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Explanation:
Initial margin is a fundamental risk management tool collected by CCPs to protect against potential future exposures in the event of a counterparty default. It provides a necessary buffer to absorb losses resulting from market volatility and adverse price movements that may occur between the time of the last variation margin collection and the point at which the defaulting counterparty's positions are closed out or liquidated.
A is incorrect because operational and administrative costs are typically covered by clearing fees and membership dues, not initial margin. B is incorrect because initial margin is strictly a collateral requirement for risk mitigation purposes, not a source of profit or commercial revenue for the clearinghouse. D is incorrect because initial margin is held by the CCP to protect the clearinghouse itself and ensure systemic stability, and losses are managed through a structured default waterfall process (which includes the liquidation of positions), rather than being used to directly and immediately compensate non-defaulting parties without liquidation.
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Q.6169 In the context of risk management practices employed by Central Counterparties (CCPs) for centrally cleared derivatives, a focus is placed on understanding the purpose and application of initial margin. Which of the following correctly describes the primary role of initial margin in the context of CCPs managing centrally cleared derivatives?
A
Initial margin is primarily used by CCPs to cover the operational expenses and administrative costs associated with the clearing of transactions.
B
Initial margin is set by CCPs to serve as the profit margin for the clearinghouse, ensuring their commercial viability and competitive edge in the market.
C
Initial margin is collected by CCPs to cover potential future exposure in the event of a counterparty’s default, providing a buffer against market volatility and unexpected price movements.
D
Initial margin is utilized by CCPs to directly compensate the non-defaulting parties in a transaction, ensuring immediate recovery of losses without the need to liquidate positions.