Malz' Chapter 12 - Liquidity and Leverage

[brian.field]

Just so everyone knows, this chapter is a bear!

 

[Hamam]

Hi David,
Hope your well, I have a quick question. Please see below:

"Securities used as collateral “circulate,” since the borrower of securities can typically lend them to another, a practice called re-hypothecation or re-pledging of collateral."

Shouldn't this statement read the lender can use the securities used as collateral by the borrower to re-hypothecate?

 

[David Harper CFA FRM]

Hi @Hamam Thank you, hope you are well too. I don't know (or recall) the exact context, but that sentence appears to be correct (as it is written) to me. Imagine Party A borrows cash by posting (pledging) collateral to Bank B, then this is secured lending and notice we are most likely to say that Party A is the borrower (who borrowers cash) and Bank B is the lender, but it's conceivable (as one of authors, I think Tuckman does) to say that Bank B is "borrowing securities." (we might even say that Bank B is borrowing securities collateralized by cash!). But in the common frame here the (fungible) cash is secured by the collateral and Bank B is the collateral taker or receiver. Re-hypothecation is a feature of that collateral, that means Bank B can re-use the (securities) collateral to itself borrow. It does not refer to Party A using the collateral for another loan, which might be called cross-collateralization (did I maybe also see that called "collateral stacking" somewhere ...)

My question 20.6.3. actually specifically queries this distinction, it is here at https://forum.bionicturtle.com/thre...erivatives-market-hull-ch-17.23270/post-82254 i.e.,

20.6.3. C. False, doubly: Rehypothecation is when collateral posted by A with B is used by B to meet collateral demands from C (it is NOT when party A uses the same collateral twice) and Hull says that the new regulations will REDUCE the use of rehypothecation.

In regard to (A), (B) and (D), each is TRUE.

To me (and I'm not taking the time to reference check this currently, it is covered in Gregory), rehypothecation implies the securities are pledged but not sold (in a title transfer) because if they are sold, presumably there is no need to explicitly specify re-hypo right; the existence of a re-hypo right, to me, implies that the title remains with the original collateral giver. We've got some discussion on the forum but you said quick (lol) question and so I won't go further here. Thanks,

P.S. But hopefully I've convinced you, at least, that "borrower" can be a vague term in this context! When you wrote, "the lender can use the securities used as collateral by the borrower to re-hypothecate?", the bolded phrase confuses me (I don't know who you mean). I would re-edit it thusly to write a sentence that is true to me: "re-hypothecation is when the cash lender (who takes collateral, or receives pledged collateral as security ["to secure"] the loan) can use (aka, pledge) those securities when it goes out to borrow funds".

 

[Hamam]

Hi @Hamam Thank you, hope you are well too. I don't know (or recall) the exact context, but that sentence appears to be correct (as it is written) to me. Imagine Party A borrows cash by posting (pledging) collateral to Bank B, then this is secured lending and notice we are most likely to say that Party A is the borrower (who borrowers cash) and Bank B is the lender, but it's conceivable (as one of authors, I think Tuckman does) to say that Bank B is "borrowing securities." (we might even say that Bank B is borrowing securities collateralized by cash!). But in the common frame here the (fungible) cash is secured by the collateral and Bank B is the collateral taker or receiver. Re-hypothecation is a feature of that collateral, that means Bank B can re-use the (securities) collateral to itself borrow. It does not refer to Party A using the collateral for another loan, which might be called cross-collateralization (did I maybe also see that called "collateral stacking" somewhere ...)

My question 20.6.3. actually specifically queries this distinction, it is here at https://forum.bionicturtle.com/thre...erivatives-market-hull-ch-17.23270/post-82254 i.e.,


To me (and I'm not taking the time to reference check this currently, it is covered in Gregory), rehypothecation implies the securities are pledged but not sold (in a title transfer) because if they are sold, presumably there is no need to explicitly specify re-hypo right; the existence of a re-hypo right, to me, implies that the title remains with the original collateral giver. We've got some discussion on the forum but you said quick (lol) question and so I won't go further here. Thanks,

P.S. But hopefully I've convinced you, at least, that "borrower" can be a vague term in this context! When you wrote, "the lender can use the securities used as collateral by the borrower to re-hypothecate?", the bolded phrase confuses me (I don't know who you mean). I would re-edit it thusly to write a sentence that is true to me: "re-hypothecation is when the cash lender (who takes collateral, or receives pledged collateral as security ["to secure"] the loan) can use (aka, pledge) those securities when it goes out to borrow funds".

Thanks David, really cleared the concept for as usual! I'm kicking it up a notch now for my part 2 exam in December so ill probably be more active on the forum.

 

[David Harper CFA FRM]

@Hamam cool, my favorite sort of "more active" is somebody who helps answer other candidates' questions , but if you are just warning me that you'll need more support from me, you don't need to do that! The forum is already daily work for me ...

 

[Hamam]

@Hamam cool, my favorite sort of "more active" is somebody who helps answer other candidates' questions , but if you are just warning me that you'll need more support from me, you don't need to do that! The forum is already daily work for me ...

lol Noted & I appreciate everything you do for me and the other candidates