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Answer: The presence of collateral decreases the current exposure, but increases the volatility of the exposure between remargining periods.
## Explanation This question deals with the impact of collateral on credit exposure and volatility between remargining periods. ### Key Points: - **Current exposure**: Collateral reduces current exposure because it provides security against potential losses - **Volatility between remargining periods**: When correlation is zero between the exposure and collateral, the combined position volatility is calculated as: \[ \sigma_{combined} = \sqrt{\sigma_{exposure}^2 + \sigma_{collateral}^2} \] Given: - Exposure volatility = 6% - Collateral volatility = 8% - Correlation = 0 \[ \sigma_{combined} = \sqrt{6^2 + 8^2} = \sqrt{36 + 64} = \sqrt{100} = 10\% \] ### Analysis: 1. **Current exposure**: Collateral decreases current exposure because it provides security 2. **Volatility**: The combined volatility (10%) is higher than the individual volatilities (6% and 8%), so volatility increases between remargining periods 3. **Correlation effect**: Zero correlation means the assets move independently, leading to diversification benefits being limited ### Conclusion: - Collateral decreases current exposure ✓ - Volatility increases between remargining periods ✓ Therefore, option B is correct: "The presence of collateral decreases the current exposure, but increases the volatility of the exposure between remargining periods."
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An underlying exposure with an effective annual price volatility of 6% is collateralized by a 10-year U.S. Treasury note with an effective price volatility of 8%. The correlation between the exposure and the U.S. Treasury note is zero. Changes in the value of the overall position (the exposure plus collateral) are calculated for a 10-day horizon at a 95% confidence interval. Which of the following would one expect to observe from this analysis?
A
The presence of collateral increases the current exposure and increases the volatility of the exposure between remargining periods.
B
The presence of collateral decreases the current exposure, but increases the volatility of the exposure between remargining periods.
C
The presence of collateral increases the current exposure, but decreases the volatility of the exposure between remargining periods.
D
The presence of collateral decreases the current exposure and decreases the volatility of the exposure between remargining periods.
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