Cheapest-to-Deliver Collateral and Funding Costs

Summary

The document explains cheapest collateral in a collateral optimization setting where a party can choose which asset to post. For securities, one view is that the economically cheapest asset is the one with the highest repo funding rate: delivering it avoids the cost of financing that security while retaining it. When cash is also eligible, its collateral remuneration must be compared with the securities’ funding costs. Foreign-currency securities require translating their financing economics into the domestic currency, including the effect of the basis swap.

The responses also point out that usage varies with context. Some practitioners describe the cheapest asset as having the lowest funding cost, often assuming ordinary government bonds and excluding special or hard-to-borrow securities; others use “cheapest” to mean the least valuable asset in the eligible basket. The practical choice therefore depends on the party’s funding position, collateral remuneration terms, eligible assets, and currency. The discussion gives no worked calculation and does not establish one universal convention for the term.

Key ideas

• A party choosing collateral generally considers the funding cost of retaining each eligible security.
• Posting a security with a high repo rate can avoid paying that rate to finance it.
• Cash collateral should be evaluated against security funding costs and its own remuneration terms.
• Foreign-currency collateral requires accounting for domestic-currency funding effects, including basis swaps.
• The phrase can have different meanings depending on conventions and which assets are included.

Tags

# What is the definition of "cheapest collateral"?


# What is the definition of "cheapest collateral"?












Optimizing collateral is a hot topic in the financial industry. I came across the term cheapest collateral. What does it actually mean in the context of collateral optimization, please ?

## Answer by dm63 (score 4)

https://quant.stackexchange.com/a/68737

Just want to make sure we have got it right here. The cheapest collateral to deliver (if you have a choice of securities) is that with the highest cost of funds, which means the highest repo rate. By delivering such a security, you avoid having to pay that financing cost to hold it. And then, if you also have a choice to deliver cash, you need to compare the interest received on cash collateral (specified in the document) with the repo rates of the securities. Lastly if you have the choice of foreign securities , their financing cost needs to be understood in domestic currency terms so you need to take account of the basis swap when doing the calculations.

## Answer by JoshK (score 0)

https://quant.stackexchange.com/a/68710

Generally the collateral with the lowest cost of funds. For example, treasuries usually fits the bill. When people use this term they often mentally mean to exclude actual hard-to-borrow or special securities, which are actually the cheapest as you get paid to hold them.

## Answer by Randor (score 0)

https://quant.stackexchange.com/a/70429

Ctd option means party that has to post collateral can choose from a basket of assets which of them he wants to post. Obviously he will post the one with least value, IE the cheapest.

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