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[[Variation margin]] is designed to | [[Variation margin]], or “[[VM]]”, is a [[credit mitigation]] technique designed to minimise the [[credit risk]] parties have to each other under bilateral [[derivative]] transactions. It requires the counterparties give each other [[collateral]] — typically [[cash]] — each day to ensure that their net collateralised [[exposure]] is effectively nil. For example, if the net “replacement cost” of the swaps between two counterparties on a given day is $10 million, the “[[out-of-the-money]]” party, who would have to pay it were all the transactions terminated, has to pay the “[[in-the-money]]” counterparty $10 million in [[cash]] (subject to agreed {{csaprov|Threshold}}s and {{csaprov|Minimum Transfer Amount}}s). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. [[volatility|Volatile]] markets can quickly move — a day is a long time when [[black swan]]s are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need [[initial margin|''initial'' margin]]. | ||
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Latest revision as of 17:42, 22 January 2022
Variation margin, or “VM”, is a credit mitigation technique designed to minimise the credit risk parties have to each other under bilateral derivative transactions. It requires the counterparties give each other collateral — typically cash — each day to ensure that their net collateralised exposure is effectively nil. For example, if the net “replacement cost” of the swaps between two counterparties on a given day is $10 million, the “out-of-the-money” party, who would have to pay it were all the transactions terminated, has to pay the “in-the-money” counterparty $10 million in cash (subject to agreed Thresholds and Minimum Transfer Amounts). This happens every day; variation margin can be paid either way, depending on how the net portfolio moves. Volatile markets can quickly move — a day is a long time when black swans are on the wing — so parties often want a little something extra to tide them over for expected movements between now and the next variation margin payment date. For that, you need initial margin.