L5a- Interbank Markets Flashcards
Interbank Market place
short term liquid instruments are traded
mostly IR pricing (bond)
large-scale markets where players are CREDIT institutions
organised markets that settles its operations via the ECB settlement system (TARGET 2)
function
- allow obtaining price of money via loans that financial entities carry to which each other
(main actor in EU –> central banks) - allow F.E. to manage their treasury surplus efficiently - giving possibility of lending among themselves for a profit
- allow F.E. to cover possible shortfalls n their compliance with liquidity ratios - as they can borrow very ST funds
- allow obtaining financing for active operations (financial leveraging)
- an important indicator of monetary&financial climate of a country - as they are 1st markets to receive the signals given by the monetary authorities to the financial system as a whole
Segments of IBM
- unsecured lending/deposit transaction
- secured transactions (repos, reverse repos)
- foreign exchange swaps (FX swaps)
- overnight index swaps (OIS)
- ST securities issuances
after crisis: secure has increased over nonsecure
- Deposit Market
=unsecured
credit institutions lend money to one another
overnight or for longer F (lss 1 yr)
market is at European level
most operations are overnight (1 day)
Deporate used as reference for many products
–> Eonia
–> Euribor
- Deposit Market
Eonia &Euribor
A) EONIA:
- euro OVERNIGHT index average
- measure of effective IR in euro IB overnight
- calculated as weighed average of IR on UNSECURED overnight lending (trans. in Euros)
- reported by panel of contributing banks
b) EURIBOR:
- Euro INTERBANK OFFER RATE
- IR indicative of euro zone
- main eurozone banks five their daily IR on interbank funds to 1 day &1yr
- not calculated from transaction but info banks sent to ECB just for 11 am
- then remove 15% higher and lower rounding to 3dcp.
- important ate for being BENCHMARK (indicator) for mortgages (12m), FRAS settlement (Euribor term); Corp. loans/credit (3m)
- Deposit Market
unsecured market activity:
- top 5 credit institutions lend 62% and borrowed 30%
- more than half of the market in hands of only 5 credit institutions
GRAPHS:
- Eonia, UK and US 1-d move together
- except end of sample increase in IR of USA
- 1yr Euroibor (negative terms until 2024)
- Deposit Market
Eonia replaced by EuroSTR
Euro Short Term Rate
since 2007 IBM has followed drastic reduction in volume
- excess liquidity (ECB monetary policy)
- new regulatory solvency framework (repos over deposits)
- new counterparty risk calibration after FC
- manipulation of EUribor
Solution: ECB develops new risk-free index
- published daily (overnight rate)
- based on indv. transactions of more than 50 entities (not just banks) - increase power of estimation
- gradual transition: until 2021 EONIA is calculated by applying a fixed spread over ESTR (rather than relying on info by credit inst.)
- spread: 8.5 BSp (margin between land &deposits by institutions)
difference:
- lower rate as it focuses on deposits in general (not only loans of banks)
- diff types of investors (pension funds, inst. invstor as well as banks, as before)
Aim: make euribor more regulated, reliable, coming from actual transaction info, not merely quotes of credit institutions
- FRA Market
forward rate agreement
contract (B/S) on future loan at prev. agreed IR on predetermined quantity and period (maturity)
guaranteed IR in future whether to lend or borrow
obligation contract
FRAs don´t involve actual loans being produced bu simply, (derivatives) parties settle the difference
types:
- variable: maturity set by parties
- fixed: standardised maturity, volume subsequentt trading
- FRA Market
Equation
Buyer of FRA:
L = amount * (IRagreed - IRreal) * time / 1+ IR
T= 3 months = 90/360 (1+IR) = (1+IRactual * time) - simple (less 1yr)
agreed i > real i = buyers pays to seller (positive)
agreed i < real i = buyer receives (negative)
- Repo Market
sale of instruments with agreement to buy them back, similar principle to deposits
loans secured with gov. bonds or another HQ instrument (collateral)
e.g. one party transfers Public debt security to other for short period (<1yr) with repurchase agreement on agreed date
repurchase price = implicit on IR of operation
ECB &BCN only intervene, (not in depo) as collateral demanded when lending funds
- Repo Market
transactions
Settlement day:
dealer (has asset no money) lends collateral and received money from counterparty
End of term:
pay backs money + IR at reporate
and takes back security from counterparty
- Repo Market
Example
Dealer repos 30 mill of treasury bond to bank for 51 days
- market value of collateral = 31,228
- bank takes 2% haircut hence 0.98 * 31,228 = 30,604
- repo rate =5.25%
return: 30,604 * (1+5.25%* 51/360) = 30,831
note: repo rates are simple IR that use an actual/360 calendar
- Repo Market
Hair cut
discount on collaterised transaction
% diff. between an asset MV and amount that can be used as collateral
diff. between this values as market price changes and hence lender needs to accommodate for
haircut decided by ECB can change daily
depends on diff. characteristics of issuer (risk), covenants of bond (Senior, subordinated) or currency
- Swaps Market
Interest Rate Swaps
contract in which 2 parties make commitment to exchange a series of amounts of money or g/S on specific dates in the future
most common: future exchange of IR
regarded a derivative (swap which value depends on the value of the asset)
Example:
taking comparative advantage on IR: fixed-floating
- LIBOR SWAP
Overnight index swap
IR swap where periodic floating rate of swap
= geometric average of an overnight index (published IR) over very day of payment period
(.g. ref: Eonia, Sonia)
index IR considered less risky than corresponding LIBOR
OIS (in US) are calculated by reference to daily Federal Funds Rate
OIS rates (spec. diff. in spread between OIS and LIBOR rates) = important measure of RISK &LIQUIDITY in MM the higher spread-worst liquidity
