Lowering the threshold for collateral calls means that collateral will be requested earlier, i.e., as soon as the exposure reaches a smaller amount. This approach reduces credit risk as it ensures that additional protection is in place sooner, especially important in a volatile market where exposures can change rapidly.

A is incorrect because increasing the threshold actually increases credit risk. It means that more exposure is allowed before additional collateral is demanded, reducing the protective buffer.

C is incorrect as changing the threshold does significantly impact credit risk. A lower threshold increases protection against credit risk, while a higher threshold increases exposure.

D is incorrect because, while a higher threshold does decrease the frequency of collateral calls and reduces administrative costs, it also increases credit risk by allowing greater exposure without additional collateral.

Things to Remember

• Threshold for Collateral Calls: This is the predetermined level of exposure at which additional collateral is required. Lowering it increases security but may also increase operational efforts.
• Strategically setting the threshold can significantly impact a firm's balance between credit risk and operational efficiency.
• Understanding the relationship between the threshold and market volatility is crucial for effective risk management in derivative portfolios.
• Regular reassessment of the threshold in response to changes in market conditions and the firm's risk appetite is advisable.