tradeable instruments - ii

8/10/2019 Tradeable Instruments - II

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Tradeable Instruments - II

By Zenub Husain


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Table Of Contents Debt Market and subdivisions

Fixed Income Capital Market Instruments

Bonds and their classificationsBond Yield

Bond Valuation

Mortgage Backed Securities

CDO and their role in financial crisis

Money Market Instruments

TreasuryBills

Bankers Acceptance

Certificate of Deposit

Commercial Paper

Repos

Fed FundsCall Loans


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Debt Markets Bigger source of borrowed funds than the banking system.

Divided into money market(short-term debt, maturity of one year or less) and

capital market(long-term debt).

Money Market is the part of financial market where instruments with high liquidity

and very short-term maturities are traded.

Also called cash equivalents

Issued by governments, financial institutions and large corporations.

Trade in very high denominations Low risk, low return

Fixed Income Capital Market deal with long term securities. Also popularly knows

as Bond market.


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Money Market Trading

Trading through OTC

Core of the money market consists of interbank lending.

Helps Industries in securing short-term loans to meet their working capital

requirements .

Helps finance trading

Government meets its funding needs

Retail Investors can gain access through money market mutual funds and money

market accounts
http://en.wikipedia.org/wiki/Interbank_lending_markethttp://en.wikipedia.org/wiki/Interbank_lending_market


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Money Market Instruments

Treasury Bills

Bankers Acceptance

Certificate of Deposit (CD)

Commercial Paper

Federal Funds

Call/Notice & Term Money

Repos


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Treasury BillsIssued by the Central Governments

Issued at discount through competitive bidding process at auctions

Low risk and Low return

Most marketable: High liquidity

Short term securities with maturity of less than 1 year

Retail investors can buy T-bills directly


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Bankers Acceptance

Commercial bank draft requiring the bank to pay the holder of the instrument

a specified amount on a specified dateMaturities between 30-180 days typically 90 days

Issued by Banks usually merchant banks to finance international trade

Issued at discount and paid in full when it becomes due


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Certificate of Deposit

Tradable Unsecured Time deposit with banks

Issued by commercial banks but can be bought at brokerage houses

Similar to bonds with specified maturity dates and interest rates

Slightly higher return due to presence of default risk

Maturity Period between 3 months to 5 years

Lock in period with substantial penalties

Eurodollar CDs are dollar-denominated CDs issued by banks abroad


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Commercial Paper

Unsecured short term loan

Issued by Corporation to avoid dealing with banks

Issued at discount and at maturity it gets the return plus invested amount

Maturity periods ranging from 1-270 days with typical maturity 30-35 days.

High denomination amounts typically in multiples of $1 million


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Call/Notice & Term Money

Call Rate


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Federal Funds

Risk Free Rate

Fed Fund Rate


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Repos

Repurchase agreement

Used as a form of short term borrowing

Term Repo: Maturity period > 30days Reverse Repo: Dealer buys government securities and

then sells them back on a later date at a higher price


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ReposLegal Framework

Collateral is not pledged but sold to buyer.

Legal Ownership transferred to buyer

Economic ownership retained with seller Manufactured Dividend payment


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Role of Reserve Bank of India:

The Reserve Bank of India (RBI) plays a keyrole of regulator and controller of moneymarket. The intervention of RBI is varied

curbing crisis situations by reducing key policyrates or curbing inflationary situations byrising key policy rates such as Repo, ReverseRepo, CRR etc.

Tool of domestic market intervention

Control future interest rates


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Fixed Capital Market Instruments

Bonds

Mortgage Backed Securities


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Current Yield

The current yield on a bond refers to the ratio of

the annual interest payment to the current market

price .

Yield to Maturity

This is the rate of return that investors earn if they

buy the bond at a specific price and hold it untilmaturity.


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Current Yield vs YTM

Bonds : Current Yield Vs Yield to

Maturity Current Yield

The current yie ld on a bond refers to the ratio of the annual interest payment to the current market price .

Yield to Maturity

This is the rate of return that investors earn if they buy the bond at a specific price and hold it until

maturity.

+


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Bond Pricing and Valuation

Price vs Yield


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Corporate Bonds

Corporations can raise capital for long-term projects

. A company with a good credit rating can issue long-term bonds at

low interest and deduct interest payments as a business expense

AAA, AA, A, BBB -- investment grade

BB, B, CCC, CC -- speculative grade

C, DDD, DD, D -- questionable to default grade

Callable Bonds

Retractable Bonds

Convertible Bonds

Insurance companies are the predominant holders of corporate

bonds


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Floating Rate Notes

T Notes (2,5, 10 years increment) T Bonds

(Terms of 30 years)


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MunicipalBonds

Issued by states, counties, cities and other local governments

in the United States

Bond insurance raises bond rating and lowers bond yield

As a result of the downgrades of the major bond insurance

firms, only about 6% of all municipal bonds now come to

market with insurance, compared with about 55% up to 2007.

steep declines in muni bond prices after 2008


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MORTGAGE-BACKED SECURITIES

MBS are actually pools of mortgages packaged into securities for

sale in the secondary market.

Most MBSs are issued by the government agencies Fannie Mae,

Freddie Mac and Ginnie Mae

MBSs are classified as pass-through securities or CollateralizedMortgage Obligations

A pass-through securityrepresents a pro-rata ownership of the

principal and interest of a pool of mortgage loans.

A CDO divides holders of the MBS into classes based on priority toreceive prepayments. These securities essentially take the interest

and principal payments from several MBS and create additional

securities with varying maturities and coupons.


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CDOs and Financial Crisis

Will add


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Summary View

tradeable instruments - ii

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