Credit Risk Management Practice Exam

What is the primary purpose of rehypothecation in collateral management?

1. To protect posted collateral legally

2. To convert posted collateral for cash

3. To transfer posted collateral to other counterparties

4. To enhance the value of collateral

The correct answer is: To transfer posted collateral to other counterparties

Rehypothecation in collateral management primarily serves the purpose of allowing financial institutions to use collateral that has been posted by one party to secure their own obligations, typically in transactions with other counterparties. This process enables the institution to utilize the collateral more efficiently by reallocating it to meet various financing needs or to support additional transactions. The practice enhances liquidity in the financial system by allowing for better utilization of assets without the need for the original posting party to take on additional risk. Through rehypothecation, the initial posting of collateral can effectively serve multiple roles, benefiting both the party providing the collateral and the institution that is rehypothecating it. In contrast to this primary function, protecting posted collateral legally is more focused on ensuring compliance with regulatory and legal frameworks, while converting posted collateral for cash involves a direct transaction to liquidate the asset rather than enhancing its utility. Enhancing the value of collateral typically refers to strategies that increase the marketability or worth of the collateral rather than the movement or reallocation of it to other parties.