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Money Markets PDF
Money Markets PDF
Debt Markets
• Money markets are a key segment of the debt
market
• Why do we have debt markets?
– So that those in need of funds can interact with
those who have a surplus
Introduction
Introduction
• All debt markets have a common feature
On one hand we have On the other hand we have
parties ready to borrow by parties willing to lend in the
issuing securities process of acquiring
securities
needs
3
1
Introduction
Purpose of borrowing
• The purpose for which money is borrowed
differs from
– borrower‐to‐borrower
– transaction‐to‐transaction
1. A corporation may issue long term bonds to
finance the construction of a building
2. It may issue short‐term promissory notes to fund
the acquisition of raw materials.
4
Introduction
Types of financial assets
• Money is borrowed to create different
kinds of financial assets with
– different maturities
– different risk profiles
– different size
Introduction
Term to maturity
• Loans in the money market have an original
term to maturity of <1 year
Original term to Actual term to maturity
maturity
The OTM of a security is its The ATM is the current term
term to maturity at the time to maturity of the security
of issue
It cannot change once a It will keep declining with
security is issued the passage of time
2
Introduction
Money Markets
• Money market securities have to be debt
securities
– Since equity shares have no maturity date.
• Money market consists of transactions to
meet short‐term cash needs
– Meant for current account, not for capital account
• It is a mechanism by which holders of
‘temporary cash surpluses’ interact with those
with ‘temporary cash deficits’
– The nature of transactions range from overnight to
1 year
7
Introduction
Why?
• Why do we need money markets?
– For most individuals / institutions inflows &
outflows of cash will rarely match.
– Inflows may happen at a time different from
when outflows are required to be met
Introduction
Why the attention?
• Why are we so concerned about short‐term
transactions?
– Money is an extremely perishable commodity
– When idle cash is not invested there is an
opportunity cost ‐ interest income is foregone
– Income that is lost is lost forever
– When large amounts are involved, the lost
income even a day can be substantial
9
3
Introduction
Example
• A firm has 12MM dollars available overnight.
• Assume interest rate @ 3.60% p.a.
• Assume the year has 360 days
– A common assumption in many money markets
• If money is kept idle overnight the lost income
will be:
12,000,000 x 0.036 x (1/360) = $1,200
• If the money were to remain idle for a week
the income foregone will be $8,400
10
Analogies
• We can give similar examples from the travel
and hotel industries
– If the New York Hilton has 20 unoccupied rooms
on a day the revenue is lost forever
• You cannot put two guests in a room on a subsequent
night
– If British Airways were to fly from New York to
London with 10 empty seats
– The income is lost forever
• We cannot put 2 people per seat on a subsequent flight
11
Introduction
Borrowers & Lenders
• It is very difficult to classify an economic entity
as a borrower or a lender.
– The same institutions frequently operate on both
sides of the market
• E.g. Citibank
Borrower Lender
It will borrow regularly in At the same time it will be
the money market by way making short term loans to
of Certificates of Deposit, corporate borrowers
borrowings of Federal
Funds etc. 12
4
Introduction
What do investors want?
• Investors in the market primarily seek
– Safety and liquidity
– An opportunity to earn some extra income
• Liquidity is paramount because participants
may seek to enter and exit in an unanticipated
fashion.
13
Introduction
Central Banks
• The market is overseen by the Federal Reserve Bank in the
U.S. and by the central banks of other countries. These
are:
– U.K. – Bank of England
– Canada – The Bank of Canada
– Switzerland – The Swiss National Bank
– Japan – Bank of Japan
– Europe – European central bank
– Germany – Bundesbank
– Australia – Reserve Bank of Australia
– India – Reserve Bank of India
14
Introduction
Features (Cont…)
• There is no central trading arena.
– It is a market connected by telephones and
computers
– Speed is of the essence since money is perishable.
