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Collateral Management by Michael Simmons

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CHAPTER 2The Nature and Characteristics of Collateral Types

 

The two most common types of collateral used within financial services are cash and bonds.

2.1 CASH COLLATERAL: OVERVIEW

2.1.1 Introduction

The most commonly accepted currencies as collateral are US Dollars (USD), Euros (EUR) and British Pounds (GBP).

If a firm’s exposure is in for example USD, and USD cash collateral is taken from the counterparty, there is no foreign exchange (FX) risk, as there is no conversion to be made between currencies. Conversely, if that same firm has the same USD exposure, but receives another currency (e.g. EUR) as collateral, the firm is exposed to FX currency rate movements thereafter and this could result in collateral taken having a lower value than the firm’s exposure. Should such exposure occur, the exposed firm would need to make a margin call on its counterparty in order to cover the shortfall and mitigate its exposure.

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