
Explanation:
The level of collateral posted by different types of institutions is given in the table below:
| Institution type | Collateral posting |
|---|---|
| Dealer Banks | Very High |
| Other Banks | High |
| Supranationals, Local Authorities, Private Equity Funds | Low |
| Corporates | Low |
| Sovereigns | Very Low |
Note:
The table in the solution takes into account more than just the credit quality of the parties. We have to remember that In some OTC derivatives trading relationships, CSAs (credit support annex) are not used because one or both parties simply cannot commit to collateral posting because of one of two possible reasons:
(I) The party feels that their credit quality is high (both in individual and comparative terms), or
(II) an inability to manage the liquidity needs that come with collateral posting
A typical example of this is the relationship between a bank and a corporate where the latter's inability to post collateral means that a CSA is not usually in place (for example, a corporate treasury department may find it very difficult to manage their liquidity needs under a CSA). It may not have as many liquid assets compared to a dealer bank, for example, and collateral calls might force it to make some decisions that trigger economic losses, e.g., selling a position prematurely.
This also applies to supranationals and sovereigns. They will rarely agree to post collateral due to the operational workload that would come with that decision. But in relative terms, a supranational organizations like the EU is more likely to agree to collateral posting than a sovereign country.
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