– Transactions are conducted in a matter of seconds
and payments are made instantaneously
15
5
Key Dates in Cash Market
Instruments
16
Key Dates
Key Dates
• Transaction date
• Value date
• Maturity Date
17
Key Dates
Transaction Date
• Date on which terms and conditions of a
financial instrument are agreed upon
– Date on which parties enter into a contract
• Also known as Trade date, Dealing date, Done
date
18
6
Key Dates
Value Date
• Date on which instrument starts to earn or
accrue a return
• This date may/may not be same as transaction
date
19
Key Dates
Types of Value Dates
Value Date
20
Key Dates
Maturity Date
• The date on which the instrument ceases to
accrue a return
• Maturity date is often not a date
– It is a term to maturity which is a whole number of
weeks/months after the value date
• Date of maturity normally follows two
conventions
– The Modified Following Business Day Convention
– The End/End Rule
21
7
The Modified Following Business Day
Convention
• This convention consists of the following three
rules
– 1. Maturity is set for the same date as the value
date
• If the value date is 21 March
– The one month maturity will be 21 April
– The two month maturity will be 21 May
– 2. If the maturity as per rule 1 is a non‐business
day, then it is moved to the following business day
22
Modified…(Cont…)
– 3. If the following business day according to rule 2
falls in the next calendar month
• Then the maturity date is moved back to the last
business day of the calendar month.
23
Illustration
• Consider a 3‐M deposit with a value date of 21
June 20XX
• The maturity date should be 21 September
20XX
• But if 21 September is a Sunday
– The maturity date will be Monday 22 September
– Assuming it is not a holiday
24
8
Illustration‐2
• A 1‐M deposit was made on 31 July 20XX
• The maturity date will be 31 August 20XX
• If 31 August is a Sunday
– Then the maturity will be fixed for Friday 29
August
25
The End/End Rule
• If the value date is the last business day of the
current calendar month
– Then the maturity date will be the last business
day of the relevant calendar month.
• Consider a one month deposit with a value
date of 31 May.
– It will mature on 30 June if it is a business day.
• Consider a one month deposit with a value
date of 30 June
– It will mature on 31 July if it is a business day
26
The End/End Rule (Cont…)
• Consider a one month deposit with a value date
of 31 January
– It will mature on 28 or 29 February
• Consider a one month deposit with a value date
of 28 or 29 February
– It will mature on 31 March
• If the maturity date as per this rule were to be a
holiday then
– The modified following business day convention
would apply.
27
9
Other Roll Conventions
• If the expected interest payment date is a holiday
then the payment must be rolled to a good
business day
• Rules or guidelines on when the interest is paid
are referred to as `Roll Conventions’
• We have already seen the Modified Following
Business Day Convention
– Other conventions are
– The Following Business Day Convention
Preceding Business Day Convention
28
Roll Conventions (Cont…)
• The following business day convention states that
if the payment date is a holiday then the
payment is postponed to the next business day
– Even if it were to fall in the next calendar month
• The preceding business day convention states
that if the payment date is a holiday then the
payment is brought forward to the preceding
business day
29
Roll Conventions
Illustration‐1 (Cont…)
• Assume that the payment due date is 25
November which is a Sunday
– In the following business day convention it will be
postponed to 26 November
– The same holds true for the modified following
business day convention
– If the preceding business day convention is
applied then the maturity date will be 23
November (Friday)
30
10
Roll Conventions
Illustration‐2 (Cont…)
• Assume the maturity date is 31 August which
is a Sunday
– As per the modified following business day
convention payment will be made on 29 August
(Friday)
– As per the following business day convention it
will be on 1 September (Monday)
– As per the preceding business day convention it
