Question

a) A main task of the clearing house of a futures exchange is to set and adjust the level of margin requirements from time to time. What is a major factor that the exchange considers in setting the level of margin for a given contract? Please elaborate.

b) Daily marking-to-market is a standard feature in futures trading. Briefly explain the importance of this feature.

Answer 1

Factors to be considered while setting the level of margin for a given contract:

1.Nature of account, concentrated or non concentrated.In concentrated accounts margin occurs very spontaneously with very light fall in price. Margin for concentrated accounts is 50 % while for high margin requirement securities, they may vary from 45%, 60%, 75% , 90 to 100%.

2. Buying power: Margins also depends on whether all the securities are purchased by cash and buyer has used the power partially or all it's power.

3. Duration of long position: Initial margin gets blocked till the time funds are held in long position.

4. Price of future :As the future price will increase, price of initial marginwill also increase. As the future price will decrease , price of initial margin will also decrease.

5.Mark to market margin also depends on contract size / total number of lots.

Importance of mark to market approach:

Mark-to-market approach is use to determine the value of an asset in accordance with the current market price. MTM approach reflects the true value of an asset. This approach determines the profit or loss of the investors at the end of each day. It helps investor to know his true status of total profit/loss.

Due to this principle, investors are saved from accumulating losses beyond the level they can afford which in turn also reduces the risk of clearing house, in case investor makes default.