The Global money markets THE FRANK J. FABOZZI SERIES Fixed Income Securities, Second Edition by Frank J. Fabozzi Focus on Value: A Corporate and Investor Guide to Wealth Creation by James L. Grant and James A.
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MANN MOORAD CHOUDHRY John Wiley & Sons, Inc. FJF To my wife, Donna, and my children, Karly, Patricia, and Francesco SVM To my wife Mary and our daughters Meredith and Morgan. MC To Olga—like the wild cat of Scotland, both elusive and exclusive… The views, thoughts and opinions expressed in this book are those of the authors in their pri- vate capacity and should not be taken to be representative of any employing institution or named body. The views of Moorad Choudhry are those of his in his individual capacity and should not in any way be attributed to JPMorgan Chase Bank, or to Moorad Choudhry as a representative, officer or employee of JPMorgan Chase Bank.
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Some content that appears in print may not be available in electronic books. ISBN: 0-471-22093-0 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 contents About the Authors vii Acknowledgements viii CHAPTER 1 Introduction 1 CHAPTER 2 Money Market Calculations 7 CHAPTER 3 U. Treasury Bills 23 CHAPTER 4 Agency Instruments 45 CHAPTER 5 Corporate Obligations: Commercial Paper and Medium-Term Notes 67 CHAPTER 6 Debt Obligations of Financial Institutions 85 CHAPTER 7 Floating-Rate Securities 101 CHAPTER 8 Repurchase and Reverse Repurchase Agreements 119 CHAPTER 9 Short-Term Mortgage-Backed Securities 151 CHAPTER 10 Short-Term Asset-Backed Securities 187 v vi Contents CHAPTER 11 Futures and Forward Rate Agreements 209 CHAPTER 12 Swaps and Caps/Floors 229 CHAPTER 13 Asset and Liability Management 275 CHAPTER 14 Bank Regulatory Capital 297 INDEX 315 about the authors Frank J. Fabozzi is editor of the Journal of Portfolio Management and an adjunct professor of finance at Yale University’s School of Management.
He is a Chartered Financial Analyst and Certified Public Accountant. Fabozzi is on the board of directors of the Guardian Life family of funds and the BlackRock complex of funds. He earned a doctorate in economics from the City University of New York in 1972 and in 1994 received an honorary doctorate of Humane Letters from Nova Southeastern University. Fabozzi is a Fellow of the International Center for Finance at Yale Uni- versity.
He is an Advisory Analyst for Global Asset Management (GAM) with responsibilities as Consulting Director for portfolio construction, risk control, and evaluation. Mann is a Professor of Finance at the Darla Moore School of Business, University of South Carolina. He earned a doctorate in finance from the University of Nebraska in 1987. His research interests are in the area of investments, particularly fixed-income securities and derivatives.
He has published over 35 articles in finance journals and books. Mann is an accomplished teacher, winning 16 awards for excellence in teaching. He is a consultant to investment/commercial banks and has conducted more than 60 training programs for financial institutions throughout the United States. Moorad Choudhry is a vice-president in structured finance services with JPMorgan Chase in London.
He previously worked as a government bond trader and money markets trader at ABN Amro Hoare Govett Sterling Bonds Limited, and as a sterling proprietary trader at Hambros Bank Lim- ited. Moorad is a senior Fellow at the Centre for Mathematical Trading and Finance, City University Business School, and is also a Fellow of the Securities Institute. He is Editor of the Journal of Bond Trading and Man- agement, and has published widely in the field of debt capital markets, derivatives, and yield curve analysis. vii acknowledgements The authors wish to thank Dean Joel Smith and Professor Greg Niehaus for their efforts in bringing a Bloomberg terminal to the Moore School of Busi- ness.
The following graduate students at the Moore School of Business assisted in proofreading the book: Oscar Arostegui, Keshiv Desai, Jeffrey Dunn, and Brandon Wilson. In addition, we want to thank Michael Ken- ney for his assistance. viii CHAPTER 1 Introduction he money market is traditionally defined as the market for financial T assets that have original maturities of one year or less. In essence, it is the market for short-term debt instruments.
