PowerPoint Presentation
Organisational and Administrative
Management for Banking
BSF 414
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Week 7: Short-term Debt Markets, Money Markets
& Foreign Exchange Markets
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7.1 Introduction to Short-term Debt Markets
7.2 Money Markets
7.3 Credit Ratings
7.4 Foreign Exchange Markets
Week 7
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7.1 Introduction to Short-term Debt Markets
Remember: Banks dominate the debt markets:
• They bo
ow (to on-lend)
• Place surplus cash to earn returns
• Act as
okers for clients’ trades
• Act as market makers
• Engage in Proprietary Trading
Money Markets: 1 year or less
Debt Markets: > 1 yea
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7.2 Money Markets
• Negotiable Instruments
• Sold at discount to par (except CDs & inte
ank
deposits, which are issued at par)
• Effective interest rate for lending
• Yield is difference between what you pay & what
you get at maturity
• Discount and Yield (rate of return) depends on:
• Maturity
• Risk of instrument
• Participants: banks, governments, corporations, institutions
(e.g. pension funds, who need low risk liquidity for a
percentage of their funds), Central Banks (OMOs)
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7.2 Money Markets
• Electronic dealing; some private dealing with central clearing
• Very liquid
• T-Bills: raises money for governments
• Negotiable, easily traded
• “risk-free”
• Money Market Funds:
• Administered by banks
• Returns linked to underlying investments &
instruments in fund
• Spare cash of corporates put to work in money market
funds (sweeping/cash management)
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7.2 Money Markets
Source: Trustnet.com
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7.2 Money Markets
Source: Trustnet.com
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Source: Trustnet.com, Fund Factsheet
7.2 Money Markets
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7.2 Money Markets
Source: Morningsta
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7.2 Money Markets
Bonds – long-dated version of money markets; we will see more
on this next week but:
• Raising money for governments or corporates
• Negotiable, easily traded
• Coupons annual/semi-annual
• Sovereign bonds = “risk free” – different governments rated
differently (see credit ratings later)
• Maturity: classified according to time remaining to maturity
(not from date of issue)
shorts < 7 years
mediums 7-15 years
longs > 15 years
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7.3 Credit Ratings
Specialist organisations that assign credit ratings, rating a
o
ower’s ability to repay debt & the likelihood of default
• Depends on likelihood of payment of both interest &
capital
• Debt not being repaid at all
• Recoverability of debt
• Rate both long-term & short-term debt
Who pays for the rating report?
Role of agencies during XXXXXXXXXXcrisis: many securities
that were highly rated downgraded to junk overnight
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7.3 Credit Ratings
Source: Moody’s
Where have
you seen a
similar
procedural
approach?
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7.3 Credit Ratings
What do rating agencies look for?
• Ratio of assets to liabilities
• Outstanding debt
• Cash Flow generation
• Quality of management
• Competitive Position
• Vulnerability to economic cycle
Quantitative
Qualitative
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7.3 Credit Ratings
Investment Grade
Non-investment Grade
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7.3 Credit Ratings
Downgrade:
• High leverage
• Weak FCF
generation
• Reputational
Risk
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7.3 Credit Ratings
Fitch Ratings-London-15 April 2019: Banks in several
'AAA' rated countries face rising risk from the household
sector amid a build-up of financial imbalances, Fitch
Ratings says in a new report. In Australia, Canada, Norway
and Sweden, high household debt amid slowing housing
markets represent a growing risk to banks in those
countries, which are among the world's most exposed to
esidential mortgage lending. The major banks also have,
to varying degrees, a reliance on wholesale funding, which
can increase their vulnerabilities during a market stress.
Source: Fitchratings.com
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7.3 Credit Ratings
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7.3 Credit Ratings
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7.3 Credit Ratings
Source: countryeconomy.com
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7.4 Foreign Exchange Markets
One cu
ency exchanged for another, the rate determined by
supply and demand
• Developed in response to international trade
• Banks do most of FX trading
• USD dominant cu
ency
• >$4’000bn traded daily, London an important centre
• 24-hour trading
• OTC, not regulated on-exchange
• FX trading now on apps/tablets
• Degree of self-regulation (mostly “run” by banks)
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7.4 Foreign Exchange Markets
Buyers & Sellers of FX
Commercial
Companies:
Import/Export
Brokers
uying/selling FX on
Clients’ behalf
Tourists & Investors
needing to pay in
foreign cu
ency
Source: FT Banking, Fig 23.4
International banks
ca
ying out
Proprietary Trading
Governments
needing FX for
overseas trade
Fund mangers
investing a
oad
Central Banks
managing rate to
desired level
Speculators &
A
itrageurs
Dealers trading &
acting as Market
Makers
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7.4 Foreign Exchange Markets
• Single transaction
• Cu
ent price
• Settlement T + 2
SPOT FORWARD SWAPS
• Single deal with 2 parts:
• 1 – actual exchange of 2
cu
encies on specific
date at agreed rate (spot
or fwd)
• 2 – reverse exchange
of same cu
encies at
date further in future
than agreed today
• Agree rate today,
delivery later (as
agreed) i.e. fix rate
• FX futures are
similar, but
standardised as
traded on-exchangeFwds & Swaps used to:
• Balance FX positions
• Reduce risk
• Earn higher returns
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7.4 Foreign Exchange Markets
Exchange Rates – Price of Base Cu
ency expressed in
terms of another (the counter) e.g. $1.51/£1
• Smallest variation “pip” = XXXXXXXXXXof one unit of cu
ency
• Bid rate: rate at which you buy base cu
ency
• Offer rate: rate at which you sell base cu
ency
• Spread = difference
e.g. $/£ XXXXXXXXXX
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7.4 Foreign Exchange Markets
FX Volatility:
• Rates change constantly
• Income to be received from a
oad
• Valuation of foreign assets & liabilities
• Long-term viability of operations in certain countries
• Accept
eject overseas investments or projects
• i.e. Changes in FX can affect viability &
go/no-go decisions
FX Risk – manage through forwards, hedging (bo
ow
funds in money markets), cu
ency option hedges
(calls & puts – banks often write options for pm)
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7.4 Foreign Exchange Markets
Source: UBS XXXXXXXXXX)
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7.4 Foreign Exchange Markets
Source: UBS XXXXXXXXXX)
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7.4 Foreign Exchange Markets
Source: UBS XXXXXXXXXX)
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7.4 Foreign Exchange Markets
Source: UBS XXXXXXXXXX)
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Week 8: Stock Markets & Securities Markets,
Proprietary Trading
See you next week!
