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Explanation:
The initial margin requirement helps in reducing the exposure, thereby lowering the credit value adjustment (CVA) and debit value adjustment (DVA) toward zero, which contributes to the mitigation of potential losses that clearing members might encounter. When central counterparties (CCPs) like GCH enforce initial margin requirements, they reduce the credit risk exposure to their clearing members, which is an action that helps mitigate wrong-way risk to
Q.5475 Global Clearing House (GCH) has recently introduced new initial margin requirements to mitigate potential losses in its clearing services. As GCH updates its risk management practices, senior management is concerned about the implications of wrong-way risk (WWR) on Central Counterparties (CCPs) like themselves. Based on the recent industry events such as the Nasdaq default, is GCH likely to achieve a reduction in WWR exposure due to the implementation of the new initial margin requirements?
A
Yes, the initial margin will mitigate WWR entirely as it ensures continuous full collateralization of exposures, effectively eliminating the risk of clearing member losses.
B
Yes, the initial margin helps reduce exposure, and as such, credit value adjustment (CVA) and debit value adjustment (DVA) trends towards zero, lessening the potential for clearing member losses.
C
No, the initial margin increases the exposure due to the potential opportunity cost of not being able to use the posted collateral for other investments, hence WWR is not reduced.
D
No, while initial margin requirements do reduce exposure, they do so only for uncollateralized cases, and GCH’s clearing members are already fully collateralized.
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