and the total market value of the shares becomes $12,000?
a. $18,000
b. $21,000
c. $15,000
d. $9,000
24.3.3. After the 2007-2008 financial crisis, OTC derivatives markets have seen significant regulatory changes, including increased use of Central Counterparties (CCPs) and more rigorous collateral requirements.
How do these changes primarily benefit market participants?
a. They allow for greater customization of derivatives products to better meet the specific needs of end users.
b. They enhance market transparency and reduce counterparty credit risk by mandating daily mark-to-market and collateral posting.
c. They eliminate the need for bilateral clearing, completely shifting all OTC transactions to CCPs.
d. They significantly reduce the transaction costs associated with trading derivatives by streamlining the clearing and settlement process through multilateral netting.
Answers here:
Questions:
24.3.1. Emma, a risk manager, is assessing the margining processes in exchange-traded and OTC derivatives markets. Her goal is to ensure her firm understands and complies with margin requirements, utilizing the different advantages of each market type.
Emma examines a trade in the exchange-traded corn futures market (5,000 bushels at $4.00 per bushel) to explain the margining process to her team. She wants to illustrate how initial and variation margins are calculated and compare these practices with those in OTC markets.
Given this scenario, select the option that best explains the complete margining process and the differences between the two types of markets.:
a. Initial Margin: $1,000; Variation Margin: $750 if corn price drops to $3.85 per bushel, reflecting a predictable margining process typical of exchange-traded markets.
b. Initial Margin: $1,000; Variation Margin: $750, applicable when price drops to $3.85 per bushel, which showcases precise and fixed margin calculations typical of exchange-traded markets.
c. Initial Margin: $1,000; Variation Margin: Incorrectly assumes no variation margin is required unless there is a significant drop, such as $0.50 per bushel, underestimating the sensitivity of margin calls to smaller market movements.
d. Initial Margin: $1,000; Variation Margin: $750 for a price drop to $3.85 per bushel, emphasizing the contrast with OTC markets where margin terms can be negotiated and are not strictly based on market price movements.
24.3.2. A trader purchases 1,000 shares at $60 per share using a margin account, where the initial margin requirement is 50%, and the maintenance margin is set at 25%. After some market fluctuations, the share price drops to $12 per share. The trader's margin account now shows a significant loss.
What is the amount the trader needs to deposit to meet the maintenance margin if the share price drops to $12 per share and the total market value of the shares becomes $12,000?
a. $18,000
b. $21,000
c. $15,000
d. $9,000
24.3.3. After the 2007-2008 financial crisis, OTC derivatives markets have seen significant regulatory changes, including increased use of Central Counterparties (CCPs) and more rigorous collateral requirements.
How do these changes primarily benefit market participants?
a. They allow for greater customization of derivatives products to better meet the specific needs of end users.
b. They enhance market transparency and reduce counterparty credit risk by mandating daily mark-to-market and collateral posting.
c. They eliminate the need for bilateral clearing, completely shifting all OTC transactions to CCPs.
d. They significantly reduce the transaction costs associated with trading derivatives by streamlining the clearing and settlement process through multilateral netting.
Answers here:
