How is initial margin (i.e. exposure limit”) calculated?
Earlier, we remarked that the member will not default when the one-day loss is smaller than the initial margin”. Assuming that MTM margin is fully and correctly computed and charged (i.e., net losses are taken from members on the same day, net profits are paid to members on the same day), the correct” level of initial margin is that which is larger than what can be expected for a one-day loss to the position, with a comfortable safety margin. Intuitively, thecorrect” level has to be sensitive to the composition of the position taken. If a person has a position with 100% of the exposure in Apollo Tyres, then this is a highly risky position. The level of initial margin required here would be quite large. If, instead, a person has a well-spread out position with positions spread over numerous securities, then the risk is lower because he is diversified. In this case, the worst one-day loss” scenario becomes less volatile, and therefore, the level of initial margin required is lower. We qu