L3 Money, Bond and Equity Market Flashcards
Whats the Money Market?
Money market is where very short-term securities are traded, with original maturities of one year or less (typically 90 days). making them suitable for investors looking for short-term investments or funding needs.
A highly liquid market, a network of banks, institutional investors, and money dealers. Money market instruments are highly liquid, meaning they can be easily bought or sold with minimal impact on their prices. This liquidity is essential for investors who may need to access their funds quickly.
Money markets are largely unregulated and informal where most transactions are conducted over phone, fax, or online.
Money market is linked to other markets through arbitrage. (Arbitrage involves exploiting price differences of identical or similar financial instruments across different markets to make a profit with minimal risk.)
Money market has two interrelated parts:
Domestic MM deals with short-term domestic currency deposits and loans within the country of issue. It includes various financial instruments like treasury bills, commercial paper, certificates of deposit, and interbank loans denominated in the domestic currency. The domestic money market provides liquidity to financial institutions, facilitates short-term funding needs, and influences domestic interest rates.
International money market consists of short-term financial instruments denominated in national currencies held outside the country of issue. It includes foreign exchange markets, Eurocurrency markets, and offshore banking centers where international banks and corporations conduct transactions in various currencies. The international money market allows for global capital flows, facilitates cross-border trade and investment, and helps manage currency and interest rate risks.
What are some types of domestic money markets
Call Money: This refers to a type of short-term borrowing and lending among banks, typically for very brief durations ranging from overnight to a few days. It’s part of the broader money market, which deals with short-term debt instruments and monetary assets.
Interbank Market: where banks and financial institutions lend and borrow funds from each other. It facilitates short-term borrowing and lending transactions,ranging from overnight to one year (often to 14 days), among commercial and investment/merchant banks, other non-bank FIs. The interbank market is crucial for managing liquidity and interest rate fluctuations within the banking system.
Whats LIBOR interest rates
LIBOR (London Interbank Offered Rate): LIBOR is a key benchmark interest rate that reflects the average interest rate at which banks in the London interbank market offer to lend funds to each other. It’s a vital reference rate used globally in various financial contracts and products, particularly in the interbank market and related derivatives markets.
Whats a domestic Treasury Bill and whats Local Authority/Public utility Bills
Domestic Treasury Bills: These are short-term debt securities issued by the government of a country. They are considered risk-free because they are backed by the government’s credit. Treasury bills are highly liquid and have a well-developed secondary market where they are traded. They are typically sold at a discount to their face value, and the difference represents the interest earned by the holder upon maturity.
Local Authority/Public Utility Bills: These are debt securities issued by local governments or public utilities to raise funds for various projects or operational needs.
What are certificates of deposit (CD) and commercial papers
Certificates of Deposit (CD): CDs are time deposits offered by banks and financial institutions. The depositor invests a certain amount of money for a fixed period and receives interest on it. CDs can be negotiable or non-negotiable:
Negotiable CD: These CDs are tradeable in the secondary market.
Non-negotiable CD: These CDs cannot be traded and must be held by the depositor until maturity.
Commercial Papers: These are short-term unsecured promissory notes issued by corporations to raise funds for short-term obligations such as payroll and inventory.
Whats LIBOR
LIBOR is the interest rate at which banks offer to lend funds to other banks in the international interbank market. It serves as a benchmark for short-term interest rates globally.
There is a high correlation between LIBOR and the rate of interest prevailing in the Treasury bill market.
LIBOR is usually marginally higher and more volatile than the Treasury bill market.
Whats TED spread
The TED Spread measures the difference between the interest rates on interbank loans and short-term U.S. government debt. It is calculated as the difference between the 3-month LIBOR and the 3-month U.S. Treasury Bill rate. An increase in the TED Spread indicates that lending conditions in the interbank market are tightening and banks are becoming more cautious about lending to each other.