will be on 29 August (Friday)
31
Interbank Market
32
Interbank Mkt
Interbank Market
• It is a market for large or wholesale loans
and deposits
• It is an arena for transactions between
commercial banks
• Borrowing / lending is for periods <= 12
months
• Participants
– Commercial banks
– Insurance companies
– Pension funds
33
11
Interbank Mkt
Need for Interbank Market
• All commercial banks are required to
maintain an account with the central bank
• Banks with surplus lend to banks with
deficit
– The lending bank earns some interest
– The bank with a deficit covers its deficit
34
Interbank Mkt
Types of Loans
1. Overnight money: Money lent on a given day
is scheduled to be repaid on next banking day
2. Day to Day money: The deposit is for an
unspecified time. Funds can be called back at
any time and will be repaid on same day
– Also called ‘money at call’
35
Interbank Mkt
Types of Loans
3. Notice money: Money lent with a short
notice of withdrawal
– E.g. 2 days or 7 days notice
4. Fixed money: Money lent for a fixed period
– E.g. 1 week or 1 month
5. Intra day money: Money lent and repaid on
same day
36
12
Interbank Mkt
LIBOR
• LIBOR London Interbank Offer Rate
• Rate at which bank with high credit rating is prepared to lend
to a similar bank
• LIBOR is quoted for different tenors
• Each bank quotes its own indicative LIBOR rate
37
Interbank Mkt
ICE LIBOR
• ICE Inter‐Continental Exchange
• It is the most widely used benchmark for
short term interest rates
• ICE maintains a panel of banks
– For the US Dollar there are 18 banks
• These banks submit rates which are then
combined
38
ICE LIBOR is Provided for 5 Currencies
• USD
• GBP
• EUR
• JPY
• CHF
39
13
Interbank Mkt
LIBID
• LIBID London Interbank Bid Rate
• It is rate at which a London bank with good
credit rating will pay on funds deposited with
it by another top rated bank
• LIBID is quoted for different tenors
40
Interbank Mkt
EURIBOR
• It is a benchmark rate used by international
market for the Euro
– Produced by European Banking Federation –
Brussels
• Euribor is reported at 11 a.m. Brussels time
everday
– The rates are spot rates
– Interest is computed on Actual/360 basis
– Maturities are 1‐w; 2‐w; 1‐m; 2‐m; 3‐m; 6‐m;
9‐m; 12‐m
41
Interest Computation Methods
• For inter‐bank loans and some money market
securities – interest is paid on the principal value
of the instrument
– It is paid at the end of the loan period along with the
principal
• However securities like T‐bills and commercial
paper are discount securities
– They are issued at a discount to the principal and pay
the principal at maturity
– They are analogous to ZCBs
42
14
Interest (Cont…)
• For inter‐bank loans interest is computed and
paid with the principal
• The method of computation depends on the
currency
– For most currencies including USD and EUR an
ACT/360 method is used
– For the GBP an ACT/365 convention is used
– The Indian market uses an ACT/365 convention
43
Interbank Mkt
Calculating Interest
• Interest payable on assumption of a 360 day
year
P x (r/100) x (T/360)
P Principal
T No. of days
r Rate of interest
44
Illustration‐1
• A bank makes a loan of 10MM Euros from 15
July – 15 October
– Interest rate is 5.75% per annum
– # of days = 16+31+30+15 = 92
• Interest = (10,000,000 x 5.75 x 92)/(100 x 360)
= EUR 146,944.44
45
15
Interbank Mkt
Illustration‐2
• Bank makes a loan = $7.5 MM
• Period: 1 year (365 days)
• Interest rate = 5.25% p.a.
Interest = $7,500,000 x (5.25/100) x (365/360)
= $ 399,218.75
46
Illustration‐3
• A bank makes a loan of GBP 7.5MM for 180
days at 4.95% per annum
• Interest
= GBP (7,500,000 x 4.95 x 180)/ (100 x 365)
= GBP 183,082.19
47
T‐Bills
48
16
T-Bills
Treasury Bills
• Purchases / Sales of T‐bills often represent
the largest volume of daily transactions in the
money market.
– Interest rates on such bills are the benchmark for
all other money market rates.
• What are the important features of T‐bills?
a. Zero default risk
b. Ready marketability
c. High liquidity
49
T-Bills
Regular Series Bills
• Regular series bills are issued routinely every
week or month by way of competitive
auctions.
