Optimizing collateral is a hot topic in the financial industry. I came across the term cheapest collateral. What does it actually mean in the context of collateral optimization, please ?
Just want to make sure we have got it right here. The cheapest collateral to deliver (if you have a choice of securities) is that with the highest cost of funds, which means the highest repo rate. By delivering such a security, you avoid having to pay that financing cost to hold it. And then, if you also have a choice to deliver cash, you need to compare the interest received on cash collateral (specified in the document) with the repo rates of the securities. Lastly if you have the choice of foreign securities , their financing cost needs to be understood in domestic currency terms so you need to take account of the basis swap when doing the calculations.
Generally the collateral with the lowest cost of funds. For example, treasuries usually fits the bill. When people use this term they often mentally mean to exclude actual hard-to-borrow or special securities, which are actually the cheapest as you get paid to hold them.