A type of transformation in which involves a temporary exchange of less liquid forms of collateral for liquid collateral. Typically, this process is facilitated by the repo market: cash is lent in return for a bond at the repo rate, such as overnight index swap (OIS) rate plus 3 basis points. The repo rate can be set against the overnight cash rate to set up a market position (e.g., obtain government bonds in a repo transaction as collateral for another market transaction such as a swap agreement). An asset manager (with a corporate bond portfolio) that needs to post collateral (such cash collateral) for a specific transaction (for a derivative transaction) may find that it has not enough eligible assets. The manager can enter the repo market to obtain cash using bonds as collateral.

Collateral transformation may also refer to the process of turning relatively risky assets (low quality assets) into reasonably safer assets (e.g., government or agency assets), or vice versa.