2.4 Other Asset Classes Flashcards
Why hold cash?
- liquidity
- emergency funds, planned spending, security
- no volatility (safe)
- generates income as rate of interest (fixed or variable depending on deposit account)
What affects interest returns on cash?
Size and term of the
deposit:
* Larger deposits and longer terms attract higher rates of interest
What are the risks of cash?
- potential default of deposit taker (FSCS)
- inflation and tax reducing returns (real returns after tax can be negative)
- interest rate changes can affect returns
What are the extra risks if depositing cash abroad?
Additional risk including
* FX risk
* Withholding tax
* Exchange controls restricting repatriation
What are t-bills?
- short term (less than 12 months) unsecured debt
- zero coupon
- return on t-bill can be used as benchmark risk-free rate
What is the minimum denomination for t-bills in the UK?
- trade in secondary markets (on auction) for minimum £25,000
What is commercial paper?
essentially t-bill issued by company:
- discount security issued by companies
- unsecured st (up to 1 yr in uk, 270 days in US) debt (typically 3 months)
How is commercial paper issued?
Through a CP programme
- usually a rolling programme (not all at once)
What are the two types of CP issuance?
dealer paper: programmes promoted by dealers
- IBs help companies market their CP
- freely tradable in secondary market
direct paper: Larger issuers, especially finance companies, have the market presence to issue their paper directly to investors
- typically buy and hold investors (eg. money market funds)
- has no secondary market
What is rollover risk?
Where a company uses a new issue of CPs to pay off the existing CPs, it
rolls over the debt. The risk associated with being unable to issue enough
CPs to cover the existing issue is called rollover risk.
What is ICE benchmark Administration (IBA)
- find out the interest rates being charged by all banks in the inter-bank market across different time periods, currencies etc.
- publishes an average of rates of the middle 50% = LIBOR
London Inter Bank Offered Rate
Where is UK now moving towards instead of LIBOR
SONIA - Sterling Overnight IndeX Average
What is the REPO market?
2 stage trade; consists of a sale and a repurchase
arrange forward contracts to agree to buy back what you sold at fixed price in future
what is a reverse repo agreement?
Purchase and resale agreement
What is the repo rate?
Difference between sale and repurchase price (it is in effect interest paid for borrowing money)
What is a tripartie repo?
REPO with a third party, usually a custodian bank
What is an open repo?
where there is no fixed time for repurchase.
what is a term repo?
Maturity dates in excess of overnight are called term repos
- have to document future repurchase date
what are the uses of repos and reverse repos?
Repos may be used as a method of borrowing funds (using gilts as
collateral)
reverse repos to cover a short position taken on by a
market maker in the course of its market making activities
what is the most common period for a repo?
overnight
What are the features of cryptocurrency?
Money outside of control of gov and CBs
- encryption technology used to control supply and record transfers/ownership
examples:
bitcoin
litecoin
dogecoin
ethereum
How can cryptocurrency be obtained?
- buy w fiat money
- earn through browsing and posting
- crypto-mining
What are the risks of crypto?
- volatility
- decentralised and not reserve-backed
- largely unregulated
- operational risk and hacking
how are cryptos settled?
Via distributed ledger technology
What is a distributed ledger?
centralised ledger of transactions w decentralised network of computers holding all copies of exactly the same ledger
What are the pros of a distributed ledger?
- trustworthy and reliable record
- prevents single point of failure as numerous nodes can be used
- v difficult to hack because of use of multiple nodes
- removes costs and delays caused by need to maintain and update single central database
What kind of market is the FX market?
- OTC (private)
- mostly for major international banks
- split into two main types:
spot market
forward market
What is the difference between spot and forward market?
settlement period:
spot: T+2
forward: >T+2
What is the base currency?
the fixed currency which always has a unit of 1
What is the exception to the US dollar being the base currency?
GBP:USD
What is the name for the variable currency?
counter/quote currency
What is a cross rate?
Any FX rate that doesn’t directly involve the USD
Who does the FX spread always benefit?
The bank - company always gets short end of stick (sell at lower end of spread, buy at higher end)
What is a 1 unit movement in price for FX markets referred to as?
1 Pip movement (0.0001)
What will happen in the Forward FX market if a bank thinks a currency will weaken/strengthen?
make a forward adjustment
weaken: add number of pips
strngthen; subtract number of pips
What must we consider when making a 2 way pip adjustment to the spot’s bid and offer?
We must appl y the adjustment in whichever way makes the spread bigger as this covers more risk for the bank
What is interest rate parity ? (IRP)
Arbitrage-free method of pricing FX forwards
How do we find the forward fx rate using the IRP method?
F = Spot price x (1+Rvar)/(1+Rbase)
r = interest rate
What should you look out for when using interest rates in IRP method for Forward FX?
Use only the interest rate for the period
- if it is a 6 month period deannualise interest rates by halving them
