Explanation:
All the definitions are correct. Netting involves the offsetting of the contracts, which reduces the exposure of the counterparties in the open positions and reduces the costs of maintaining open positions as the parties will be required only to post margins against net positions. The variation margin account only requires members to pay or receive the cash or other assets against gains and losses in their positions, while the initial margin provides coverage against losses in case of default in case a trader is unable to pay the variation margin.
Key Concepts:
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Q.829 The majority of the derivative transactions are a zero-sum game. Therefore, the party with the loss is less likely to pay for its losses or fulfill its obligations. To mitigate such situations, exchanges have developed netting and margining methods. Identify if the given definitions of margining and netting are correct.
I. Netting is referred to as the offsetting of contracts that reduce the exposure or risk of counterparties related to the open positions to which they are exposed. It also reduces the costs of maintaining open positions as the parties will be required to only post margins against net positions.
II. Margining is divided into two types - the variation margin, and the initial margin. In the variation margin account, members receive and pay cash or other assets against gains or losses in their positions.
III. In the initial margin account, members provide coverage against losses in case they default on their contracts.
A
Only statement I is correct.
B
Only statement II is correct.
C
Only statements II and III are correct.
D
All of the statements are correct.