Collateral

What it means

Assets pledged to secure an exposure, reducing loss if the counterparty defaults.

The exam angle

Converts credit risk into liquidity and operational risk — the obligation to post more collateral at short notice is itself a failure mode.

Where it appears in the syllabus

• Credit Risk Measurement & ManagementFRM Part II · exam weight 20% · Merton and reduced-form models, credit VaR, counterparty risk, CVA, CDOs.
• Liquidity & Treasury RiskFRM Part II · exam weight 15% · Funding vs market liquidity, LVaR, transfer pricing, IRRBB, LCR and NSFR.

See it worked through

• Initial margin and the uncleared margin rules, explainedWho has to post it, how it is sized, and why the phase-in dates matter.

There is also a short video: watch it on YouTube.

Related terms

• Adverse selectionThe problem that arises when the party with better information self-selects into a transaction, leaving the…
• Counterparty credit riskThe risk that the other side of a derivative defaults before settling, when the contract has positive value to you.
• Credit default swapA contract in which the buyer pays a periodic premium and receives compensation if a specified borrower suffers a…
• Credit spreadThe extra yield a borrower pays over a risk-free benchmark of the same maturity, compensating for default and…
• Credit valuation adjustmentThe reduction in a derivative’s value to reflect the possibility that the counterparty defaults.
• Expected lossThe average credit loss anticipated over a horizon.