292Banking book, 225, 292Base currency, 94–5, 292Basis, 74, 293bond basis, 294money-market basis, 309value basis, 74, 321Basis point, 30–1, 293Basis risk, 74, 197–8, 293Basket arrangements, 184, 293Bear spread, 293Bearer security, 29, 293Bid price, 7, 96–8, 293Big ﬁgure, 98, 293Bilateral netting, 293Bill of exchange, 25, 34, 294Bond basis, 294Bond yield in last coupon period,43–4Bond-equivalent yield, US Treasurybill, 56–7, 278Borrowing:cost of, 14–15forward-forwards, 26, 60break-even, 62–3pricing, 61–2Broken dates, 5, 17, 294BUBOR, 30Bull spread, 294Business risk, 210–11Buy/sell-back, 294
324Cable, 98, 294Calendar spread, 86–7, 294Capital adequacy, 294requirements, 224–9future developments, 229own funds, 225risk asset ratio, 224–5, 316risk-weighted assets, 225–9Capital Adequacy Directives (CAD),224, 294Capital markets, 25, 295Cash market, 6–7, 295Certiﬁcate of deposit (CD), 25, 29,31–2, 276, 295ﬂoating rate (FRCD), 303paying more than one coupon,46–8, 276price of, 39–43Charting, 188Cherry-picking, 205, 295Chicago Mercantile Exchange(CME), 71, 295Choice price, 98, 295Clean deposit, 31, 296Clean price, 44, 296Clearing houses, 72–3, 202Collateral, 296Commercial paper (CP), 25, 33, 296Competitive exposure, 232–3, 296Compound interest, 8, 296Continuous real-time linkedsettlement (CLS), 207, 296–7Contract date, 297Contracts for differences, 6–7, 207,297Convertible currency, 297Corporate risk management, 230–50analysis of risks, 230–6economic exposure, 232–6transaction exposure, 230–1translation exposures, 231–2currency exposure reporting,246–8internal reporting within theﬁnance department, 247reporting from divisions, 246–7reporting from ﬁnancedepartment to division,247–8forecasts, 242, 244–6forward premiums anddiscounts, 245–6
Indexrange forecasts, 244–5policy establishment, 236–42amount of cover, 239–40instruments, 241–2responsibility, 242speculation, 237–9what to manage, 237target setting, 242–4commercial target rates, 242–3short-term dealing targets,243–4treasury management successevaluation, 248–9Correlation, 213–15Correlation coefﬁcient, 214–15, 297Cost of borrowing, 14–15Counterparty risk, 201–2, 203,226–8, 297factor for transaction type, 226–8risk weighting for counterparty,226Coupon, 29, 39–41, 297accrued coupon, 44, 291CDs paying more than onecoupon, 46–8Covariance, 213–15, 297Cover, 297amount of, 239–40Covered interest arbitrage, 150,161–7, 283, 297Crawling peg system, 184, 298Credit risk, 201–7, 298controls, 203–4netting, 204–7, 310contracts for differences, 207DvP and PvP, 206–7systems, 206Cross-rates, 95–6, 298forwards, 133–6, 282spot transactions, 95–6, 101–4Cumulative probability distribution,217, 298Currency codes, 3, 284–90Currency relationships, 182–92analysing currency movements,188–92effective exchange rates, 192forward rate, 192fundamental analysis, 188–92long-term view, 189–90medium-term view, 190–1
Index
325
Daylight limit, 200, 298Delivery versus payment (DvP)system, 207, 298Deposit, 298Depreciation, 298Derivative, 298Devaluation, 299Direct exchange rate quotation, 299Dirty ﬂoating system, 184, 299Dirty price, 44, 299Discount, 29, 114–17, 299forecasting, 245–6Discount instruments, 29, 50–2,277–8, 299Discount rate, 29, 52–5, 299Discounting, 14, 29Drawee, 34, 299Drawer, 34, 299Dual exchange rates, 184, 300
