The Money Markets Handbook A Practitioners' Guide

The Money Markets Handbook

A Practitioners' Guide

Moorad Choudhry

John Wiley & Sons (Asia) Pte Ltd

Copyright © 2005 Moorad Choudhry Published in 2005 by John Wiley & Sons (Asia) Pte Ltd 2 Clementi Loop, #02-01, Singapore 129809

All rights reserved.

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as expressly permitted by law, without either the prior written permission of the Publisher, or authorization through payment of the appropriate photocopy fee to the Copyright Clearance Center. Requests for permission should be addressed to the Publisher, John Wiley & Sons (Asia) Pte Ltd, 2 Clementi Loop, #02-01, Singapore 129809, tel : 65-4632400, fax: 65-4646912, e-mail : enQuir.y@wiley.com.sg.

The views, thoughts and opinions expressed in this book are those of the author in his individual private capacity and should not in any way be attributed to KBC Financial Products or to KBC Bank N.V., or to Moorad Choudhry as a representative, officer, or employee of KBC Financial Products or KBC Bank N.V.

Whilst every effort has been made to ensure accuracy, no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this book can be accepted by the author, publisher or any named person or corporate entity.

No part of this book constitutes investment advice and no part of this book should be construed as such. Neither the author nor the publishers or any named individual or entity is soliciting any action, response or trade in response to anything written in this book.

The material in this book is based on information that is considered reliable but neither the author nor the publishers warrant that it is accurate or complete, and it should not be relied on as such. Opinions expressed are current opinions only and are subject to change. The author and publishers are not soliciting any action based upon this material. Moorad Choudhry and any named person or entity may or may not have a position in any capital-market instrument described in this book, at the time of writing or subsequently. Any such position is subject to change at any time and for any

reason.

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Typeset in 10.5/13 points, Times by Paul Lim Printed in Singapore by Saik Wah Press Pte Ltd 10 9 8 7 6 5 4 3 2 1

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For every lost opportunity ...

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Contents

Foreword

Preface

Acknowledgments

About the Author

Introduction to the money markets

Chapter 1 The money markets

Chapter 2 Foreign exchange markets

Chapter 3 Floating-rate notes

Chapter 4 Repo instruments and structured funding vehicles

Chapter 5 Money market derivatives

Chapter 6 The money market yield curve

Chapter 7 Asset and liability management

Chapter 8 Bank regulatory capital

Appendix

Glossary

Index

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IX xi

Xlll xv

1

1 3

73

87

1 03

1 69

255

287

345

375

397

433

Foreword

The book you are about to read is filled with a ton of information on the world of Money Markets . It will give you all the technical knowledge you will need. There is another aspect to this business and perhaps to all careers, that should be mentioned and has personally affected me - attitude and luck.

Attitude is something that can separate good from great. Usually, given 2 people with the same technical skills, and educational background, attitude can and will make the difference.

I have often thought of the money market world as a place where many people start a career in the financial arena. Very quickly one finds out in this arena - a traditional high volume and low margin business - that hustle, stamina and a willingness to work in a team-oriented atmosphere are a must. It is also imperative that you realize that you are part of something bigger, much bigger in the fi,nancial world. But, you have to be willing to pay the price and the price is high. You always need to go the extra mile. To be willing to work and keep on working even when things are tough. Let's face it, a bear market, a repo squeeze, or a credit crunch can take their toll. A good example of this is what happened on Sept 1 1 , 2001. Financial markets were in disarray and the short end of the market needed to play its part to keep the liquid short-dated markets flowing. The job was done with excellence. I was never so proud to be a part of this business as I was during this particular time. Watching people numbed by the tragic events, carry out their jobs until everything was in order, is so very typical of the money market person. You stay ; you focus ; you finish the job at hand.

Many of you will use the money market arena as a stepping stone to a career in other financial settlings . . . But many of you, myself being a good example, will find the challenges and joy of this arena to be one that lasts an entire career. To do your job and help others do theirs . You have to be willing to do the right thing ALL THE TIME and to believe that what you are doing IS important. You will listen to your clients, pay attention to what is important to them and then try to execute as they want you to - this will allow you to be a hallmark of client service that lives in the short end. You will always remember that it's about the client. Do this and learn the money market world, so it can spring you to personal greatness . Learn about

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partnering and be a great partner. This world is not better because of people working in silos. It is great because 1 plus 1 equals 3.

I have found my career in the money market world to be one that has given me all the personal and professional challenges I needed to grow. Trading or sales skills are necessary, as are client skills . But two other areas worked in my favor. One is attitude, which I have already mentioned. The other was luck. Yes, my career in money markets over the last 20-plus years was also laced with about as much good luck as one could ever hope. Maybe luck for me could be traced back to my attitude and maybe my attitude was there because of the upbringing or my playing sports when I was growing up. Who knows what forces really do play a part in this . . . ? Whatever it was, I am deeply grateful. My suggestion is not to discount the value of luck in your future - it will play a part. I hope it's all good . . . . . .

I am also deeply grateful to all the people I have met along the way. There have been so many. Many of them have worked alongside me for all those years and many others have gone on to other paths in life. To them, I wish all the joy and challenges life has to offer.

To those just starting out on their journey, studying this excellent book and taking along the right attitude, will get you on your way.

Good luck on your journey ! !

