Collateral FRM P2.T8 Liquidity and Leverage Reading

[IDosh1374]

What is the difference between variation margin and Haircut related to a Collateral (Study notes page 37)

 

[Clay Carter]

What is the difference between variation margin and Haircut related to a Collateral (Study notes page 37)

@IDosh1374

Variation Margin is the daily (or intraday) cash payment required to cover changes in the market value of a position. Whenever a derivative or collateralized exposure moves against you, you’re asked to post variation margin so that your counterparty holds enough collateral to reflect the mark-to-market loss as of that moment. In other words, variation margin ensures that neither side carries a stale, underwater exposure, if your position loses value today, you must immediately top up collateral to make the other party whole.

A Haircut, is a percentage “discount” applied when valuing non-cash collateral. If you pledge a security (e.g., a bond or equity) as collateral, the lender doesn’t count 100 % of its market value toward your margin requirement. Instead, they apply a haircut, say 2 % on a Treasury or 10 % on a corporate bond, so that if the collateral’s price drops unexpectedly, there’s still a buffer. That buffer protects the lender against sudden price swings or liquidity stress.

Key exam differences:

• Timing vs. valuation
  • Variation margin is about when and how much cash must be posted or returned each day based on mark-to-market.
  • A haircut is about how much collateral value you’re allowed to count at any given time when you pledge a security.
• Purpose
  • Variation margin keeps the exposure current—if your position falls in value, you pay immediately so no one runs a deficit.
  • Haircuts build in a cushion against collateral depreciation—when you hand over a bond, the lender “shaves off” a percentage so that if its price falls, they remain covered.
• Use in margining
  • On a cleared futures or swap, you pay (or receive) variation margin daily based purely on price movements.
  • When you post non-cash collateral (e.g., bonds or equities), the clearinghouse or counterparty applies a haircut before counting that asset toward your initial or variation margin.