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Explanation:
If an institution has a positive Mark-to-Market (MtM) value on a trade, it means the counterparty owes the institution money, exposing the institution to counterparty credit risk. Therefore, the institution will request collateral from the counterparty. Conversely, if the MtM is negative, the institution owes the counterparty, creating credit risk for the counterparty, who will then request collateral from the institution. This reflects the standard mechanics of collateral agreements designed to limit credit exposure.
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Q.1899 Whenever an institution enters into a trade agreement with a counterparty, there is always the risk of default. A collateral agreement limits risk exposure by posting of collateral by the counterparty at risk of default. From the perspective of the financial institution, this implies that:
A
in case of a positive MtM, an institution will provide collateral. On the other hand, if it has negative MtM value, it will request collateral to reduce its risk exposure.
B
in the case of a positive MtM, the institution will request collateral. If the MtM is negative, the counterparty will request collateral.
C
in case of a negative MtM, the institution will request for collateral. If the MtM is positive, the counterparty will be required to provide collateral.
D
collateral is a constant requirement if the institution has a lower credit rating compared to the counterparty.