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PowerPoint Presentation Organisational and Administrative Management for Banking BSF 414 1 2 Week 7: Short-term Debt Markets, Money Markets & Foreign Exchange Markets 3 7.1 Introduction to Short-term Debt Markets 7.2 Money Markets 7.3 Credit Ratings 7.4 Foreign Exchange Markets Week 7 4 7.1 Introduction to Short-term Debt Markets Remember: Banks dominate the debt markets: • They borrow (to on-lend) • Place surplus cash to earn returns • Act as brokers for clients’ trades • Act as market makers • Engage in Proprietary Trading Money Markets: 1 year or less Debt Markets: > 1 year 5 7.2 Money Markets • Negotiable Instruments • Sold at discount to par (except CDs & interbank deposits, which are issued at par) • Effective interest rate for lending • Yield is difference between what you pay & what you get at maturity • Discount and Yield (rate of return) depends on: • Maturity • Risk of instrument • Participants: banks, governments, corporations, institutions (e.g. pension funds, who need low risk liquidity for a percentage of their funds), Central Banks (OMOs) 6 7.2 Money Markets • Electronic dealing; some private dealing with central clearing • Very liquid • T-Bills: raises money for governments • Negotiable, easily traded • “risk-free” • Money Market Funds: • Administered by banks • Returns linked to underlying investments & instruments in fund • Spare cash of corporates put to work in money market funds (sweeping/cash management) 7 7.2 Money Markets Source: Trustnet.com 8 7.2 Money Markets Source: Trustnet.com 9 Source: Trustnet.com, Fund Factsheet 7.2 Money Markets 10 7.2 Money Markets Source: Morningstar 11 7.2 Money Markets Bonds – long-dated version of money markets; we will see more on this next week but: • Raising money for governments or corporates • Negotiable, easily traded • Coupons annual/semi-annual • Sovereign bonds = “risk free” – different governments rated differently (see credit ratings later) • Maturity: classified according to time remaining to maturity (not from date of issue) shorts < 7="" years="" mediums="" 7-15="" years="" longs=""> 15 years 12 7.3 Credit Ratings Specialist organisations that assign credit ratings, rating a borrower’s ability to repay debt & the likelihood of default • Depends on likelihood of payment of both interest & capital • Debt not being repaid at all • Recoverability of debt • Rate both long-term & short-term debt Who pays for the rating report? Role of agencies during 2007-8 crisis: many securities that were highly rated downgraded to junk overnight 13 7.3 Credit Ratings Source: Moody’s Where have you seen a similar procedural approach? 14 7.3 Credit Ratings What do rating agencies look for? • Ratio of assets to liabilities • Outstanding debt • Cash Flow generation • Quality of management • Competitive Position • Vulnerability to economic cycle Quantitative Qualitative 15 7.3 Credit Ratings Investment Grade Non-investment Grade 16 7.3 Credit Ratings Downgrade: • High leverage • Weak FCF generation • Reputational Risk 17 7.3 Credit Ratings Fitch Ratings-London-15 April 2019: Banks in several 'AAA' rated countries face rising risk from the household sector amid a build-up of financial imbalances, Fitch Ratings says in a new report. In Australia, Canada, Norway and Sweden, high household debt amid slowing housing markets represent a growing risk to banks in those countries, which are among the world's most exposed to residential mortgage lending. The major banks also have, to varying degrees, a reliance on wholesale funding, which can increase their vulnerabilities during a market stress. Source: Fitchratings.com 18 7.3 Credit Ratings 19 7.3 Credit Ratings 20 7.3 Credit Ratings Source: countryeconomy.com 21 7.4 Foreign Exchange Markets One currency exchanged for another, the rate determined by supply and demand • Developed in response to international trade • Banks do most of FX trading • USD dominant currency • >$4’000bn traded daily, London an important centre • 24-hour trading • OTC, not regulated on-exchange • FX trading now on apps/tablets • Degree of self-regulation (mostly “run” by banks) 22 7.4 Foreign Exchange Markets Buyers & Sellers of FX Commercial Companies: Import/Export Brokers buying/selling FX on Clients’ behalf Tourists & Investors needing to pay in foreign currency Source: FT Banking, Fig 23.4 International banks carrying out Proprietary Trading Governments needing FX for overseas trade Fund mangers investing abroad Central Banks managing rate to desired level Speculators & Arbitrageurs Dealers trading & acting as Market Makers 23 7.4 Foreign Exchange Markets • Single transaction • Current price • Settlement T + 2 SPOT FORWARD SWAPS • Single deal with 2 parts: • 1 – actual exchange of 2 currencies on specific date at agreed rate (spot or fwd) • 2 – reverse exchange of same currencies at date further in future than agreed today • Agree rate today, delivery later (as agreed) i.e. fix rate • FX futures are similar, but standardised as traded on-exchangeFwds & Swaps used to: • Balance FX positions • Reduce risk • Earn higher returns 24 7.4 Foreign Exchange Markets Exchange Rates – Price of Base Currency expressed in terms of another (the counter) e.g. $1.51/£1 • Smallest variation “pip” = 0.0001 of one unit of currency • Bid rate: rate at which you buy base currency • Offer rate: rate at which you sell base currency • Spread = difference e.g. $/£ 1.5137 - 1.5141 25 7.4 Foreign Exchange Markets FX Volatility: • Rates change constantly • Income to be received from abroad • Valuation of foreign assets & liabilities • Long-term