In finance, a margin is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty (most often their broker or an exchange). This risk can arise if the holder has done any of the following:
- borrowed cash from the counterparty to buy financial instruments,
- sold financial instruments short, or
- entered into a derivative contract.
I can understand the purpose of collateral in the first two cases, but don't in the third one "entered into a derivative contract".
So I wonder why there is collateral in this third case? What is the purpose of collateral?
Thanks and regards!