Explanation:
Setting a higher threshold for collateral calls means that collateral is requested only when the exposure exceeds a certain higher amount. This reduces the frequency of collateral movements, thereby saving on administrative efforts. However, it also means that the fund is exposed to a higher level of credit risk as the buffer against counterparty default is increased.
A is incorrect because a longer remargining period, while reducing operational efforts, actually increases exposure to market volatility and the risk of counterparty default, especially in fast-moving markets.
C is incorrect as a lower minimum transfer amount indeed increases the frequency of collateral movements, which can reduce exposure risk but at the cost of higher transaction costs and operational complexity.
D is incorrect because changing the remargining period, threshold, and minimum transfer amount significantly impacts the fund’s exposure and associated risks, especially in terms of credit risk and operational efficiency.
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Q.5492 ACME Capital, a hedge fund, is actively engaged in derivative trading with multiple financial institutions. As part of its risk management strategy, ACME Capital employs collateralization to mitigate credit risk. The fund's current policy includes specific conditions for the remargining period, the threshold for collateral calls, and the minimum transfer amount. These policies are under review to better understand their impact on the fund's overall exposure and the associated risks. In the context of ACME Capital's derivative trading, how does the collateralization policy impact the fund's exposure, and what are the risks associated with the remargining period, threshold, and minimum transfer amount?
A
A longer remargining period reduces operational burden as well as exposure risk due to potential market value changes of derivatives.
B
A higher threshold for collateral calls decreases the frequency of collateral exchanges, reducing administrative costs but increasing credit risk.
C
A lower minimum transfer amount increases the frequency of collateral movements, thereby reducing exposure as well as transaction costs.
D
Shortening the remargining period and lowering the threshold and minimum transfer amount have no significant impact on the fund's exposure or associated risks.