a)explain how banks quote spot rates to customers.
b)what is the instruments for raising fords inthe share market? Explain detail about syndicated loan
a)explain how banks quote spot rates to customers.
DEFINITION OF 'SPOT RATE'
The price quoted for immediate settlement on a commodity, a security or a currency. The spot rate, also called “spot price,” is based on the value of an asset at the moment of the quote. This value is in turn based on how much buyers are willing to pay and how much sellers are willing to accept, which depends on factors such as current market value and expected future market value. As a result, spot rates change frequently and sometimes dramatically.
In currency transactions, the spot rate is influenced by the demands of individuals and businesses wishing to transact in a foreign currency, as well as by forex traders. The spot rate from a foreign exchange perspective is also called the “benchmark rate,” “straightforward rate” or “outright rate.”
Besides currencies, assets that have spot rates include commodities (e.g., crude oil, conventional gasoline, propane, cotton, gold, copper, coffee, wheat, lumber) and bonds. Commodity spot rates are based on supply and demand for these items, while bond spot rates are based on the zero coupon rate. A number of sources, including Bloomberg, Morningstar and Thomson Reuters, provide spot rate information to traders.
Spot settlement i.e. the transfer of funds that completes a spot transaction, normally occurs one or two business days from the trade date, also called the horizon. The spot date is the day when settlement occurs. Regardless of what happens in the markets between the date the transaction is initiated and the date it settles, the transaction will be completed at the agreed-upon spot rate.
The spot rate is also used in determining a forward rate—the price of a future financial transaction—since a commodity, security or currency’s expected future value is based in part on its current value and in part on the risk-free rate and the time until the contract matures. Traders can extrapolate an unknown spot rate if they know the futures price, risk-free rate and time to maturity.
1. What is the difference between a forward rate and a spot rate?
The forward rate and spot rate are different prices, or quotes, for different contracts. The forward rate is the settlement ..
2. How do I calculate yield to maturity of a zero coupon bond?
Zero coupon bonds do not have re-occurring interest payments, which makes their yield to maturity calculations different ...
3. How is the forex spot rate calculated?
The forex spot rate is determined by supply and demand. Banks all over the world are buying and selling different currencies ..Read
4. What are the different types of price discrimination and how are they used?
Price discrimination is one of the competitive practices used by larger, established businesses in an attempt to profit from ... Read Full Answer >>
5. What is the difference between a capitalist system and a free market system?
A capitalist system and a free market system are economic environments where supply and demand are the main factors of price ... R
6. How does securitization increase liquidity?
Securitization involves taking an illiquid asset (or group of assets) and consolidating with other assets in an effort to ...
The Spot Market What is the Spot Market? A spot transaction is the exchange of one currency for another currency, fixed immediately in respect of an underlying foreign exchange commitment, at a specified rate, where settlement takes place two business days later. The two day settlement process is due to the fact that the bank requires two business days notice to process payments due to time zones and currency cut-off times. In instances where urgent payments/receipts are to be processed, one-day value or even same-day value rates of exchange may be provided depending on currency cut-off times. It is also commonly known as ‘Spot Cover’. Dealing date Settlement (Transaction date) (Value date) There are two spot rates for a currency. The bid rate is the rate at which one currency can be purchased in exchange for another (the price maker’s buying rate), while the offer rate is the rate at which one currency can be sold in exchange for another (the price maker’s selling rate). The difference, or spread, between the two rates provides the bank’s profit margin on transactions. It is very important to understand who is buying and who is selling, this is because the opposite of what the client wants is what happens from the bank’s perspective. That is, • if the client is buying – the bank is selling • if the client is selling – the bank is buying. Each decimal in an exchange rate is commonly referred to as a ‘point’ or ‘pip’. For example, if the USD to rand (ZAR) rate is quoted as USD/ZAR6.8550 and subsequently weakens to USD/ZAR6.8620, the rate is said to have moved by 70 points or pips. Example: A Forex Trader quotes you the following price: USD/ZAR6.4640/50. The USD is referred to as the base currency or commodity currency (BID) that is the rate at which the dollars are bought. For each dollar received, the trader will pay ZAR6.4640. The ZAR is referred to as the quoted currency or the terms currency (OFFER) that is the rate at which dollars are sold. For each dollar sold, the trader will receive ZAR6.4650. The meaning of the quote is that if you wanted to sell one USD, the trader will pay you ZAR6.4640 and if you wanted to buy one USD, you will pay the trader ZAR6.4650. If the trader simultaneously had one buyer and one seller at the price above, the trader would generate a profit of USD0.0010 per transaction. Thus, on a trade of one million rand, the trader would make a profit of USD1 000. Global Markets The Spot