Financial assets traded in this market include such instruments as U. Treasury bills, commercial paper, some medium-term notes, bankers acceptances, federal agency discount paper, most certificates of deposit, repurchase agreements, floating-rate agreements, and federal funds. The scope of the money market has expanded in recent years to include securitized products such mortgage-backed and asset-backed securities with short average lives. These securities, along with the derivative contracts associated with them, are the subject of this book.
The workings of the money market are largely invisible to the aver- age retail investor. The reason is that the money market is the province of relatively large financial institutions and corporations. Namely, large borrowers (e. Treasury, agencies, money center banks, etc.) seek- ing short-term funding as well as large institutional investors with excess cash willing to supply funds short-term.
Typically, the only contact retail investors have with the money market is through money market mutual funds, known as unit trusts in the United Kingdom and Europe. Money market mutual funds are mutual funds that invest only in money market instruments. There are three types of money market funds: (1) general money market funds, which invest in wide variety of short-term debt products; (2) U. government short-term funds, which invest only in U.
Treasury bills or U. government agencies; and (3) short-term munic- ipal funds. Money market mutual funds are a popular investment vehicle for retail investors seeking a safe place to park excess cash. In Europe, unit trusts are well-established investment vehicles for retail savers; a number of these invest in short-term assets and thus are termed money market unit 1 2 THE GLOBAL MONEY MARKETS trusts.
Placing funds in a unit trust is an effective means by which smaller investors can leverage off the market power of larger investors. In the UK money market, unit trusts typically invest in deposits, with a relatively small share of funds placed in money market paper such as government bills or certificates of deposit. Investors can invest in money market funds using one-off sums or save through a regular savings plan. THE MONEY MARKET The money market is a market in which the cash requirements of market participants who are long cash are met along with the requirements of those that are short cash.
This is identical to any financial market; the distinguishing factor of the money market is that it provides for only short-term cash requirements. The market will always, without fail, be required because the needs of long cash and short cash market partici- pants are never completely synchronized. The participants in the market are many and varied, and large numbers of them are both borrowers and lenders at the same time. They include: ■ the sovereign authority, including the central government (“Treasury”), as well as government agencies and the central bank or reserve bank; ■ financial institutions such as the large integrated investment banks, commercial banks, mortgage institutions, insurance companies, and finance companies; ■ corporations of all types; ■ individual private investors, such as high net-worth individuals and small savers; ■ intermediaries such as money brokers, banking institutions, etc.; ■ infrastructure of the marketplace, such as derivatives exchanges.
A money market exists in virtually every country in the world, and all such markets exhibit the characteristics we describe in this book to some extent. For instance, they provide a means by which the conflicting needs of borrowers and lenders can achieve equilibrium, they act as a conduit for financing of all maturities between one day and one year, and they can be accessed by individuals, corporations, and governments alike. In addition to national domestic markets, there is the international cross-border market illustrated by the trade in Eurocurrencies.1 Of 1 A Eurocurrency is a currency that is traded outside of its national border, and can be any currency rather than just a European one. Introduction 3 course, there are distinctions between individual country markets, and financial market culture will differ.
For instance, the prevailing financial culture in the United States and United Kingdom is based on a second- ary market in tradable financial assets, so we have a developed and liq- uid bond and equity market in these economies. While such an arrangement also exists in virtually all other countries, the culture in certain economies such as Japan and (to a lesser extent) Germany is based more on banking relationships, with banks providing a large pro- portion of corporate finance. The differences across countries are not touched upon in this book; rather, it is the similarities in the type of instruments used that is highlighted. In developed economies, the money market is large and liquid.1 illustrates the market growth in the United States during the 1990s.2 illustrates the breakdown of the United Kingdom money market by different types of instrument, each of which we cover in detail in this book.
OVERVIEW OF THE BOOK In Chapter 2 we cover money market calculations.