PowerPoint Presentation
Organisational and Administrative
Management for Banking
BSF 414
1
2
Week 8: Stock Markets & Securities Exchanges;
Proprietary Trading
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8.1 Introduction: What & How Banks Trade
8.2 Fixed Income
8.3 Equities
8.4 Asset Management
8.5 Prime Brokerage
Week 8
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8.1 Introduction: What & how Banks Trade
Remember:
PRIMARY MARKETS
• Users of funds
(governments, companies)
aise funds by issuing
financial instruments e.g.
shares (stocks) & bonds
• New Issue of securities e.g.
IPO
• Exchange of funds for
financial claim
• Funds for bo
ower, IOU fo
lende
SECONDARY MARKETS
• Markets where financial
instruments are traded
among investors
• Trading/dealing fo
previously issued shares,
onds, derivatives,
commodities, cu
encies
• No new funds for issue
• Provides liquidity for selle
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8.1 Introduction: What & how Banks Trade
BROKER
• Act on Clients’ behalf (retail
& wholesale clients)
• Corporate Broking arm of
Investment Bank acts for
company, advising on
market conditions, rules &
egulations for listed
companies, manage process
for any new issues (gauge
demand, pricing,
underwriting etc)
• Long-term relationship
anking
PROPRIETARY TRADING
• “Own account” dealing
• Use bank’s capital to
generate trading income
(realised & unrealised gains)
• 1990s – 2010 huge growth in
prop trading, banks made
huge (risky) bets on trades
• New rules post crisis (e.g.
Volker Rule Dodd-Frank Act)
to prevent domino-like
collapse of other banks
when one reneged on its
obligations i.e. prevent
systematic risk
MARKET MAKER
• Dealers, who agree to always
provide price at which to
uy/sell i.e. facilitate trade,
provide liquidity
• Quote-driven systems,
dealers always ready to
trade
• Bid < offer, thus dealer
always makes a profit
• Risk – dealers must always
hold inventories of
securities, thus often engage
in stock bo
owing
• Strict rules to prevent price
manipulation
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8.1 Introduction: What & how Banks Trade
What about ethics, legal issues and conflicts of
interest?
Source: r-bloggers.com
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8.1 Introduction: What & how Banks Trade
What about ethics, legal issues and conflicts of
interest?
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8.2 Fixed Income
Focus tends to be
oking & market making (sales & trading),
ather than prop trading
Bonds – long-dated version of money markets
• Raising money for governments or corporates
• Negotiable, easily traded
• Coupons annual/semi-annual
• Sovereign bonds = “risk free” – different governments rated
differently (see credit ratings later)
• Maturity: classified according to time remaining to maturity
shorts < 7 years
mediums 7-15 years
longs > 15 years
Not from
date of issue
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8.2 Fixed Income
What do rating agencies look for?
• Ratio of assets to liabilities
• Outstanding debt
• Cash Flow generation
• Quality of management
• Competitive Position
• Vulnerability to economic cycle
Quantitative
Qualitative
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8.2 Fixed Income
Investment Grade
Non-investment Grade
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8.2 Fixed Income
“The 10-year Treasury closed at
2.50% on Friday while the 2-year
note closed at 2.29%. Longer-
term Treasury yields are being
pulled by action in the German
and Japanese bond markets,
where 10-year bunds close at -
0.02%, while 10-year JGBs
closed at -0.03%. There simply
isn't enough yield in key global
ond markets, so multinational
financial companies end up in
the U.S. Treasury market.”
Source: Ivan Martchev, XXXXXXXXXX
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8.2 Fixed Income
Source:
countryeconomy.
com
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8.2 Fixed Income
Types of Corporate Debt:
BONDS
Higher risk
eturn than government debt
Some listed, but majority OTC (investor deals directly with
ond dealer)
Coupon: annual/semi-annual, fixed/floating/variable rate/
Index-linked
DEBENTURES
DEEPLY DISCOUNTED
& ZERO COUPON
BONDS
Very secure bond, with fixed/floating charge over co’s assets
i.e. company free to use assets, default event triggers
crystallisation of charge over assets. Receiver appointed to
dispose of assets & distribute proceeds to creditors
Good for bo
owers with low Cash Flows in near-term
e.g. property development where maturity (& CFs) some
distance in future
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8.2 Fixed Income
Types of Corporate Debt:
HIGH YIELD
“junk” < BBB – or lower, subordinate intermediate or low
grade thus very high risk (but potentially high reward)
Can come with equity kicker e.g. wa
ants or share options
(Hy
id Finance)
CONVERTIBLES Pay coupon but