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TFS (FX market (Explaining movements (Forcasting- Dealers attempt intra…

- - - - Bid-offer quotes & midpoint rates - Cross rates (non USD) FX dealers quote buds (buying price) & offers (selling price)
  - - - Exchange of currencies in T+2 based on agreed spot exchange rate. Dealers store FX reserves in low risk securities.
    - - Exchange of currencies at further specified date - after T+2. Mostly arranged on monthly basis monthly. Net requirements - covered by holding securities in those currencies that mature on the future settlement date.
      - Fcom/terms - Scom/terms has a lower interest rate & trade at a forward premium.
      - Dealers
        
        Dealers may have many forward contracts & ensure they have maturing securities sufficient to cover their net settlement obligations each day
        
        Forward rate doesn't expose dealer to FX risk - its based on interest rates in 2 currencies
        
        Dealers income = spread between their forward bid & offer rates
        
        Dealers don't set forward rates on basis of speculation but rather on interest rate differentials.
    - - Combination of 2 FX contracts with different settlement dates taken simultaneously. Currencies are exchanges at agreed rate (usually current spot rate) & arrangements made to exchange then at agreed forward rate. Cost = forward (swap) points
      - FX swap = risk management product. Buy/sell (sell/buy)FX swap - foreign currency is first (sold) bought & later sold (bought) can hedge FX risk of an investment (loan) in a foreign currency
  - - - FX risk = bus. has future foreign currency obligations/receipts.
      - Importers (exporters) - AUD depreciating (appreciating) as this increase (decrease) AUD cost.
      - Foreign loan (investment) exposes borrower (investor) of AUD depreciating (appreciating) .
  - - - Wholesale & OTC - dealer is organisation listened by ASIC,
        Inter-dealing trading - allows dealers to manage their inv.
        Dealers trading with counter parties
      - Order-driven inter-dealer broking systems. Anonymous bids & offers are accepted
      - FX dealers trade by phone or EBAs (ICAP & Reuters 3000)
        Integrate front & back office functions
        Price discovery
        Lower cost & narrower spreads
- - - - Short Position - they contracted to sell the contracts holder on settlement date at agreed price.
      - Long Position - This is obligation to buy contract item on settlement date at agreed price
    - - Non deliverable must be cash.
  - - - Novation of trades - Clearinghouse is counter party to each transactions, Traders only have obligation to clearinghouse.
      - Margin payments -Initial margin are required from buyer & seller when position is first traded daily resettlement - is required from losing side when lance in its margin account falls below maintenance level - marking to market. Winners receive margin payments back.
- - - - Primary, Wholesale OTC
      - Pros:low default risk,tailormade,convenient
        Con: no secondary market
  - - - Forward interest rates - Commences at future date & extends for specified term
      - Spot interest rates - Current rates of interest - term of spot is given by term to maturity
      - Slide 11
    - - Normal - slopes upward as short term rates are lower than long term
      - Inverse - slopes downward as long term rates are lower than short term
      - Flat - curve is horizontal
      - Construcuted from yields on traded securities . Securites need to little/no credit risk. Yields calculated on single payments e.g. BABs, bonds are stripped of coupons.
  - - - yield curves include a price risk premium as well as expectations
      - Market interest rates include risk premiums that are higher for long term rates or may be expected to change.. Price risk biases choice. Only explains normal yield curves.In isolation, liquidity only explains normal yield cures
    - - Assumes borrowers & lenders are unbiased in choice of securities with different terms.
      - hypothesises that expectation so future spot rates detainee forward rates & thus yield curve shape.
      - normal yield curve = market expects spot rates to rise
  - - - Hedging with dervatives
        
        Estables a forward rates through cast settlement Netiher party knows who'll pay cash settlement as it relies on future spot rates.
        
        For borrower Forward rate hedges risk of higher expected rates
        Eliminates chance of benefiting form a lower than expected rate
        
        For Lender: Forward rate hedges risk of lower than expected rates
        Elimates change of benefiting from higher rate
        
        Spot rates lower than expected = Lender is compensated by cash
      - Market = hedgers mange risk exposure or speculators
    - - Borrower - if rates increase than $P will be lower than expected = higher interest payments
      - Banks, business & gov. have it when they borrow.lend or borrow/invest at floating rate
- - - - Companies - Most companies can't issue bonds so raise funds via bill facility - floating-rate borrower
      - Government - Borrows though fixed-rate bonds but will swap some of its exposure to floating
      - Banks -
  - - - Fixed rate elders imposing higher risk premiums
        Home-group advantages
        Taxes & regulations that impact borrowers differently
- - - - Flow of funds - Alternatives, wholesale direct financing though short-term debt securities issued by gov., bank & companies. Low risk & return.
      - Gives banking system a low risk market - bank sources of funds raised through NCDs & holds liquid reserves e.g. loans
      - Price discovery through short-term interest rates - BBSW - found by ASX at 10am - used in loan contracts in which interest rate is reset on future dates.
      - RBA implements monetary policy - daily open market operations to maintain cash rate at target
    - - Short term, low credit risk, FV paid at maturity
        
        Repurchase agreements - agreement to sell securities & repurchased later at an agreed price. Short-term finance for seller (Securities provider) from buyer (cash provider).
        
        BABs
        
        Promissory
        
        Commercial paper - dealer panel by low risk borrowers. NCDs Treasury notes - competitive tender, risk free & trade below BBSW. 10% of securities
    - - Dealers
        
        Dealers attract trade (being hit) by setting competitive quotes & shade quotes. Hold inventory, salary = interest + trading income
        
        Yields & prices are inversely related. Sell low = bid high, Sell high = offer low. Quotes are private & only valid for that call.
      - OTC, wholesale market. Austraclear - T+2. NCDs + BABS have 2 maturity buckets.
    - - Hold bill to maturity
      - Analysing
        
        Price risk - risk of capital loss
        
        Capital Gains/losses from changes in market yield
        
        Holding period yield = actual yield achieved
  - - - Flow of funds - Wholesale borrowers raise large sums for long terms in defensive assets class. Low credit risk & market risk (change in yield)
      - Price discovery
        
        Default-free interest rates - shown by treasury bonds with 3 & 10 years yields as benchmarks
        
        Credit risk premiums - Credit spread when margin above default free rate a brewer has to pay due to credit rating. Trading in some-vo. & non-gov. bonds show size of credit risk premiums
    - - Wholesale OTC market - dealers are market markers operate to AFMA protocol & trade with wholesale clients & each other. Trade by phone/electronic systems, bid -offer yields on semi annual compound basis, Settlement is arcane by Austraclear on T+ 2 RTGS basis & standard size is $10M.
    - - Treasury bonds
        
        Fixed-rate bond - Bond series identified by coupon rate & date, New series can be added or issued.
        
        issued by gov. - price discovery of default free rates
      - Rating agencies - Informed opinion on credit risk of a security from a ratings agency.Ratings show credit risk so lower rating = higher yieldAus bonds have high rating. Bonds are rated in order to be issued, cost paid by issuer & subject to review.
      - Semi-gov. bond - Issued by State borrowing authorities or agencies. Yields exceed treausury bonds & issues concentrated in benchmark series & issued through declare panels often as closed auction. Dealers make secondary market.
      - Non-gov. bonds
        
        Non-resident bonds
        
        Slide 39
        
        Financials
        
        Mortgage-backed securities
        
        Non-financial companies
    - - Investment return = coupons + interest earned on reinvestment & bonds FV/Selling price.
      - Reinvestment risk - reinserting coupons at a lower yield than purchase yield.
      - Price risk - risk of capital loss if bond is sold at a higher market yield than purchase yield