Market 2 working days Time Authorised financial services and registered credit provider (NCRCP15) The Standard Bank of South Africa Limited (Reg. No. 1962/000738/06). SBSA 144907-5/13 Types of spot deals The types of spot deals in the South African market are: Rand/USD deals – The bank sells USD to an importer against a payment in rand, or the bank buys USD from an exporter and settles in rand. USD/Foreign currency deals – The bank sells foreign currency to an importer against payment in USD, or the bank buys foreign currency from an exporter and settles in USD. Rand/Foreign currency deals – The bank sells foreign currency to an importer against payment in rand, or the bank buys foreign currency from an exporter and settles in rand. Foreign currency/Foreign currency deals – The bank sells foreign currency, such as British sterling (GBP), to an importer against payment in another foreign currency, say euros. Or, the bank buys foreign currency, such as British sterling, from an exporter and settles in another foreign currency, say euros. Settlement The settlement date is referred to as the ‘value date’, which is the date on which funds change hands, that is the date the sender’s account is debited and the receiver is credited. There are various methods of settlement, which varies the settlement dates or value dates depending on the type of transaction. As mentioned before, spot transactions are settled two business days after the application date. The exchange rate is fixed at the rate quoted when the deal was negotiated, even if there have been exchange rate fluctuations since then. A deal done with one-day value means that the foreign currency is settled one business day after the application date. A deal done with same day value means that the foreign currency is settled the same day as the application date. It may not be possible to obtain ‘same day’ value for certain transactions, for example when dealing with Japan or Australia, owing to the time differentials. No foreign exchange trade dealings take place on Saturdays, Sundays and public holidays. Cross rates In the foreign exchange market, all currencies are quoted against the USD. As you would expect, not all cross border transactions are conducted exclusively in USD. Merchants invoice, or are invoiced in, a variety of currencies. This necessitates determining a price or exchange rate between the rand and the other currencies. Thus, there is a need for a ‘cross rate’ where currencies are quoted against other currencies which are not the USD. By knowing the USD/ZAR exchange rate, as well as the price of other currencies to the dollar, it is a simple mathematical calculation to establish a cross rate, that is the rand to the foreign currency exchange rate. (Bear in mind that banks and brokers run books in cross currencies and therefore a client can ask for a cross rate directly without the trader having to do all the calculations). Example: A Japanese importer of electronic equipment asks the bank for a EUR/JPY quote, thus the bank trader would calculate the price as if the client wanted to: (a) Sell JPY and buy USD (the bank would buy JPY and sell USD) and (b) sell USD and buy EUR (the bank would buy USD and sell EUR). If the following quotes were given: USD/JPY 112.75/85 and EUR/USD 1.0785/95, then part (a) of the transaction would be done at 112.85 and part (b) of the transaction at 1.0795. The resulting exchange would be: 112.85 x 1.0795 = 121.82 (This is the EUR/JPY quote). Multiplication occurs as the USD is quoted against the JPY as the base currency and against the EUR as the quoted currency. Should the reverse occur (the foreign currency is the quoted currency against the USD), the individual rates would be divided. Authorised financial services and registered credit provider (NCRCP15) The Standard Bank of South Africa Limited (Reg. No. 1962/000738/06). SBSA 144907-5/13 Application of spot dealing Once the spot transaction conforms to exchange control requirements, application for spot dealing can be done in writing (giving specific information on a company letterhead), by telephone (giving specific information), via Standard Bank’s Forex Trading System (clients can obtain exchange rates which can be accessed through ‘Business Online’) or by direct dealing (Companies with large foreign exchange exposures may qualify to deal directly with our forex dealing room). Both suppliers and receivers of goods or services can make use of the facility as it caters for diverse types of commercial and financial transactions. Rates of exchange fluctuate second by second. When the bank quotes a rate of exchange, the company must accept or reject it immediately. The acceptance of a rate of exchange is binding.
b)what is the instruments for raising fords inthe share market? Explain detail about syndicated loan
what is the instruments for raising funds in the share market?
Well-functioning financial markets are an essential part of any modern healthy economy. It is through these markets that funds are offered by the lenders/savers who have excess funds and purchased by the borrowers/spenders who need those funds. These borrowers and lenders may meet directly (known as direct finance) or through financial intermediaries (known as indirect finance).
Lenders and borrowers meet directly (the blue arrows at the bottom) or through a financial intermediary (the orange arrows at the top). Through these markets the funds flow that allow for the development of new products/ideas, the expansion of the production of existing products, and consumer spending on "big ticket" items like houses, cars, and college tuition. Without these markets, firms may be unable to expand production or invent new products and consumers will be unable to afford certain products.