– 4‐week, 3 and 6 month bills are issued every week
– 1 year bills are issued every month
• Of the above maturities 6 month bills provide
the maximum revenue for the Treasury.
50
T-Bills
Irregular Series Bills
• Irregular series bills are issued only when
the Treasury has a special need
– Cash management bills are issued when the
Treasury has a special need for funds
– They have maturities ranging from a few days
to as long as 6 months
– They offer flexibility for they can be issued as
and when required
51
17
T-Bills
On / Off the run securities
On the run securities Off the run securities
Newly issued securities for Securities for the same
a given maturity maturity that were issued
earlier
E.g. a 3 month bill issued E.g. a 2 year note issued
recently 21 months ago
Have 3 months to maturity, Have 3 months to maturity
but are more liquid but are less liquid
52
T-Bills
On‐the‐run bills more liquid
• Why are on‐the‐run bills more liquid?
– For a short period after issue, securities tend to
be very actively traded
– Thereafter, most securities pass into the hands
of investors who are quite content to hold
them till maturity.
– Thus compared to on‐the‐run securities, off‐
the‐run securities tend to be less liquid.
53
T-Bills - Yields
Yields
• The quoted yield for T‐bills is a discount
yield.
– DR quoted discount rate
– Tm number of days till maturity
54
18
T-Bills - Yields
Example 1
• Assume that a T‐bill with
– Face value = $100
– 90 days to maturity
– Selling price = $97.50
T-Bills - Yields
Example (Cont…)
• In the market the price will not be quoted
as 97.50
– The dealer will quote the yields as 10%
– An investor must use the yield to calculate the
price.
56
T-Bills - Yields
Example – Investment Rate
• Rate of return for an investor who buys a bill at a discount
rate of DR will always be higher than the quoted yield
Investment rate
IR = Face Value – Price 365
________________ x ____
Price Tm
57
19
Example (Cont…)
• A bill with 90 days to maturity has a face value
of $1,000,000
• The quoted yield is 4.80%
• D = $12,000
• Price = $988,000
58
Example (Cont…)
• A 364 day bill has been issued at a yield of
5.4%
• D = $54,600
• P = $945,400
59
Holding Period Return
• A bill is bought at a rate d1 with Tm1 days left
to maturity and sold at a rate d2 with Tm2
days left to maturity
60
20
HPR (Cont…)
• A bill with 180 days to maturity is bought at a
yield of 6%
• It is sold after 30 days at 5.80%
61
Dealer Positions
Funding of Dealer Positions
• Government security dealers supply a large
volume of securities to the market
– They depend heavily on the money market for
borrowed funds
– Most dealers invest very little of their own equity
– Ratios of security portfolios held to owners’ capital
of even 40:1 are common.
– The bulk of their operating capital is borrowed
from banks and other financial institutions.
62
Dealer Positions
Sources of Dealer Funds
Repurchase
Demand loans from
agreements
banks
with banks / lenders
63
21
Dealer Positions
Demand Loans
• Every major bank posts rates at which it is
willing to make short‐term loans to dealers.
• Generally two rates are quoted
– One for new loans
– A lower rate for the renewal of existing loans
• A demand loan may be called at any time.
• Such loans are virtually riskless because they
are usually collateralized by U.S. government
securities.
64
Repurchase agreements
65
Repurchase Agreements
Repos
Repurchase agreements are an increasingly
popular alternative to demand loans.
They represent a temporary extension of
credit collateralized by marketable securities
22
Repurchase Agreements
Value of Collateral
• The interest rate of repos is closely linked to
other money market rates.
• Usually the collateral is valued at the current
market price plus accrued interest less a small
discount called a Haircut to reduce the
lender’s exposure to market risk.
– The longer the term of the repo, and the riskier
and less liquid the security that is pledged, the
larger will be the Haircut.
67
Repurchase Agreements
Value of Collateral
• Repos are periodically market to market.
