Financial Markets

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Bond and Currency Markets
A bond is an instrument that typically carries a specific rate of interest (called ‘Coupon’) that the issuer agrees to pay the bond holder; as well as a promise to repay the principal on maturity. The bond market is largely an institutional market, with limited retail (individual) participation. Central Government bonds constitute the major bulk of the bonds issued and traded in these markets. We also have state government bonds and bonds issued by companies, which are called corporate bonds. The participants in the bond market are: a) b) c) d) e) Government and Corporations: They are the issuers of bonds, to raise money. Commercial Banks: They are the main subscribers to the bond issues. They purchase bonds for their own books (trading) or on behalf of clients. Investment Managers and Mutual Funds: They manage the wealth of corporations and individuals and are also subscribers to these bond issues, on their clients’ behalf. Depository & Clearing Corporation: They perform a role similar to that in stock markets, of facilitating the trades. Regulators: RBI regulates the bond market in India.

Bond Pricing
The price of a bond at any point of time, is the present value of all its future cash flows. Bond prices change due to various factors affecting demand and supply (interest rates, time to maturity, etc.). There are two steps to calculate pricing of a bond: Step 1: determine the cash flows on the bond. Step 2: find the present value of each of future cash flows. Bond Price = c / (1 + r /m )^m*t where c= coupon or cash flows, r= Yield in the market, m= number of times compounding happens in a year, t= time period in years As the yield in the market changes, the price changes inversely. Bonds are valued by ‘Marking to Market’. If a bond is purchased at say 101, end of day if the yield has changed, find the new price using the new yield. The difference between the purchase price and new market price gives the notional profit/loss at that point.

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When the market says “I buy”. 2010. An exchange rate involves two currencies: a) b) Base or fixed currency rate: which is the currency being priced. Exporters need to sell the foreign currency they receive for their exports. Money market instruments are very shortterm instruments. The bid rate will be lower than the offer rate. Importers need to buy foreign currency to pay for their imports.Financial Markets A QUALITY E-LEARNING PROGRAM BY WWW. they are selling the base currency in the currency pair.LEARNWITHFLIP. if there are two quotes available: one of INR-USD and other is USD-JPY. since the maximum business transactions are carried out in these currencies. Euro (EUR) and Japanese Yen (JPY) and Swiss Franc (CHF) are the most traded currencies worldwide. like bonds. Exchange rates are always quoted on a two-way basis: a) b) Bid rate: The rate at which the bank is willing to buy the base currency Offer rate: The rate at which the bank is willing to sell the base currency. Please do not misuse! . Money market instruments are part of the of fixed income or debt category instruments. Proprietary content. Ltd. ©Finitiatives Learning India Pvt. they have bought the base currency in the currency pair. Currency trading is conducted in the Over-The-Counter (OTC) market. unlike bonds and debentures. Foreign Exchange Rates Foreign exchange rates express the value of one currency in terms of another. that is. then a cross rate of INR-JPY can be computed. Exchange rates are typically quoted in the market against the US dollar (USD). Banks/institutions play the role of authorized dealers in these markets. via a third currency. Quoted or variable currency rate: the currency used to express the price. British Pound Sterling (GBP). Cross rates can be computed by taking their respective exchange rates against the USD. A unique feature of the currency market is that it is a 24 hour market. (FLIP). directly between the dealers.COM Money Market The money market is one where money market instruments are traded. When they say “I sell”. For example. US Dollar (USD). Foreign Exchange Markets Foreign exchange markets are markets where foreign currencies are bought and sold. Cross Rates A cross rate is a foreign exchange rate between two currencies.

two working days from the date of the transaction.000 INR 100. and Tom transactions: settle the next working day. Trading Position = Total Purchases .700.Total Sales.60 and sells it at INR 47. ©Finitiatives Learning India Pvt.LEARNWITHFLIP. 2010. Cash transactions: settle on the same day. Cash and Tom transactions are also called short dated transactions.COM Types of Exchange Rates Exchange rates are classified as a) b) c) d) Spot transactions: those that settle. Proprietary content. Forward transaction: any transaction beyond the spot date.70.INR 47. (FLIP). Please do not misuse! .000 +INR 47.000 The position is expressed in terms of the base currency and the profit is expressed in terms of the quoted currency in a currency pair. (regardless of maturity) Valuation of currencies How are currencies valued? Let us say a bank buys USD 1 mio at INR 47. Trading Position This denotes the size of holding in each currency pair and is expressed in terms of the base currency.600. Ltd.Financial Markets A QUALITY E-LEARNING PROGRAM BY WWW. What is the profit or loss? It is calculated as follows BUY USD 1 mio = SELL USD 1 mio = _________ PROFIT .

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