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P2.T6.906. Features of a collateralization agreement (Gregory Ch.6)

Nicole Seaman

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Learning objectives: Describe the mechanics of collateral and the types of collateral that are typically used. Explain the process for the reconciliation of collateral disputes. Explain the features of a collateralization agreement.


906.1. According to Gregory, collateral agreements are increasingly about funding (FVA) and capital (KVA) costs in addition to pure counterparty risk (CVA) issues. This occurs along with the shift toward central clearing. (Source: Jon Gregory, The xVA Challenge: Counterparty Credit Risk, Funding, Collateral, and Capital, 3rd edition (West Sussex, UK: John Wiley & Sons, 2015))

What is the impact of these trends (i.e., an explicit acknowledgement of funding/capital costs and the shift toward central clearing) on thresholds, in general?

a. More zero thresholds
b. More infinite thresholds
c. Irrelevant: no impact on thresholds
d. Thresholds often set equal to initial margin (false!)

906.2. An institution is re-positioning a large portfolio into significant positions in the over-the-counter (OTC) derivatives market. Its primary concern with respect to the portfolio is gap risk: the risk the portfolio may gap substantially in a short period of time. Which of the following is BEST suited to this concern; i.e., which is the most appropriate protection for gap risk?

a. Higher haircut
b. Higher thresholds
c. Higher initial margins
d. Higher minimum transfer amounts (MTA)

906.3. ToughFax International has a two-way credit support annex (CSA) with its counterparty, GreenBam Financial, in a derivatives transaction. In a two-way CSA, both parties agree to post collateral. Their CSA includes the following mutual parameters: threshold of $1,000,000; a minimum transfer amount (MTA) of $100,000; and rounding equal to $25,000 (these happen to be the same assumptions as Gregory's illustration!). Prior to today's re-margin determination (collateral call), ToughFax held no collateral, but GreenBam held $50,000 in (previously posted by ToughFax) collateral. As of today's determination, ToughFax is significantly in-the-money on the position. Specifically, the mark-to-market (MTM) value is +$1,094,000.00 from ToughFax's perspective, and therefore -$1,094,000.00 from GreenBam's perspective.

The credit support amount is the amount of collateral that may be requested. Based on this valuation, what is the credit support amount?

a. Zero (neither call nor return)
b. GreenBam returns $150,000
c. ToughFax calls $150,000
d. ToughFax calls $300,000

Answers here:
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