European Monetary Union, 185–7,301EMU currencies, 186–7euro and, 186Exchange controls, 301Exchange rate agreement (ERA),141–4, 282–3, 302Exchange rate mechanism (ERM),see European exchange ratemechanismExchange rates:effective exchange rate, 192real effective exchange rate,192, 315forward outright exchangerate, 192Fundamental EquilibriumExchange Rate (FEER), 190regimes, 183–4basket arrangements, 184crawling peg/adjustablepeg, 184dual rates, 184ﬁxed-rate regime, 183ﬂoating-rate regime, 183–4Exchange-traded instruments, 302
Earnings at risk, 218Economic exposure, 232–6, 300hedging, 235–6Effective date, 300Effective exchange rate, 192, 300real effective exchange rate, 192,315Effective interest rate, 20–1, 300Norwegian Treasury bills, 57–8Eligible bill, 28, 34, 300End-end dealing, 5, 300Equivalent interest rates, 19–20,275, 301EURIBOR, 30, 69–70, 301Euro, 186, 301Eurocurrency, 7, 301Euromarket, 301European Central Bank (ECB), 186European exchange rate mechanism(ERM), 184, 185, 302ERMII, 187European Monetary Institute(EMI), 186European monetary system (EMS),185–6, 301
Face value, 29, 302Figure, 302Fixed deposit, 25, 31, 36–7, 275–6,302breaking, 44–6quoting for ﬁxed deposits withdelayed interestsettlement, 37Fixed exchange rate regime,183, 302Fixed interest rate, 30Flat yield curve, 27, 302Floating exchange rate regime,183–4, 303Floating interest rate, 30, 303Floating rate CD (FRCD), 303Floating-rate note, 303Forecasts, 242, 244–6forward premiums and discounts,245–6range forecasts, 244–5Forward, 303Forward exchange agreement (FXA),141–4, 282, 303
short-term inﬂuences, 191–2technical analysis, 188currency blocs, 182–3European Monetary Union, 185–7exchange rate regimes, 183–4Currency risk, 196, 228
326Forward outrights, 107–11, 132,144–5, 280–1cross-rate calculation, 133, 282exchange rate, 192hedging, 154–5, 179–80long dates, 139–41, 282non-deliverable forwards (NDFs),136–8, 207, 310prices, 108–11short dates, 123–7time options, 138–9, 144, 320Forward rate agreement (FRA), 26,60–1, 63–8, 303applications of, 77–88arbitrage, 88calendar spread, 86–7cross-market spread, 87hedging, 77–84, 156–61quoting for ﬁxed deposits withdelayed interest settlement,84–5speculation, 85–6strip trading, 86creation in one currency from anFRA in another currency,168–71, 283periods longer than one year, 67–8pricing, 64–5rate, 278settlement, 65–7, 75vs futures contracts, 75Forward swaps, 111–23, 144–5,280–1covered interest arbitrage, 150,161–7cross-rate calculation, 133–5, 282discounts and premiums, 114–17forecasting, 245–6forward-forwards, 127–31hedging, 150–4, 173–9historic rate rollovers, 121–3, 305long dates, 139–41short dates, 123–7, 134–5valuation of a swap book, 121Forward value date, 4–5Forward-forwards, 303borrowing, 26, 60break-even, 62–3pricing, 61–2hedging, 155–61, 283rates, 278
Indexswaps, 127–31, 132, 145cross-rate calculation, 135FRABBA, 206Fraud, 209Front ofﬁce, 209, 304Fundamental analysis, 188–92, 304effective exchange rates, 192forward rate, 192long-term view, 189–90medium-term view, 190–1short-term inﬂuences, 191–2Fundamental Equilibrium ExchangeRate (FEER), 190, 304Funds, 304Fungible, 73, 304Future value, 304Futures contracts, 5, 26, 61, 68–74,304applications of, 77–88arbitrage, 88calendar spread, 86–7cross-market spread, 87hedging, 77–84, 155–61quoting for ﬁxed deposits withdelayed interest settlement,84–5speculation, 85–6strip trading, 86mechanics of, 72–4basis, 74clearing, 72–3closing out, 73–4limit up/down, 74margin requirements, 73market participants, 72open outcry vs screen-trading,72pricing, 69–72short-term interest rate (STIR)futures, 68, 70, 279, 318underlying, 321vs forward rate agreements, 75Gap analysis, 199, 200–1, 304General risk, 229, 305GMRA (Global Master RepoAgreement), 206, 305Hedging, 4, 77–84, 144–5, 305an FRA position with futures,80–4economic exposure, 235–6
