Chapter 4: Specialist asset classes Flashcards
i. Discuss the characteristics of specialist financial instruments Financial instruments available for short-term lending and borrowing Corporate debt and credit derivatives Swaps and swaptions Private debt
i. Characteristics of financial instruments available for short-term lending
State:
1. How are money market rates are often quoted.
- the two factors that influence the spread of money market rates.
- MM interest rates are quoted relative to LIBOR (London Inter Bank Offer Rate)
- Two factors that influence spreads:
- default risk
- market liquidity
i. Characteristics of FIASL
List the six different types of mm instruments and state which three are the most important.
- Treasury bills
- Local government bills/government agency bills
- Commercial paper
- Repos
- Banker’s acceptance and eligible bills
- Certificate of deposit/bank time deposits
The three most important and major instruments are:
- Treasury bills
- Commercial paper
- repo agreements
i. Characteristics of FIASL
List ways in which in investors can access MM instruments?
- Deal on their own account
- suitable for large firms - Invest funds in a MM fund which are small and offer diversification.
- suitable for smaller investors - Hire an investment firm to trade on their behalf.
- suitable for large investors who do not have expertise to deal in mm
i. Characteristics of FIASL
Define the main features of the market for Treasury bills.
- issued by government, so very secure
- Typically issued in 3-month (91 day), 6-month (182 day) and one-year forms
- usually issued by auction…
-… where competitive and non-competitive bids may be entered…
with the latter filled at the average price of successful competitive bids - Deep and liquid secondary market, ie very marketable.
i. Characteristics of FIASL
Explain what is meant by commercial paper.
- Short-term unsecured notes issued directly by company (overriding need for financial intermediation)
- Issued at a discount (and redeemed at par), usually for a term of a few months, but typically presented to issuer (or to dealer) for repurchase
- Bearer document and single-name instrument
- Default risk means effective rate of interest slightly higher than on Treasury bonds
- Size of margin reflects company’s credit rating
- companies issuing must meet certain minimum criteria
i. Characteristics of FIASL
What does the following mean and what the implications of the combination of these two:
1. Bearer document
2. Single name instrument
- Single bearer
- A bearer document is a negotiable instrument where ownership is simply by physical possession.
- Whoever holds the physical document is considered the legal owner and can present it for payment at maturity. - Single-Name Instrument:
- A single-name instrument means there’s only one party obligated to repay the debt represented by the commercial paper.
Implications :
1. Security:
- the security of the investment rests solely on the creditworthiness of the issuing company.
2. Benefits and risks:
- Bearer documents can be easier to transfer and negotiate compared to registered instruments
- Higher returns that TB
- The lack of additional security and reliance on a single issuer significantly increases the risk of default.
i. Characteristics of FIASL
Explain what is meant by a repo.
- It is an agreement whereby one party agrees to sell stocks (government bonds or TB) with a simultaneous agreement to repurchase it at a later date at an agreed price
- Holders of government bonds and other high quality assets can use repos as a short-term financing tool, whist maintaining their underlying economic exposure to these assets.
- The “stock” involved is usually either Government bonds or Treasury bills.
- Overnight repos are very common and are very liquid instruments.
- rep rate = repurchase price - selling price
i. Characteristics of FIASL
Explain what is meant by a ‘reverse repo’.
- it is the counterparty/opposite side to the repo agreement
- it is a form of secured lending as cash is being lent for the duration of the repo by the party buying the stock, with the security as collateral .
i. Characteristics of FIASL
Explain what is meant by government agency bills.
- Near-government sector of the market which issues and trades securities that are almost as risk-free as Treasury bills (e.g., nationalized industries, local authorities)
- similar to TB and secondary liquid markets also exist
1. but not quit as marketable as TBs and slightly higher level of risk
2. but risk margin not significant
i. Characteristics of FIASL
Define the main features of the bank time deposits.
- Bank deposits with specified term
- Banks major providers and borrowers
- Interbank borrowing and Certificates of Deposits (Negotiable term deposit) are typical securities involved
- CDs main features:
1. bearer document
2. secondary market exists
3. typical 1 to 3 months
4. Domestic and international CDs exist in many currencies
i. Characteristics of FIASL
Explain what is meant by:
- Banker’s acceptance bill.
- Eligible bill.
- Banker’s acceptance bill (Non-recourse factoring)
tradable IOUs, company supplies goods or services and will have invoice accepted by a bank (who thereby guarantees payment at the due date). The bill can then be traded in a secondary market to raise immediate cash, at a discount. - Eligible bill (Recourse factoring)
- A bill of exchange drawn by the seller on the buyer and endorsed by the seller’s bank. Upon acceptance by the buyer, the endorsed bill becomes a short-term debt instrument
- The seller’s bank may discount the bill for the seller, essentially advancing them the face value minus a discount fee.
- This provides immediate cash flow for the seller, while the bank holds the bill until maturity and collects payment from the buyer
Characteristics of FIASB
Give five forms of short-term borrowing from banks.
TRIBE
1. Term loans - borrowing fixed amounts for fixed term
2. Revolving credit - similar to evergreen credit, but with a fixed maturity of up to 3 years
-There is a commitment fee you pay
3. International loans - borrowing from a bank or syndicate of banks overseas
4. Bridging loans - very short-term loans to bridge gap until long-term finance becomes available
5. Evergreen credit - An overdraft facility, with no fixed term
- May have commitment fee
- bank may required period payment of loan to prevent long-term borrowing
Characteristics of FIASB
Give four issues that differentiate between different types of bank loan.
- Commitment - whether there is a prior commitment by lender to advance funds when required (often requiring payment of commitment fee to lender)
- maturity - term of which lending made
- rate of interest - may be either fixed or floating
- Security - whether loan is secured against assets
i. Characteristics of Corporate debt
Give examples of corporate debt
- Debentures
- Loan stock
- preference shares
i. Characteristics of Corporate debt
What are the two primary additional risks?
- Default risk - the risk that the issuer will not be able to make payment of the interest or redemption payments, either on the due date or at all.
- Liquidity risk (strictly marketability risk)
- the risk that a holder of the bond will not be able to realise value for it in certain market conditions
- This might be because the bond has certain unusual terms or covenants
- or because the issue is small and unlikely to be attractive to major investors
These risks are not necessarily independent