viability of operations in certain countries • Accept/reject overseas investments or projects • i.e. Changes in FX can affect viability & go/no-go decisions FX Risk – manage through forwards, hedging (borrow funds in money markets), currency option hedges (calls & puts – banks often write options for pm) 26 7.4 Foreign Exchange Markets Source: UBS (24.04.2019) 27 7.4 Foreign Exchange Markets Source: UBS (24.04.2019) 28 7.4 Foreign Exchange Markets Source: UBS (24.04.2019) 29 7.4 Foreign Exchange Markets Source: UBS (24.04.2019) 30 Week 8: Stock Markets & Securities Markets, Proprietary Trading See you next week! PowerPoint Presentation Organisational and Administrative Management for Banking BSF 414 1 2 Week 8: Stock Markets & Securities Exchanges; Proprietary Trading 3 8.1 Introduction: What & How Banks Trade 8.2 Fixed Income 8.3 Equities 8.4 Asset Management 8.5 Prime Brokerage Week 8 4 8.1 Introduction: What & how Banks Trade Remember: PRIMARY MARKETS • Users of funds (governments, companies) raise funds by issuing financial instruments e.g. shares (stocks) & bonds • New Issue of securities e.g. IPO • Exchange of funds for financial claim • Funds for borrower, IOU for lender SECONDARY MARKETS • Markets where financial instruments are traded among investors • Trading/dealing for previously issued shares, bonds, derivatives, commodities, currencies • No new funds for issuer • Provides liquidity for seller 5 8.1 Introduction: What & how Banks Trade BROKER • Act on Clients’ behalf (retail & wholesale clients) • Corporate Broking arm of Investment Bank acts for company, advising on market conditions, rules & regulations for listed companies, manage process for any new issues (gauge demand, pricing, underwriting etc) • Long-term relationship banking PROPRIETARY TRADING • “Own account” dealing • Use bank’s capital to generate trading income (realised & unrealised gains) • 1990s – 2010 huge growth in prop trading, banks made huge (risky) bets on trades • New rules post crisis (e.g. Volker Rule Dodd-Frank Act) to prevent domino-like collapse of other banks when one reneged on its obligations i.e. prevent systematic risk MARKET MAKER • Dealers, who agree to always provide price at which to buy/sell i.e. facilitate trade, provide liquidity • Quote-driven systems, dealers always ready to trade • Bid < offer,="" thus="" dealer="" always="" makes="" a="" profit="" •="" risk="" –="" dealers="" must="" always="" hold="" inventories="" of="" securities,="" thus="" often="" engage="" in="" stock="" borrowing="" •="" strict="" rules="" to="" prevent="" price="" manipulation="" 6="" 8.1="" introduction:="" what="" &="" how="" banks="" trade="" what="" about="" ethics,="" legal="" issues="" and="" conflicts="" of="" interest?="" source:="" r-bloggers.com="" 7="" 8.1="" introduction:="" what="" &="" how="" banks="" trade="" what="" about="" ethics,="" legal="" issues="" and="" conflicts="" of="" interest?="" 8="" 8.2="" fixed="" income="" focus="" tends="" to="" be="" broking="" &="" market="" making="" (sales="" &="" trading),="" rather="" than="" prop="" trading="" bonds="" –="" long-dated="" version="" of="" money="" markets="" •="" raising="" money="" for="" governments="" or="" corporates="" •="" negotiable,="" easily="" traded="" •="" coupons="" annual/semi-annual="" •="" sovereign="" bonds="“risk" free”="" –="" different="" governments="" rated="" differently="" (see="" credit="" ratings="" later)="" •="" maturity:="" classified="" according="" to="" time="" remaining="" to="" maturity="" shorts="">< 7="" years="" mediums="" 7-15="" years="" longs=""> 15 years Not from date of issue 9 8.2 Fixed Income What do rating agencies look for? • Ratio of assets to liabilities • Outstanding debt • Cash Flow generation • Quality of management • Competitive Position • Vulnerability to economic cycle Quantitative Qualitative 10 8.2 Fixed Income Investment Grade Non-investment Grade 11 8.2 Fixed Income “The 10-year Treasury closed at 2.50% on Friday while the 2-year note closed at 2.29%. Longer- term Treasury yields are being pulled by action in the German and Japanese bond markets, where 10-year bunds close at - 0.02%, while 10-year JGBs closed at -0.03%. There simply isn't enough yield in key global bond markets, so multinational financial companies end up in the U.S. Treasury market.” Source: Ivan Martchev, 30.04.2019 12 8.2 Fixed Income Source: countryeconomy. com 13 8.2 Fixed Income Types of Corporate Debt: BONDS Higher risk/return than government debt Some listed, but majority OTC (investor deals directly with bond dealer) Coupon: annual/semi-annual, fixed/floating/variable rate/ Index-linked DEBENTURES DEEPLY DISCOUNTED & ZERO COUPON BONDS Very secure bond, with fixed/floating charge over co’s assets i.e. company free to use assets, default event triggers crystallisation of charge over assets. Receiver appointed to dispose of assets & distribute proceeds to creditors Good for borrowers with low Cash Flows in near-term e.g. property development where maturity (& CFs) some distance in future 14 8.2 Fixed Income Types of Corporate Debt: HIGH YIELD “junk” < bbb – or lower, subordinate intermediate or low grade thus very high risk (but potentially high reward) can come with equity kicker e.g. warrants or share options (hybrid finance) convertibles pay coupon but bbb="" –="" or="" lower,="" subordinate="" intermediate="" or="" low="" grade="" thus="" very="" high="" risk="" (but="" potentially="" high="" reward)="" can="" come="" with="" equity="" kicker="" e.g.="" warrants="" or="" share="" options="" (hybrid="" finance)="" convertibles="" pay="" coupon="">