Optimizing collateral is a hot topic in the financial industry. I came across the term cheapest collateral. What does it actually mean in the context of collateral optimization, please ?
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3 Answers
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Just want to make sure we have got it right here. The cheapest collateral to deliver (if you have a choice of securities) is that with the highest cost of funds, which means the highest repo rate. By delivering such a security, you avoid having to pay that financing cost to hold it. And then, if you also have a choice to deliver cash, you need to compare the interest received on cash collateral (specified in the document) with the repo rates of the securities. Lastly if you have the choice of foreign securities , their financing cost needs to be understood in domestic currency terms so you need to take account of the basis swap when doing the calculations.
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$\begingroup$ I understand that if you can post multiple currencies, you would choose the one with the highest funding cost as you would get pay the highest interest. But I cannot get my head around when the collateral are securities. Are you saying after posting a treasury that I own as a collateral to my counter party, I do not need to pay for the financing cost of this treasury ? $\endgroup$– PeacefulCommented Nov 15, 2021 at 20:40
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1$\begingroup$ thanks for confirmation. this is what I do not understand. I still need to fund the bond position and give it to my counter party as the collateral, right? I.e., I still need to pay for the funding cost of the bond collateral. $\endgroup$– PeacefulCommented Nov 15, 2021 at 23:46
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Generally the collateral with the lowest cost of funds. For example, treasuries usually fits the bill. When people use this term they often mentally mean to exclude actual hard-to-borrow or special securities, which are actually the cheapest as you get paid to hold them.
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$\begingroup$ thanks. this is one thing that I did not get. Does it make an economically difference on posting a cheap collateral versus a more expensive one？ if you post a more expensive one, you would get paid the a higher interest from the counter party anyway , wouldn't you ? $\endgroup$– PeacefulCommented Nov 9, 2021 at 23:53
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$\begingroup$ Yes, b/c the haricut will be best on the cheapest collateral. You can post less of it. $\endgroup$– JoshKCommented Nov 10, 2021 at 2:09
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Ctd option means party that has to post collateral can choose from a basket of assets which of them he wants to post. Obviously he will post the one with least value, IE the cheapest.