Example: 3 month $ Treasury bill: 4.20%, 3 month $LIBOR: 4.50%
TED Spread=4.5%-4.2%=30 basis points
Increase in the TED is the sign of Funding become more difficult in the interbank market, banks become more distrustful of each other
International Money Market: What is Eurocurrency Market
Borrowers and lenders of funds from different countries.
Eurocurrency Market: This market involves the lending and borrowing of currencies outside their home countries, allowing for international transactions to take place. Since transactions in the Eurocurrency market involve currencies other than the domestic currency of the country where the transaction occurs, it is inherently international in nature. Participants in the Eurocurrency market include banks, corporations, and governments from various countries, making it a significant component of the international money market.
Centres for Eurobank activities: London, Paris, Luxembourg and Frankfurt.
Offshore banking: Bahrain, Bahamas, Cayman Islands, HK, Panama, and Singapore.
Both the Eurocurrency market and offshore banking serve as key components of the international money market, providing avenues for cross-border financing, investment, and currency transactions among participants from different countries.
Eurobanks are generally free of government regulation, i.e., compulsory reserve requirements, interest ceilings or deposit insurance.
Main users: Eurobanks, non-Eurobanks, financial institutions, multinational corporations, international institutions, central and local government
International Money Markets: What are Eurobanks benefits
Accepting Deposits and Making Loans in Foreign Currencies: Eurobanks operate in multiple currencies, allowing them to accept deposits and extend loans in various foreign currencies. This provides flexibility for international transactions and financing.
Freedom from Regulatory Control: Eurobanks often operate in jurisdictions with lenient regulatory frameworks or in offshore financial centers, which may offer them more freedom from regulatory control compared to domestic banks. This flexibility can allow Eurobanks to innovate and adapt more quickly to market changes.
Economies of Scale: Eurobanks can benefit from economies of scale due to their international operations and larger customer base. This enables them to spread their fixed costs over a larger volume of business, potentially reducing their overall cost structure.
Lower Personnel and Administration Costs: Eurobanks may avoid some of the personnel and administrative expenses associated with operating in multiple countries. By centralizing certain functions and leveraging technology, they can streamline their operations and achieve cost efficiencies.
International Competitiveness: Eurobanks compete on a global scale, which fosters a highly competitive environment. This competition can drive innovation, improve services, and offer customers a wider range of financial products and options.
No Deposit Insurance Costs: Unlike domestic banks that may be required to pay for deposit insurance to protect depositors’ funds, Eurobanks operating in certain jurisdictions may not have such obligations. This can reduce their operating costs and potentially increase profitability.
Lending to High-Quality Customers: Eurobanks often focus their lending activities on high-quality borrowers with strong credit profiles. This strategy can help minimize credit risk and enhance the overall quality of their loan portfolio.
Why are we still using domestic banks?
Many still prefer domestic banks over Eurobanks due to lower transaction costs. Domestic banks offer better exchange rates and reduced fees for local transactions compared to Eurobanks, which may charge for cross-border transactions and currency conversions. Dealing with domestic banks is simpler, requiring less documentation and administrative effort. They also benefit from a more straightforward regulatory environment, resulting in lower compliance costs. Customers appreciate the familiarity with local practices, languages, and customer service standards.
International money markets: what are Eurodeposits
Euro deposits are funds held in Eurobanks or other financial institutions in a currency other than the depositor’s domestic currency. Eurobanks facilitate the transfer of surplus funds from depositors to borrowers with financing needs. These deposits allow for international transactions and investments in foreign currencies, providing flexibility for parties involved in cross-border activities. Euro deposits are subject to the regulations of the institutions holding them and are commonly used in international trade and finance.
International money markets: what are Syndicated loans and advantages
A syndicated loan involves a group of banks lending funds to a single borrower, typically with a floating interest rate based on a spread over LIBOR, adjusted every 6 to 12 months to reflect changes in LIBOR. These loans usually have maturities of 3 to 8 years. Syndicated loans offer advantages for both banks and borrowers.