– If the price of the collateral has declined the
borrower may need to pledge additional
collateral.
68
Repurchase Agreements
Example of Repo ‐ 1
• A party has made an overnight loan of $100
MM to a dealer at 7.2%
• Thus the interest payable the next day is:
$(100,000,000 x 0.072 x (1/360)) = $20,000
69
23
Repurchase Agreements
Illustration ‐ 2
• A dealer wishes to borrow by pledging
securities worth $5MM
• Market price is 100‐05
• Accrued interest is $2.50
• Dirty price is $5,132,812.50
• Repo interest rate is 4.80%
• Tenor is 45days
• Amount payable at maturity is $5,163,609.375
70
Repurchase Agreements
Illustration ‐ 2 (Cont…)
• During these 45 days there will be fluctuations
in the value of the collateral.
• These must be regularly monitored to ensure
adequate collateralization.
– Most repos are collateralized by government
securities.
– Sometimes other money market instruments like
commercial paper and BAs may be used. 71
Repurchase Agreements
Credit Risk
• In practice both borrower and lender are
subject to credit risk
• There is no strategy which will reduce the
risk for both the parties.
– Increasing protection for one means enhanced
risk for the other.
72
24
Repurchase Agreements
Credit Risk
Interest rates rise Interest rates decline
If interest rates rise If interest rates decline,
sharply, the value of the the value of the collateral
collateral will decline and will rise.
the lender will be
vulnerable
In this case, if the If the lender goes
borrower were to go bankrupt, the borrower will
bankrupt, the lender will be left with an amount that
be left with assets which is less than the market
may be worth less than the value of the securities.
loan amount.
73
Repurchase Agreements
Margins
• The lender can ask for margin.
– i.e. he can lend less than the market value of
the assets.
– This will increase the risk for the borrower
• The borrower can ask for reverse margin.
– i.e. he can ask the lender to lend more than
the market value of the securities.
– This will increase the risk for the lender
74
Repurchase Agreements
Margins (Cont…)
• In practice it is the lenders who receive
margins.
– This is because they are parting with cash
which is the more liquid of the two assets.
• Thus the market value of the collateral will
exceed the loan amount.
– The excess is called a ‘Haircut’
75
25
Motivation for Repos
• A dealer acquires a bond from a client and is
unable to sell it by EOD.
• Since trading is over he needs to arrange for
funds since the client has to be paid on the
following day
• Consequently he needs to borrow funds.
– This is the typical sequence that leads to a Repo
76
Repurchase Agreements
Reverse Repo
• Such transactions offer a convenient route for
lenders to park excess funds for short periods.
• From the perspective of the lender such an
arrangement is called a reverse repurchase
agreement or a reverse repo.
– Thus every repo must be matched by a reverse
repo.
– A dealer looking to borrow funds will do a repo.
– A dealer looking to place funds will do a reverse
repo.
77
Repurchase Agreements
Rates
• General collateral rate Most government
securities can be bought at a rate called the
general collateral rate.
– Thus most securities are close substitutes for each
other.
• Special repo rates Sometimes a security
may be in high demand and the lender may
charge a lower rate.
– Such rates are called special repo rates.
78
26
Repurchase Agreements
Repos (Cont…)
• To promote a smoothly functioning market
the Federal Reserve frequently participates
in repos with primary dealers.
– It may buy securities on a short‐term basis and
then sell them back
– It may sell securities with an agreement to buy
back
79
Repurchase Agreements
Repos (Cont…)
• By selling securities to dealers the central
banks temporarily absorbs dealer funds and
reduces the ability of the dealers’ banks to
make loans.
• Thus while dealers use repos to increase their
earnings from trading, the central banks uses
them to steady the money market.
80
Negotiable CDs
81
27
Nego CDs
What is a CD?
• It is an interest bearing receipt for funds left with a depository
institution for short periods of time.
• The minimum maturity as per U.S. law is 7 days.
