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Why Treasury Collateral Typically Earns No Separate Interest Payment

Article Quant Q&A · Author: Peaceful
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Summary

The document explains how interest is handled when one party posts a US Treasury security as collateral for a derivatives contract. Unlike cash collateral, which may be returned with an explicit interest payment, securities collateral generally does not receive a separate interest amount at settlement.

The rationale is that the Treasury can be financed or monetized through the repo market, where the overnight repo rate embeds the relevant financing return. The comparison is between posting cash and earning interest, or borrowing a Treasury and investing cash through repo before posting the security; these arrangements are described as almost equivalent. The explanation is a simplified framing and does not discuss differences in collateral agreements, haircuts, security-specific repo rates, or operational terms.

Key ideas

  • Treasury securities posted as collateral generally do not receive a separate explicit interest payment.
  • The overnight repo rate effectively provides the financing return associated with the security.
  • Posting cash and earning interest can be economically close to financing a Treasury through repo and posting it.

Tags

Fixed incomeDerivatives pricingMarket microstructure
Full text
# posting US treasury as collateral


# posting US treasury as collateral












lets say party A and party B are the two parties in a derivative contract.

If party B posts USD cash as collateral, it would expect party A to return the collateral with interest at settlement. How about if party B posts a US treasury as collateral? would it expect to receive anything on top of the security at settlement ? if so, what is the rational please?

## Answer by dm63 (score 4, accepted)

https://quant.stackexchange.com/a/75051

No, it would not. There is no need for an explicit interest payment when securities are posted. This is because an interest rate is effectively already being applied (the overnight repo rate on the securities). For example, Party B could either (a) post cash and receive interest or (b) borrow a Treasury /invest cash in the repo market, then post the Treasury. The two situations are almost equivalent.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.