For banks, they provide opportunities to diversify risk by spreading exposure across multiple lenders. For borrowers, syndicated loans allow access to larger sums of money at generally lower costs compared to individual bank loans.
International money markets: What are Euronotes and three distinct types of issuances:
uronotes refer to debt securities denominated in a currency other than the currency of the country where they are issued. These securities are typically issued in the Eurocurrency market, which is a global market for currencies deposited outside their home countries. Euronotes come in various forms, including:
Note-Issuing Facilities (NIFs): These are the original Euro-notes underwritten by syndicates of banks, typically with medium-term durations. NIFs provide medium-term financing options to borrowers through collaborative efforts of multiple banks.
Eurocommercial Paper: This involves short-term borrowing, usually less than 9 months in duration, and is not underwritten by syndicates of banks. Eurocommercial paper offers flexible short-term financing solutions without the involvement of bank syndicates.
Euro Medium-Term Notes (EMTNs): EMTNs have durations above 9 months and less than 10 years. They have gained popularity as an alternative to the traditional bond market, offering medium-term financing options with greater flexibility and diversity in terms of structure and features.
Explain what is meant by a Eurodollar. (Eurocurrency Markets)
A Eurodollar refers to a US dollar-denominated deposit held in a bank outside the United States. It is a type of deposit commonly found in the Eurocurrency markets, which are banking markets conducted outside the jurisdiction of the United States’ regulatory authorities. Eurocurrency markets operate globally and allow for the deposit, lending, and borrowing of currencies outside their home country’s legal jurisdiction.
For example, Eurodollar deposits may be held in financial centers such as London, Paris, Tokyo, or other major international financial hubs. These deposits provide flexibility for individuals and institutions to conduct US dollar-denominated transactions and investments outside the US. Eurodollar deposits are often used for international trade, financing, and investment activities, offering participants opportunities for diversification and access to global financial markets.
Discuss the historical development of the Eurodollar market
The Eurodollar market emerged in the late 1950s due to several key factors. Firstly, the Soviet Union’s accumulation of US dollars led to a reluctance to deposit them in US banks. Secondly, UK banks turned to US dollar business due to restrictions imposed by the Bank of England. Lastly, the abolition of the European Payment Union and the restoration of currency convertibility among European currencies created an environment conducive to the growth of international financial markets, including the Eurodollar market. These developments paved the way for the expansion of the Eurodollar market, providing a platform for global finance outside the jurisdiction of the United States.
what was the extent to which regulation played a role in its development
Subsequently, an important impetus for the rapid growth of theEurodollar was the increased regulation of domestic banking activities by the US authorities
- US banks developed Euro banking activities to circumvent regulations.
- In Dec 1981, the Fed legalized so-called international banking facilities and allowed US banks to conduct Euro banking busies free of US regulations in the USA by maintaining a separate set of books for this business
What are domestic bonds and their specific features
Name: Each bond is issued with a distinct name that identifies it within the market.
Nominal or Par Value: Bonds have a nominal or par value, which is the face value of the bond and the amount repaid at maturity.
Redemption Value: Typically, bonds are redeemed at their nominal value upon maturity. However, some bonds may have alternative redemption values, such as those linked to an index.
Rate of Interest: Bonds pay interest to bondholders, typically at a fixed or variable rate, known as the coupon rate.
Redemption Date: Bonds have a predetermined maturity date, upon which the issuer repays the bond’s principal amount to the bondholder.
Bonds are typically sold through open offers for sale to the public or directly placed with a smaller number of professional investors, a process known as private placement. This allows issuers to tailor bond offerings to specific investor needs and preferences
what are government bonds
Government bonds, also known as sovereign bonds or gilts in the UK, offer several advantages. They typically exhibit high liquidity and lower transaction costs compared to equities and corporate bonds. Additionally, they may receive special tax treatment in some jurisdictions. Trading in government bonds is often restricted to licensed institutions, such as gilt-edged market makers (GEMMs) in the UK, which helps maintain market stability and efficiency. These characteristics make government bonds attractive investment options for both individual and institutional investors seeking safety, liquidity, and potentially favorable tax treatment.
