Collateral has been used for a long time in the cash market and we have also
experienced significant increase of its use as an important credit risk mitigation tool
in the derivatives market for this decade. Despite its long history in the financial
market, its importance for funding has been recognized relatively recently following
the explosion of basis spreads in the crisis. This paper has demonstrated the impact of
collateralization on derivatives pricing through its funding effects based on the actual
data of swap markets. It has also shown the importance of the "choice" of collateral
currency. In particular, when a contract allows multiple currencies as eligible collateral
as well as its free replacement, the paper has found that the embedded "cheapest-todeliver"
option can be quite valuable and significantly change the fair value of a trade.
The implications of these findings for risk management have been also discussed.
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