Indexforeign exchangeforward-forwards, with FRAsor futures, 155–61, 283foreign exchange forwards, usingborrowings and deposits,150–5hedging a forward outright,154–5, 179–80hedging a forward swap, 150–4,173–9translation exposures, 231–2See also Corporate riskmanagementHerstatt risk, 202, 305Historic price movements, 221–2,305Historic rate rollover, 121–3, 305Hit, 98, 305IFEMA (International ForeignExchange Master Agreement),205, 305In-between months, 5Indirect exchange rate quotation,305Initial margin, 73, 202Interbank transaction, 306Interest calculations, 8–9compounding, see Strippingday/year conventions, 9–12,271–3, 274conversion between, 12–13, 274paying interest with differentfrequencies, 18–20Interest rates, 8bid rate, 30compounding, see Strippingdiscount rate, 14, 29, 52–5effective rate, 20–1, 300Norwegian Treasury bills, 57–8equivalent rate, 19–20, 275, 301ﬁxed rate, 30ﬂoating rate, 30, 303nominal rate, 19offer rate, 30risks, 196–7yield curve, 26–8, 76–7inﬂuences, 28International Monetary Market(IMM), 71, 306Interpolation, 17–18, 275, 306Intervention, 306
327Inverted yield curve, 27ISDA (International Swaps andDerivatives Association), 205–6,306Judgmental forecasting, SeeFundamental analysisLarge exposure risk, 228, 306Legacy currency, 187, 306Legal risk, 210, 306LIBID, 30LIBOR, 30, 63–8, 307Liffe (London International FinancialFutures and Options Exchange),69–70, 72, 307LIMEAN, 30, 64Limits, 199–200, 203Liquid market, 307Liquidity, 27–8Liquidity risk, 198–9, 307London Clearing House (LCH), 72Long position, 7, 98, 307–8Long-dated forwards, 139–41, 282Managed ﬂoating system, 184, 308Mapping, 220, 308Margin, 73, 202, 308Margin call, 308Margin transfer, 308Market makers, 93Market risk, see Bank riskmanagementMarking to market, 73, 100, 199,308Mean, 211Mine, 309Model risk, 199, 309Modiﬁed duration, 199, 309Modiﬁed following convention, 5,309Money markets, 25, 309instruments, 25–6, 31–5Money-market basis, 309Monte Carlo simulation, 220–1, 309Multilateral netting, 309My risk, 98–9, 309Negative skewness, 222, 310Negative yield curve, 27, 310Negotiable security, 28–9, 310Net present value (NPV), 121, 310
328Netting, 204–7, 310bilateral, 293contracts for differences, 207DvP and PvP, 206–7multilateral, 309systems, 206Nominal amount, 29, 310Nominal rate, 310Non-deliverable forwards (NDFs),136–8, 207, 310Normal probability function,217–18, 311Normal yield curve, 27, 311Norwegian Treasury bills, 57–8, 278Notional principal, 29, 311Odd dates, 5, 17Off, 99, 311Off-balance sheet, 311Off-market, 312Offer price, 7, 96–8, 311Open outcry dealing, 72, 312Operational risk, 207–9, 312controls, 209Option forward, 138Outright, 107, 312See also Forward outrightsOver the counter (OTC), 68, 312Overborrowed, 62, 312Overlent, 62, 312Overnight limit, 200, 312Overnight (O/N) swaps, 6, 123–7,312Own funds, 313Par, 116, 313Parity, 313Payee, 313Payment versus payment (PvP)system, 206–7, 313Points, 97, 313Position limits, 199Position risk, 228–9, 313Position-keeping, 37–9spot transactions, 99–100Positive yield curve, 27Premiums, 114–17, 314forecasting, 245–6Present value, 13–14, 274, 314net present value (NPV), 121, 310Primary market, 29, 314Probability density, 215–17, 314
