Ch 4: Financial Market Products Flashcards
Financial market products / Physical
List MONEY MARKET securities (ie < 12 months)
(6)
- cash
- treasury bills
- bank accepted bills
- NCDs
- Commercial paper (promissory notes)
- Repurchase agreemtns
Financial market products / Physical
List DEBT MARKET securities (ie >12 months)
(5)
- . CGS
- semis
- corporate bonds
- ABS
- FRNs
Delivery versus payment (define)
- reduce risk of settlement of financial transaction
- ideally, title to an asset and payment are exchanged simultaneously
- made possible with central depository system / clearing house such as Austraclear etc
Payment versus payment
- settlement for FX
- normally payment of one currency amount against receipt of another currency amount
Cash transactions:
- traditional loans and deposits
- not negotiable, and therefore not securitised
includes: - exchange settlement accounts (ESA funds)
- at call funds
- term loans and deposits
Exchange Settlement Accounts (ESAs)
- define:
ESAs are held by:
- Transactions between holders generally conducted as 11 am cash transactions, interest is paid:
- define: provided by RBA; means by which providers of payments services settle obligations which they have accrued in the clearing process
ESAs are held by: all licenced banks (as a requirement) and certain other service providers (ASX 24) - Transactions between holders generally conducted as 11 am cash transactions, interest is paid:AT MATURITY
At call funds:
- these are a loan and deposit with a notional maturity of:
- must be called, repaid or interest rate renegotiated before:
- these are a loan and deposit with a notional maturity of 1 day
- must be called, repaid or interest rate renegotiated before 11am on the day - hen\ce “11am cash”
Term loans and deposits: interest is paid:
agreed maturity & interest rate, can possibly be floating rate
interest is paid at the end of an interest period (eg reset) and/or at maturity.
Bank Accepted Bill
- define
- acceptor
Bank Accepted Bill
define:
- bill of exchange “accepted” by a bank.
- Bill of exchange: securitised evidence of debt repayable to a specific person or to bearer.
- Discounted security, redemmable at face value
- must have acceptor, ie party who accepts liability to pay proceeds
- acceptor
Commercial Paper (aka one name paper, or promissory notes)
- define
- difference with bill of exchange
- main issuers:
- define: securitised evidence of debt
- difference with bill of exchange: does not have an acceptor, credit risk lies solely with issuer
- main issuers: non bank financial institutions, large corporates with high credit ratings
NCDs:
- define:
- credit risk is with:
- interchangeable with:
- normally have a face value of:
- define: commercial paper ISSUED by a licenced bank and cannot be cashed in before maturity
- credit risk is with: issuer
- interchangeable with: BABs
- normally have a face value of: 1m
Repurchase and reverse repurchase agreements
- define
- term repo:
- open dated / at call repo =
- repo transactions are used for: (3)
- licenced banks conduct intraday repos with RBA to manage:
- define: sale (purchase) of a debt instrument with a simultaneous agreement to buy (sell) it back at an agreed price at a future date
- term repo: repo with set maturity
- open dated / at call repo = no specific maturity
- repo transactions are used for: (3)
1. source of cheaper short term funds
2. as a secure investment of excess funds
3. as a way of covering a short sale - licenced banks conduct intraday repos with RBA to manage: RTGS liquidity
Futures
- define:
- at establishment of contract pay:
- futures markets are used for:
- define: legally binding obligation to buy or sell a particular asset on a specified future date
- at establishment of contract pay: initial margin (full value is not paid or received); then mark to market daily
- futures markets are used for: hedging, speculation
30 day interbank cash rate futures
- based on
- speculate on:
- based on: interbank overnight cash rate published by the RBA
- speculate on interbank overnight rate / expectations on whether the RBA will adjust cash rate
90 day bank bills
- forms basis for:
- settlement:
-
- forms basis for: all pricing in short dated assets. Perceived value of a 90 day bank bill on the contract expiry date
- settlement: physical delivery
options on 90 day bank bills: define, american option
- options available xxx quarter months out
- quoted on yield percent per annum in multiples of 0.005 percent - this is the:
- expiry:
options on 90 day bank bills: define: right but not the obligation to buy / sell sepcific 90 day bank bill futures contract anytime (american option)
- options available 8 quarter months out
- quoted on yield percent per annum in multiples of 0.005 percent - this is the premium
- expiry: 12.30 on Friday one week prior to settlement of the underlying contract
Overnight Interest Swap:
- define
- interest
- principal
Define: OIS is a fixed rate swap against a floating rate index which is the overnight cash rate compounded daily.
- floating rate period is tied to daily overnight reference rate.
Interest: compounded daily over the term of the transaction, the difference between the fixed and floating leg is paid on maturity.
