What is collateral? Collateral refers to an asset of value that is given by one entity or firm (party A) as security for an amount owed to another entity or firm (party B).
The purpose of collateral is to provide assurance to party B that, in the event that party A does not fulfil its legal and contractual obligations relating to an underlying transaction, party B may legally sell the collateral in order to recover the full value owed by party A.
The generic and commonly used terms for such parties are collateral giver or transferor (party A) and collateral taker or transferee (party B).
For the collateral taker to be properly secured, the collateral asset must be of recognisable value in the open market place and be highly liquid, thereby enabling the collateral taker to quickly and easily convert the collateral to ready cash (should the need arise).
The underlying transactions that give rise to the giving and taking of collateral are many and varied, and in everyday life include, for example, mortgages on residential properties where the lending entity (e.g. a bank) lends cash to the homebuyer with the lender’s legal right to take possession of the property should the homebuyer fail to abide by the terms of the mortgage agreement ...