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Initial margin (IM)
In derivatives markets, initial margin is one of two types of collateral required to protect a party to a contract in the event of default by the other counterparty.
Variation margin – the other type of collateral – is paid daily from one side of the trade to the other, to reflect the current market value of the trade. Initial margin is held to cover the losses that could arise in the period between the defaulter’s last variation margin payment and the point at which the surviving party is able to hedge or replace the trade.
In cleared trades, this period is set at anywhere from five to seven days – so initial margin on a large portfolio can become a very significant commitment.
IM is posted when the trade is executed and then adjusted as necessary throughout the life of the trade. For centrally cleared trades, counterparties post IM to the clearing house; in non-cleared trades, to each other. It is usually posted in cash, government bonds or letters of credit.
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