How to understand overnight rate is on cash collateral? For my understanding, it just a short term bond without any collateral.

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    O/N rate is simply a number that tells you much interest is paid on your collateral. You post 1mm dollars to collateralise a position Then the next day you get your money back with 1-days interest at 1% per annum. Then, if you have not exited the trade, you are probably still required to post collateral so you post the money again. Note (in case you think this leads to arbitrage which it doesnt!) that the NPV of the liability is also generally larger since all cashflows are 1 day closer to realisation so are discounted less heavily. You will have to post 1mm USD plus 1-day interest a 1% . – Attack68 Sep 14 at 9:28
  • @Attack68 sorry what I read from the book O/N is one bank borrow the money from another bank then pay the interest + principle back next day, there is no collateral. – user6703592 Sep 14 at 18:31
  • I should have said an overnight (o/n) rate. Overnight is just a length of time, like 1M or 3M. But you have different indexes, you have O/N Libor or OIS (overnight indexed swap rate), or Fed Funds which is also O/N. The interest rate payable on collateral could be anything specified. It is just commonly specified as the OIS rate. – Attack68 Sep 15 at 5:37
  • Overnight operations between banks work like you say, no collateral. But suppose you are required to put up cash collateral with someone for some reason; you ask to receive some interest on this collateral (very reasonable, no? It's your money). A common practice is to request the same O/N rate on this cash as the banks are using in their interbank uncollateralized lending. – Alex C Sep 16 at 19:29

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