What are index linked gilts
Index-linked gilts, also known as inflation-linked bonds, offer investors protection against inflation by adjusting their interest payments and redemption value based on changes in an inflation index, such as the Retail Price Index (RPI). Unlike traditional bonds that pay a fixed interest rate and have a fixed redemption value, index-linked gilts provide returns that are linked to the rate of inflation. As the RPI or other inflation measures increase, the interest payments and redemption value of index-linked gilts also increase, providing investors with a hedge against the eroding purchasing power of inflation. This feature makes index-linked gilts attractive to investors seeking to preserve the real value of their investments in inflationary environments.
Why do government issue Index-linked Bonds
Attract risk-adverse investors
Monetary policy is more credible
The yield helps the government and others to estimate market views on further inflation.
Local authority/public sector Bonds, Mortgage and Asset-backed Bonds and what are Corporate Bonds
Local authority/public sector bonds are relatively rare in the UK but common in countries like France or Germany.
Mortgage and asset-backed bonds involve bundling mortgages or assets to create securities for investors, turning relatively illiquid assets into tradable securities.
Corporate bonds are issued by companies to investors, with yields influenced by the issuer’s credit rating. These bonds typically mature in 10-20 years and may include call provisions allowing the issuer to redeem them early. Risks associated with corporate bonds include interest rate, reinvestment, inflation, credit, call, and event risks.
what are Domestic bond markets: innovations
Debentures are bonds that provide holders with the legal right to sell company assets if the issuer defaults. They typically offer lower interest rates but provide security against default. However, assets tied up in debentures can lead to lengthy procedures for disposal or replacement.
Convertible bonds allow holders to convert them into shares or other assets at a later date, providing potential for capital appreciation. Exchangeable bonds offer the right to convert into another company’s shares owned by the issuer.
Warrants are options attached to bonds, giving holders the right to buy or sell the security at a specified price. Warrants have longer maturities than other options, offering issuers the potential for capital gain and a cheaper source of finance.
Preference shares are a type of equity security that offers dividends at a fixed percentage rate and typically provides non-voting rights but priority in liquidation proceedings.
Hybrid bonds are quasi-equity instruments rated by agencies, offering characteristics of both debt and equity. They are more expensive for issuers but offer tax deductibility.
Foreign bonds are issued in the domestic currency of a country by foreign entities. Junk bonds are high-risk, high-yield bonds with credit ratings below BBB (Standard & Poor’s) and Baa (Moody’s), enabling high-risk companies to access long-term funds.
International Bond market: What are Eurobonds
Eurobonds are bonds sold by domestic or foreign entities in a currency different from the country where the bond is issued. For example, a dollar bond issued in London is considered a dollar-denominated Eurobond.
These bonds typically have terms ranging from 3 to 25 years, with the majority having maturities under 10 years.
Eurobonds are underwritten by syndicates of banks and sold to investors, with London being the major market for these transactions.
The yield on Eurobonds depends on market conditions and the credit rating of the issuer, making them attractive to a wide range of investors seeking exposure to different currencies and markets.
International bond markets:What are its origins and Development
The Eurobond market originated in 1963 and has experienced substantial growth since the 1980s. The total value of outstanding Eurobonds issued far surpasses that of domestic corporate bonds. Eurobonds offer issuers less stringent regulatory and disclosure requirements compared to domestic markets. Restrictive conditions in the US for foreign entities accessing funds have further contributed to the popularity of Eurobonds. Additionally, financial innovation has enabled issuers to raise finance through various structures to meet their funding needs, further fueling the growth of the Eurobond market.
