Exposure and Collateral

$50.00 / year

The Need for Collateral. A counterparty may have an exposure to another one A’s exposure to B could arise from a number of situations: A has that lent money to B. A is a broker who allowed B to trade, though B did not have the money or securities to do so. A lent securities to B and those are returnable by B to A . A executed a one-to-one (OTC) trade with B and faces risk of failure by B to settle the trade. In the financial markets such credit exposures are often resolved by the use of Collateral. In the above example, B may place some property of its (cash or securities) as ‘collateral’ with A. In collateralization the principle is that the value of collateral should always exceed the exposure value. While that can be ensured at the beginning, nothing in this equation is static.


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