Principal: not exchanged, therefore reduced credit risk
Forward rate Agreement:
- define
- principal:
- settle by:
- define: OTC product; agreement between 2 [arties to echange interest payments at a future date based on specific amount at agreed cnotract rate
- principal: NOT exchanged, must settle difference between contract rate and market rate BBSW calculated on A/365 basis
Medium term notes:
- define
- Issued in series:
- issued with many different types of instruments allowed:
- define: debt obligations of the issuer, may rank equal without preference with other senior debt, or may be subordinate
- Issued in series: - each series may have one or mroe tranches which can be issued on different dates and may be fungible
- issued with many different types of instruments allowed: eg fixed, floating, subordinate
Inflation Indexed Annuities:
define:
Principal:
Inflation Indexed Annuities:
define:
- promise a higher return than the rate of inflation is securities held to maturity
Principal:
- no principal amount; they constitute an annuity, providing a regular stream of payments that are adjusted with inflation
Interest indexed bonds (IIBs)
define:
principal:
Define:
- pay a ocupon that varies with inflation
Principal:
- these bonds have a principal that remains constant over life of bond, coupon has a fixed rate component and a variable rate component linked to CPI
- limited market in Aus
Variable Principal Securities - Capital Index Bonds (CIBs)
Define:
Principal:
Coupon:
Define:
Principal: Adjusted quarterly, varies with movement in index (CPI), or with the level of the underlying asset pool - such as asset backed securities.
At maturity:
- indexed amount is repaid
Coupon: remains fixed percentage through life of security, applied to the indexed principal, which has the effect of indexing the coupon;
MBS:
- form of:
- bullet maturity =
- pass through security =
- form of: ABS
- bullet maturity = aall capital repaid at maturity
- pass through security = capital paid periodically as the mortgages are paid off - carries prepayment risk
Covered Bonds:
- dual recourse =
dual recourse =
- convered bonds: if issuer can no longer pay; investors have preferential claim on cocver pool & associated cashflows. If cover pool not enough: bondholders have unsecured claim on issuer. = dual recourse.
Options:
CAP:
Cap = series of options that puts a ceiling on the level of interest rates on a floating rate borrowing
- protects buyer from rising rates; it is therefore the same as a right to sell; therefore a PUT
Options:
FLOOR:
- Floor = series of options protecting buyer from fall in interest rates below certain level. As it protects buyer from a fall it is the same as giving the buyer the right to buy, therefore a CALL
Options:
SWAPTION
2 TYPES:
Swaption = option over interest rate swap
Gives buyer the right to enter a swap at a future date at predetermined rate
2 Types:
Payer swaption = buyer pays the fixed rate if exercised
Receiver swaption = buyer would be receiving fixed rate
ASX 3 and 10 year bond futures
Options on futures
- 6% coupon for 3 & 10 year govt bonds
15th day of Mar Jun Sep Dec
Cash settled against an average price of a basket of Commonwelath Government Bonds
Options on futures are automatically exercised at expiry if they are in the money
CDS
- define
- credit event
Define:
- transfer 3rd party credit risk
Credit Event:
- If credit event occurs; protection seller must pay buyer a payment to compensate for loss on underlying credit, can be physical or cash settled
CDS can be written on individual entity or basket of credits
Credit Linked Note
- define
Define
- CLN is a structured, synthetic cash security, issued by protection buyer to protection seller against the credit default risk on a specifid reference entity, with the redemption calculation at maturity being dependent on occurrence of defined credit event
- effectively a note with an embedded CDS contract
Total Rate of Return Swap
- define
Define: off balance sheet transaction that creates synthetic long position for investor on an underlying reference security
Total return receiver pays the total return payer a spread over the relevant benchmark to cover balance sheet and other costs
Credit Spread option
Bilateral financial contract where buyer pays premium for right to buy / sell a reference oblogation at predetermined spread
Collateralised Debt Obligation
- ABS backed by a pool of bonds loans or other assets.Effectively the securitisation of corporate debt.
- holders rely on the repayment of principal and interest in underlying portfolios.
Foreign Exchange
- base currency =
- terms currency =
- base currency = currency being priced
- terms currency = currency against which base currency is quoted
FX: Spot
FX spot =- Value date (date on which cashflow occurs) taked place 2BD after contract date
Forward transaction (FX)
Types
Forward transaction
- obliges one party to buy and one party to sell a currency at a specific future date.
- forward value date will occur on a date past the spot value date
Types:
- outright forward transaction
- FX swap
- Non deliverable forward
Outright forward transaction (FX)
- currency is sold or purchased against another currency at the forward exchange rate for a maturity on any day past the spot delivery date
- lock in a rate now to buy/sell at a point in time
FX Swap
(not a currency swap)
- define
- principal
two legs:
- purchase and sale of equivalent amounts of one currency, against another currency for different maturities.
- principal is exchanged at time of conclusion of contarct and again at a future date agreed at time of contract
Two legs:
- spot FX transaction
- Forward FX transaction
Non deliverable forward
- define
Define:
- outright foward transaction that does not require physical delivery of currency
- notional principal amount, FX rate, maturity date and rate fixing rate and settlement methodology are all agreed at contract inception. At maturity the difference between contract rate and prevailing spot rate is settled
Currency swap
Principal
- parties exchangee 2 fixed rate interest streams in different currencies over an agreed period.