Bob Beehler MD, European Short-Term Fixed Income JPMorgan Chase Bank

Preface

The money markets are an important element of the debt capital markets, and are defined traditionally as being the market in traded debt securities of up to one year 's maturity from date of issue. Money market instruments are used by all users and suppliers of short-term capital, and the market is the vital conduit through which the participants are brought together. This book is a succinct and hopefully clear review of the main money market securities, both cash and off-balance sheet, traded around the world. This includes cash market instruments such as CDs and T-bills, together with short-dated derivatives like Libor futures and forward-rate agreements . We have expanded the coverage however, to include a review of bank asset and liability management, or ALM, which is an essential part of banking, and regulatory capital issues. This subject has been developed considerably beyond bank short-term liquidity management, and we consider the main points here. This part of the book will therefore be useful those who are involved in bank and security house money-market trading, or those involved with bank asset & liability committees. In a separate chapter we review a substantial topic in its own right, the bond repo markets ; this covers the mechanics of repo and its uses as part of the bond and money markets . More sophisticated products that are also part of the markets , such as asset­backed commercial paper conduits and basket Total Return Swaps, are also described. In short, we aim to provide comprehensive detail on the full range of products that might be employed on the Treasury desk of a global integrated banking institution.

As well as a description of the instruments themselves, where possible we include illustrations, including Bloomberg screens where appropriate, as well as worked examples. The objective is to present a succinct account of the mechanics of the main products that make up the money markets .

This book is aimed at those with little or no previous understanding of or exposure to the money markets, but in any case all those in front office, middle office and back office banking and fund management departments . Others including corporate treasurers, risk management and legal department staff may also find the contents useful.

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Preface

The book is organised into eight chapters. These cover money market instruments including :

• cash products such as Certificates of Deposit, as well as repo; • derivative instruments such as Forward Rate Agreements and

overnight-index swaps; • hybrid instruments such as Total Return Swaps, used for funding

purposes, and other structured funding instruments ; • floating-rate notes; • commercial paper conduits and asset-backed conduits .

There are also chapters on issues of importance to money market participants , such as securitisation structures used for funding purposes.

In addition there is a chapter on the yield curve, and spot and forward rates . For beginners to the subject we introduce the basics of financial market arithmetic in an Appendix at the back of the book.

Comments on the text are welcome and should be sent to the author care of Wiley Asia.

Website

Further research on the debt capital and money markets can be found on the dedicated fixed income website at

www.YieldCurve.com

This site also publishes market research and conference presentations produced by the author and other YieldCurve.com associates.

Acknowledgements

Big, big thanks to Bob Beehler at JPMorgan Chase for the excellent Foreword, it is a privilege to know you.

Thanks to Anne Azencot at Cadwalader for sterling work when we were structuring and closing the mighty conduit that was Picaros Funding pic -

awesome stuff. Imagine that, Europe 's first ever synthetic asset-backed commercial paper conduit ! What a team, eh? © Also more Picaros big thanks to Nick Procter, Lorraine Carey and Padraic Doherty at JPMorgan Chase, Paul Kerlogue at Moodys, Andre Vollmann at S&P and Serj Walia, Rupert Page, Dave Plume, Alex Rafinski , Jasmine Matthews, Andrew Dominus and Anne Carter at KBC FP.

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Thanks big time to Johanna Foley, John Kodweis, Peter Eisenhardt and Eric Subliskey at JPMorgan Chase, they all know why, a "nice one !" thanks to Stewart Cutler at Merrill Lynch (there should be a picture of you in the dictionary under "sales and marketing" ! ) , Bill Kearns at Citigroup and Peter Holden at Merrill Lynch.

A pleasure to deal with the interest-rate derivatives desk at KBC Bank Brussels , namely Jean-Marc Hendrick, Koen Van Baarle, Philip Desmet and Francis (again ! ) , and also the repo desk at HSBC in London, that' ll be my man Adnan Jaffery. Salaam !

Thanks to Guillermo Monroy at BBVA in Madrid for help with their Bloomberg screens.

Thanks to Dan Cunningham, Gavin Allan and Lee Crooks at KBC Bank London for inviting me to assist them with their annual defence of the Kelvin Watson trophy, a pleasure and an honour to be asked . . . and happy to see we retained the title ! I am available for selection at right-back next year too, if you' re wondering . . .

As ever, thanks to Del-Boy at King & Shaxson Bond Brokers Limited . . . it 's been a long time since we traded them, but I am always grateful for the times you told me without a moment's delay what the settlement figure was. for a new-issue CD I 'd just bought . . . ©

Thanks to Paul Lim for top-quality typesetting, and to Malar at Wiley Singapore for help with production, saves me loads of headache.

Finally, thanks to Mark at Zulu Tattoo, you are an artist and true master of your craft !

KBC FP Acknowledgements

Big, big thanks to the No. 1 boys on the trading floor, the Equity Derivs desk, that ' ll be Haris Kessaris , Frank Spiteri, Hirak Chakravorty, Michiel Symoens and the lads, cheers for everything guys . . . thanks for looking after me !

Many thanks to Nick Bulloch for making things easier to book and reconcile than they otherwise would have been ! Imagine? Sophis? Piece of cake . . .

Jason Feasey - respect. Thanks to Pierre Iceta, Niall Considine, Craig Wotherspoon, Andrew Oliver, Alex Palmer, Sarah Robinson, Caroline Bailey, Daniel Bond, Richard Ward, Giles Lamb, Julie Butts, Bruno Pajusco, Simon Bourne and Oliver John. It's a pleasure to work with you chaps . . .

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