• There is no maximum limit.
• Most CDs are issued at par and pay interest explicitly.
– They are not discount instruments.
– Payment is made in Fed Funds on the day of maturity.
– There also exist discount CDs that are similar to T‐bills in structure
82
Nego CDs
True Money Market CDs
• True money market CDs are negotiable
instruments that can be resold before
maturity
– The round lot for trading is $1,000,000
– They may be registered on the books of the
issuing banks or else may be issued in bearer
form.
• CDs issued in bearer form are more convenient for
resale.
83
Nego CDs
Non‐negotiable Time Deposits vs. Negotiable CDs
28
Nego CDs
Calculations
• Consider a CD with a face value of V.
• The funds owed on maturity is given by:
V + Tm
____ x V x c
360
where:
Tm original term to maturity
c interest rate
85
Nego CDs
Example
• A firm purchases a $100,000 CD
• Duration = 6 months
• Interest rate @ 7.5%
• It would receive:
$100,000 x {1 + (0.075 x 180/360)} = $103,750
86
Yields (Cont…)
• Quoted yields are on a simple interest basis
• Let N be # of days from issue to maturity
• Tm be # of days from settlement to maturity
• c is the coupon rate
• y is the quoted yield
• V is the face value
• P is the dirty price
87
29
Yields (Cont…)
88
Example
• Original term to maturity is 180 days
• Face value is 1,000,000
• Coupon rate is 4.80%
• Current term to maturity is 144 days
• Quoted price is 1,000,000
• Maturity value = $1,024,000
89
Example (Cont…)
90
30
Yields (Cont…)
• If we are given the yield we can compute the
price
• The expression for the price is given by
91
Price
• Original term to maturity = 180 days
• Face value = 1,000,000
• Coupon = 5.20%
• Term to maturity = 108 days
• Quoted yield = 5.60%
• What is the dirty price?
92
Price (Cont…)
93
31
Price (Cont…)
• Price can be decomposed into clean price plus
accrued interest
• AI = V * c * (N‐Tm)/360
• In our example
• AI = 1,000,000x.052x(180‐108)/360 = $10,400
• Clean Price = 1,009,048 – 10,400 = 998,648
94
Commercial Paper
95
Comm Paper
Commercial Paper
• Unsecured promissory notes are known as
commercial paper
• Large corporations borrow billions of
dollars in the money market through these
• Such paper consists of short‐term
unsecured promissory notes issued by well
known companies that are financially
strong and carry high credit ratings
96
32
Comm Paper
Maturity of US Paper
• Maturities of US paper range from 3 days
(weekend paper) to 270 days
• US paper is generally not issued with a
maturity exceeding 270 days
– Because any security with a maturity in excess
of 270 days must be registered with the SEC
97
Comm Paper
Ratings and Rating Agencies
• Depending on the credit standing of the issuer
paper is rated as:
– Prime
– Desirable or
– Satisfactory
• Firms issuing paper generally seek ratings from
multiple issuers.
– It is extremely difficult to market unrated paper.
– About 75% of the firms that currently sell paper
are prime rated.
– Generally notes bearing ratings from at least two
agencies are preferred by investors.
98
Comm Paper
Summary of the Rating Systems
99
33
Comm Paper
Credit Rating
• We will illustrate using S&P’s rating scale.
– A‐1= strong degree of safety for timely repayment
– A‐2 = satisfactory degree of safety
– A‐3 = adequate safety
– B,C = risky or speculative
– D = default history
– A‐1; A‐2; and A‐3 are investment grade
100
Comm Paper
Credit Rating
• Agencies are paid by the issuers of paper.
• A good rating makes it easier and cheaper to
borrow
• However rating agencies always look at the
issue from the perspective of a potential
investor.
– Their credibility is based on their track record from
the standpoint of accuracy.
101
Comm Paper
Evaluation Criteria
• Rating agencies use the following criteria.
– Strong management.
– Good position for the company in a well
established industry.
– Good earnings record.