IndexProbability distribution, 217–18,314Produce, 314Promissory note, 314Public order member, 314Purchasing power parity (PPP),189–90, 314Real effective exchange rate, 192,315Reciprocal rate, 101, 315Redeem, 315Registered security, 29, 315Regulatory risk, 210Replacement risk, 202, 203, 315Repo, 34–5, 295–6, 315Repurchase agreement, 26, 35Reputational risk, 315Revaluation, 315Risk asset ratio, 224–5, 316Risk management, See Bank riskmanagement; Corporate riskmanagementRisk measurement, 199Risk-weighted assets, 224, 225–9,316counterparty risk, 226–8factor for transaction type,226–8risk weighting for counterparty,226currency risk, 228large exposure risk, 228position risk, 228–9, 313settlement risk, 229trading book/general bankingbook, 225–6Riskmetrics, 220, 316Rollover, 316historic rate rollover, 121–3, 305SAFEBBA, 206Screen-trading, 72SDR (special drawing right)currency, 184Secondary market, 29, 316Security, 28–9, 296, 316bearer, 29, 293negotiable, 28–9, 310registered, 29, 315zero-coupon, 322Sell/buy-back, 317
IndexSerial months, 71, 317Settlement risk, 202, 203, 229, 317Short dates, 6, 107, 123–7, 317Short position, 7, 98, 317Short-term interest rate (STIR)futures, 68, 70, 279, 318Simple interest, 8–9, 317Special drawing right, 317Speciﬁc risk, 317Speculation, 3–4, 145, 317company policy, 237–9forward rate agreements, 85–6futures contracts, 85–6spot transactions, 93Spot transactions, 93–105, 318market environment, 105position-keeping, 99–100quoting of spot rates, 94–9base currency and variablecurrency, 94–5bid and offer rates, 96–8cross-rates, 95–6, 101–4reciprocal rates, 101, 315rate calculation, 279–80uses of, 93value date, 4, 94Spot-a-week (S/W) swaps, 6, 123,318Spot-next (S/N) swaps, 6, 123–7,318Spread, 7, 97, 318bear spread, 293bull spread, 294calendar spread, 86–7, 294Square position, 7, 98, 318Standard deviation, 211–13, 318STIBOR, 30Stop loss levels, 200, 318Straight-through processing (STP),209, 318Stress-testing, 222–3Stripping, 16–17, 86, 275, 318–19Swaps, 319See also Forward swapsSwedish Treasury bills, 11SWIFT (Society for WorldwideInterbank FinancialTransfers), 319currency codes, 3, 284–90Synthetic agreements for forwardexchange (SAFEs), 141–4,207, 319
329advantages of, 142–4settlement amounts, 282–3System risk, 207, 319Systemic risk, 210, 319Tail, 196, 319Take proﬁt levels, 200, 319Taking a position, SeePosition-keepingTechnical analysis, 188, 319Tenor, 320Term, 320Term deposit, 31, 320Tick, 320Tick value, 320Time deposit, 31, 320Time options, 138–9, 144, 282, 320Time value of money, 320Tom-next (T/N) swaps, 6, 123–7,320Trading book, 225, 320Transaction exposure, 230–1, 320Translation exposures, 231–2, 321hedging, 231–2Treasury bill (T-bill), 25, 27–8,32–3, 321Norwegian, 57–8, 278Swedish, 11US, bond-equivalent yields, 56–7,278True yield, 53, 321Two-way, 321Under reference, 98, 321Underlying, 70–1, 321US Treasury bills, 56–7bond-equivalent yields, 56–7, 278Value at risk (VaR), 199, 211–24,321approaches, 219–22historic, 221–2, 305Monte Carlo simulation, 220–1,309variance/covariance, 219–20BIS recommendations, 223–4overview, 218–19problems with calculations, 222statistics, 211–18stress-testing, 222–3Value basis, 74, 321Value dates, 4–6, 123, 321
330Variable currency, 94–5, 322Variance, 211–13, 322Variance/covariance approach,219–20, 222, 322Variation margin, 73, 202Yard, 98, 322Yield, 29, 53, 275, 322calculation, 14–15true yield, 53, 321Yield curve, 26–8, 76–7, 322ﬂat, 27, 302inﬂuences, 28negative, 27, 310normal, 27, 311Yours, 322Zero-coupon security, 322
Index
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