What is collateral yield?

There are no stupid questions! 😀

The collateral’s yield is reflected in the derivative’s price. This means that the future/forward/swap’s price is affected by the fact that the collateral posted will generate a yield, be it T-bill coupons or cash earning a risk-free rate.

So whether it’s T-bills or cash, the collateral yield is often assumed to be the risk-free rate.

It’s not just on forward contracts, but any commodities derivatives, such as forwards, futures, swaps. Collateral yield is one of the components of return, along with roll or convenience yield, and the return from the change in spot price (spot price return or spot return).

When you enter into a long or short position of financial instruments such as derivatives, you’re often required to post margin, which is an asset that you have to deposit with your counterparty to cover some, or all of the credit risk you pose to your counterparty. The assets you post as margin is your collateral.

The most common form of collateral for derivatives are cash or securities like US Treasury Bills (T-bills). This collateral generates interest income, which will then be reflected in the derivative’s price, hence a collateral yield.