– Adequate liquidity.
– Ability to borrow to meet both anticipated and
unanticipated needs.
102
34
Bills of Exchange
103
Bills (Cont…)
• Drawer: He is the party who makes out the bill
• A bill is always drawn by the person who will
be paid
• Drawee: Is the party who is ordered to pay
• A bill is always drawn on the drawee
104
BAs
What is a bill?
• It is an undertaking to pay a specified amount
of money at a future date – upto 12 months in
the future
• It is a form of short‐term finance for the
debtor
• Bills can be sold in the money market at any
time prior to their maturity date
• Bills are classified on basis of the entity which
gives the undertaking to pay
– T‐Bills
– Bank bills
– Trade bills
105
35
BAs
Bills (Cont…)
• A bill of exchange is also known as a Draft
• A Draft may be a
– Sight Draft
– Time Draft
106
BAs
Sight Drafts
• In such cases the importer has to pay for
the goods on sight of the draft.
• His bank will not release the shipping
document until he pays.
• Such transactions are known as
‘Documents Against Payment’ transactions.
107
BAs
Time Drafts
• These are also known as Usance Drafts.
• The bank will release the shipping documents
in such cases as soon as the importer accepts
the draft by signing on it.
• The importer need not pay immediately.
• In other words the exporter is offering him
credit for a period.
• When the importer accepts a draft it becomes
a ‘Trade Acceptance’.
108
36
BAs
Drafts and BAs
• In the case of a sight draft the importer’s bank
will pay on presentation.
• In the case of a time draft it will accept it by
signing on it.
• A draft that is accepted by a bank is called a
Banker’s Acceptance
– It is obviously more marketable than a trade
acceptance.
109
BAs
The Market for BAs
• In the U.S. there is an active secondary
market for BAs.
– They are short term zero coupon assets which
are redeemed at the face value on maturity
– BAs with a face value of 5MM USD are
considered to constitute a round lot.
– Once a BA is issued the exporter can get it
discounted by the accepting bank.
• i.e. he can sell it for its discounted value.
• he can sell it to someone else in the secondary
market.
110
BAs
Credit Risk for BAs
• The credit risk involved in holding a BA is
minimal.
– It represents an obligation on the part of the
accepting bank.
– It is also a contingent obligation on the part of
the drawer.
• i.e. if the bank fails to pay, the holder has recourse
to the exporter who is the drawer of the draft
111
37
BAs
Buying and Selling Bills ‐ Illustration
• A co. has drawn a bill on HSBC for $5,000,000
• Maturity 150 days
• The bank accepted it and the company has
sold it to Barclays at a discount @ 5.25%
• 30 days hence Barclays sold the bill to ABN
Amro at a discount @ 4.75%
112
BAs
Illustration (Cont…)
• Purchase price:
5,000,000 [1 – (5.25/100) * (150/360)]
= $4,890,625
• Sale price:
5,000,000 [1 – (4.75/100) * (120/360)]
= $4,920,833.33
113
Valuing a ZCB with a non‐integer time
to maturity
• If the ZCB has an integer number of periods till
maturity
– We divide the discount rate by 2
– Multiply the number of years to maturity by 2
– To be consistent with bond valuation based on
semi‐annual coupons
• How do we deal with zero‐coupon bonds
which have a non‐integer time to maturity?
114
38
Illustration
• Consider a zero‐coupon bond with a face
value of $10,000
• The maturity date is 15 September 2018
• We are on 15 December 2013
• The quasi‐coupon dates on a semi‐annual
basis are
– 15 September and 15 March
115
Illustration (Cont…)
• Let us assume an Actual/Actual day‐count
convention
– Between 15 September and 15 March there are 181
days and between 15 December and 15 March there
are 90 days
– Thus the first period is 90/181 = 0.4972
• If the YTM is 10% per annum the price is
– 10000/(1.05)9.4972 = 6291.5983
• Obviously the clean price is equal to the dirty
price
116
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