How can collateral create exposure??

jaivipin

Active Member
Subscriber
I see section about collateral given in the notes, page 82, section "Impact of collateral on exposure " notes Gregory as below.

"in scenario 5, the posting of collateral creates exposure. In comparison with the
benefits shown in the other scenarios, this is not a particularly significant effect, but it is
important to note that collateral can increase as well as reduce exposure."



Can someone give some example in what scenario I would see exposure increased???

Is the reason, if values goes down to zero of collateral, and extra costs involved??

Thanks
 
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Nicole Seaman

Director of FRM Operations
Staff member
Subscriber
I see section about collateral given in the notes, page 82, section "Impact of collateral on exposure " notes Gregory as below.

, in scenario 5, the posting of collateral creates exposure. In comparison with the
benefits shown in the other scenarios, this is not a particularly significant effect, but it is
important to note that collateral can increase as well as reduce exposure.



Can someone give some example in what scenario I would see exposure???

Is the reason, if values goes down to zero of collateral, and extra costs involved??/

Thanks
Hello @jaivipin

I'm sure David or another member can answer you more specifically, but I wanted to see if you had gone through our practice questions that are related to this reading. There is a good deal of discussion in these threads regarding collateral and credit exposure.
Nicole
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
Hi @jaivipin Gregory's footnote (#18) says "In practice, this can happen when previously posted collateral has not yet been returned as required." His example in Chapter 11 is concrete and uses a short CDS example:
"11.3.6 Do two-way CSAs always reduce exposure? Two-way collateral agreements may in some specific cases increase exposure. Take the example of CDS protection. Such products create a very skewed exposure distribution: when selling CDS protection, exposure is moderate compared with the negative exposure, due to the possibility of an extreme credit spread widening and/ or credit event( s). The overall result of this is that in a short CDS protection position, collateral is much more likely to be posted than received, as illustrated for one simulation in Figure 11.13. The net result is to increase the overall EE, as shown in Figure 11.14. The increased risk from posting collateral has dominated the reduced risk from receiving it. For a long protection single-name CDS position (Figure 11.15), the situation is reversed and the CSA is seen to be beneficial." -- Gregory, Jon. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral, and Capital (The Wiley Finance Series) (p. 258). Wiley. Kindle Edition.
 
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