- at least 1 stream is at floating rate of interest
Principal
- exchanged in different currencies at prevailing swap, and two streams of interest payments on the initial cashflows are made in the different currencies.
- at maturity, the principal amounts are exchanged back at an exchange rate agreed at the start of the contract.-
Cross currency basis swap
2 floating rates in different currencies are exchanges, with principal exchanged at inception and maturity
Preference shares
- entitle shareholder to dividends ahead of company’s ordinary shareholders
- generally shares are at a set dividend rate that does not vary with profits of company
- cumulative: any unpaid dividends are carries forward
- redeemable - company is allowed to redeem
Perpetual step up
- treated as:
- remarketing period
Define: - main type of hybrid Treated as: - equity on balance sheet Remarket: - make changes to certain key terms - issuer could repurchase/redeem, convert into shares, or start paying distributions at increased margin instead of remarketing
Perpetual step up: Remarket: Holders may respond with: - Step up Notice: - Bid notice - Hold Notice
- Step up Notice: only cnotinue holding if new margin is the step up margin
- Bid notice: indicate desired new margin within the range offered
- Hold Notice: continue to hold at new margin determined by issuer
Convertible notes:
Define:
Treated as:
Define: debt instrument with embedded option, bonds with equity call option
Treated as: Debt on balance sheet, distributions are unfranked, coupon payments may be tax deductable
Warrants
Define:
Trading Warrant
Investment style warrant
Define:
- form of derivative which gives holder right to purchase or sell a securityt at a specific price within a certain timeframe. Can be on securities such as shares, a basket of different securities, index, debt, currency, commodities
Trading warrant: short dated, traded frequently, may be looking for short term leveraged exposure to underlying
Investment style: longer dated, less frequent. Lower risk return profile. Long term leveraged exposure.
INVESTMENT STYLE WARRANTS
Instalment warrants:
Endowment Warrants:
Capital Protected Warrants:
Generic Capped Warrants:
Instalment warrants:
- buy listed securities by paying several instalments. If share price is below instalment share price can choose not to exercise
Endowment Warrants:
- Long dated investment style call warrants
Capital Protected Warrants:
- Usually cover basked of securities or share index specified by issuer, capital protection
Generic Capped Warrants:
- Cap potential profits; give some other benefit in return.
TRADING WARRENTS
Equity warrants:
Domestic index warrant:
Currency Warrant
Knock out warrant
Commodity warrant:
Equity warrants:
- call / put options issued over securities, potential losses limited to amt paid for warrant
Domestic index warrant:
- Index call / put warrants
Currency Warrant
- right to exchange an amount of FX for A$ on or before expiry
Knock out warrant
- highly geared, low cost. Call/puts on rising / falling share or index.
Commodity warrant:
- linked to performance of commodity, generally underlying asset is futures over commodity.
CFDs
Define:
Define:buyer and seller exchange difference in value of a particular instrument between time contract is opened and when it is closed. Reference = underlying. Provider sells at proportion of total cost
- leveraged (ie full exposure without having to pay full price
- no direct connection with main physical market; if provider goes bankrupt, CFDs are worthless
- majority is OTC
How are commodities bought & sold
- cash sale
- forward contract
- futures contract
- option
Precious metals vs base metials
Precious: gold, silver, platinum, palladium
- OTC & ET
- COMEX & NYMEX
Base metals: lead, zinc, copper
- LME
6 groups of commodity fuures
- foodstuffs
- fibres
- livestock
- grains
- energy
- metals
ELECTICITY / ENERGY DERIVATIVES
- National Electicity Market
- Market is operated by:
National Electicity Market:
- wholesale elecricity pool
- all generators of capacity >30MW are obliged to compete to supply electricity to the pool
- retailers buy from the pool and compete to sell to retail market
Market is operated by:
- AEMO (Aus Energy Market operator); states are members
Electricity Derivatives:
- delivery:
- majority of instruments traded are:
- derivatives include:
delivery:
- no physicla delivery. Financial settlemnt
majority of instruments traded are:
- OTC swaps
derivatives include:
- fowrards, swaps, options, exchange traded futures & options
Electricity swaps:
- floating leg is:
floating leg is pool price as determined by market operator (AEMO) at the regional reference node specified in contract.
- pool price different for each period, so settlement needs to be calculated for every period
Electricity caps:
half hourly struck call option where buyer has the right to buy at the strike price
- if pool price is above strike price, owner receives cash settlement equal to difference
- protects purchaser from rise in elecricity prices in any half hourly period for duration of contract
Elecricity Floor
- half ourly put, buyer has the right to sell at strike price
- If pool price is below strike price, opption is automatically exercised; owner received difference between strike and spot price
Elecricity Collar
- combination of cap and floor; sets a min & max price when used as hedges
- can also be traded in swaptions
- manyu are zero cost collars
Electricity swaption
Put swaption: right to receive fixed pay floating
Call elecricity swaption: right to pay fixed and receive floating
Elecrticity flexible swap option
- option over a swap contract; buyer has right to increase or decrease volume at predefined price
- helps manage volume risk
