Hi A ques in one of the past paper states that Discuss the risks from investing in RPI swaps and how these can be mitigated. The ans states that one of the mitigation techniques is Regular collateral call to make sure that five any in the money amounts. Pls explain what does this mean.As per my understanding swaps are OTC traded,so from does the talk about collateral come into the picture? Thanks in advance!
Broadly speaking, over the counter (OTC) simply means that a deal is bespoke and so can be designed to take whatever form the two parties wish. One issue when doing a deal is the risk that the other party defaults on their obligations to make payment(s) to you at some future point and so you lose out. This risk can be reduced if the other party deposits collateral - essentially assets which become available to you if the other party defaults to make up at least some of the loss you incur as a result. So, as part of an OTC swap, both parties may agree to deposit collateral, reducing risk for the other party.
