Mechanics of collateral and the types of collateral

[wahahahaha]

Hi @David Harper CFA FRM,

In P2.T6. Collateral,

on slide 29/50, "Some counterparties may subtract a spread on cash to discourage receiving cash collateral (and encourage securities), since cash must be invested to earn interest or placed back in the banking system"

on slide 38/50, "Some institutions offer to pay in excess of such a rate to incentivize the collateral giver to post cash rather than other riskier and volatile securities."

Based on the above, some counterparties prefer cash, while there are some which prefer securities?

thanks!

 

[wahahahaha]

Hi @David Harper CFA FRM,

In P2.T6. Collateral,

on slide 29/50, "Some counterparties may subtract a spread on cash to discourage receiving cash collateral (and encourage securities), since cash must be invested to earn interest or placed back in the banking system"

on slide 38/50, "Some institutions offer to pay in excess of such a rate to incentivize the collateral giver to post cash rather than other riskier and volatile securities."

Based on the above, some counterparties prefer cash, while there are some which prefer securities?

thanks!

@David Harper CFA FRM, could you please advise me on the above? thanks!!

 

[David Harper CFA FRM]

HI @wahahahaha Yes, that's what Gregory says: receivers of collateral may have different motivations such that they may or may not prefer cash as collateral. I think we can all understand why cash (as collateral) would be preferred: it is the most liquid asset! However, cash needs to be deposited somewhere, which involves a "cash reinvestment" decision. Further, if the interest on the cash is minimal yet must be returned to the collateral giver, the collateral receiver may prefer an asset that throws off no interest/dividend (says Gregory, "The receiver of margin must pass on coupon payments, dividends, and any other cash flows. One exception to this rule is in the case where an immediate margin call would be triggered. In this case, the margin-holder may typically keep the minimum component of the cash flow (e.g. coupon on a bond) in order to remain appropriately collateralised."-- Gregory, Jon. The xVA Challenge (Wiley Finance) (Kindle Locations 5274-5276). Wiley. Kindle Edition.). I hope that's helpful,

 

[wahahahaha]

HI @wahahahaha Yes, that's what Gregory says: receivers of collateral may have different motivations such that they may or may not prefer cash as collateral. I think we can all understand why cash (as collateral) would be preferred: it is the most liquid asset! However, cash needs to be deposited somewhere, which involves a "cash reinvestment" decision. Further, if the interest on the cash is minimal yet must be returned to the collateral giver, the collateral receiver may prefer an asset that throws off no interest/dividend (says Gregory, "The receiver of margin must pass on coupon payments, dividends, and any other cash flows. One exception to this rule is in the case where an immediate margin call would be triggered. In this case, the margin-holder may typically keep the minimum component of the cash flow (e.g. coupon on a bond) in order to remain appropriately collateralised."-- Gregory, Jon. The xVA Challenge (Wiley Finance) (Kindle Locations 5274-5276). Wiley. Kindle Edition.). I hope that's helpful,

thank you so much David for the quick replies!
it really helped alot in eliminating my confusion!