The transfer of available funds takes place through the buying and selling of financial instruments or securities. Your book offers the following definition of a financial instrument (36):
A financial instrument is the written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions.
This is a mouthful, but breaking it down, we see several key features. First, this is a binding, enforceable contract under the rule of law, protecting potential buyers. Second, there is the transfer of value between two parties, where a party can be a bank, insurance company, a government, a firm, or an individual. The future dates may be very specific (like a monthly mortgage payment) or may be quite uncertain and depend on certain events (like an insurance policy).
Financial instruments, like money, can function as a means of payment or a store of value. As a means of payment, financial instruments fall well short of money in terms of liquidity, divisibility, and acceptance. However, they are considered better stores of value since they allow for greater increases in wealth over time, but with higher levels of risk. A third function of these instruments is risk transfer. For certain instruments, buyers are shifting risk to the seller, and are basically paying the seller to assume certain risks. Insurance policies are a prime example of this.
Most financial instruments are standardized in that they have the same obligations and contract for buyers. Google stock shares are the same obligation, regardless of buyer. Car loan and mortgage loans contracts use uniform legal language, differing only in specific loan amounts and terms. This standardization reduces costs (since the same types of contracts are used over and over) and makes it easier for buyers and sellers to trade these instruments over and over. In addition to this standardization, financial instruments must provide certain relevant information about the issuer, the characteristics and the risks of the security. This information requirement is a way to even the playing field among different parties and reduce unfair advantages.
the size, timing and certainty of cash flows are all important in determining the value of a financial instrument:
• How much is promised? $1000? $10,000? $1 million? The larger amount promised, the greater the value.
• When is it promised? In 30 days? 1 year? Over 10 years? The sooner the payments are promised, the greater the value.
• How likely is it the payments will be made? How creditworthy is the issuer of the financial instument? If the issuer is the U.S. government, payment is considered a certainty. If the issuer is my brother-in-law, well good luck with that... The more certain the payments, the greater the value.
• Under what conditions are the payments made? For some instruments, payment is contingent on an event, like a fire, or car accident. The more needed the payment, the greater the value.
There is not one financial market, but rather many markets, each dealing with a particular type of financial instrument. But all financial markets perform crucial functions. By providing a mechanism for quickly and cheap buying and selling of securities, financial markets offer liquidity. Financial markets allow the interaction of buyers and sellers to determine the price and the price conveys important information about the prospects of the issuer. Finally, financial markets are the mechanism for buying and selling the instruments that transfer risks between buyers and sellers.
We can classify financial markets into narrower categories based on the type of assets traded, their characteristics, or even the location of markets.
Primary vs. Secondary Markets
The primary market is like the new car market. The financial instruments sold in the primary market are brand new, or new issues. They are sold to the buyer by the issuer. The secondary market is like the used car market (or as car dealers like to say "previously-owned vehicle"). The securities sold in the secondary market are being resold by previous buyers for the second, tenth, or fortieth time.
Financial intermediaries play a role in both markets. In the primary market, investment banks assist a business in selling a new issue to the public. Investment banks underwrite new securities, meaning that they buy the new issue from the business and sell it to the public. Investment banks charge fees for this service, along with any profits from reselling the issue at a higher price. Underwriting is big business. The largest underwriters of new equity securities include Merril Lynch, Salomon Smith Barney, and Goldman Sachs.
Even in the secondary market, financial intermediaries are an important part of a well-functioning market. Securities brokers facilitate trade by match buyers with sellers. For this they charge a commission on each match (or trade).
Securities dealers act as the buyer and seller by continuously quoting a price at which they will buy a security (the bid price) and the price at which they will sell the security (the ask price). The bid price is lower than the ask price (the difference is known as the bid-ask spread), and this is how dealers make their money. Dealers own an inventory of the securities in which they deal. Since dealers stand ready to be the buyer or seller for a security, dealers are said to "make a market" in that security, and dealers are often referred to as "market-makers". If a buyer is looking for a seller, the dealer acts as the seller. If a seller is looking for a buyer, the dealer acts as a buyer. This way there is always a buyer and seller, so there is always a market.
Why have a secondary market? Keep in mind that the better the secondary market, the better the primary market. Why? Because if securities are easily bought and sold, then they will be more popular in the first place. The ease of which a security is converted to cash is known as its liquidity. High liquidity is considered a good feature. If, for example, Microsoft stock is easy to buy and sell in the secondary market (highly liquid) then it will be popular in the primary market.
Exchanges vs. OTC Markets
Secondary markets can be classified by where or how the trading of securities takes place. When buying and selling occurs in a central, physical location, then securities are traded on an exchange. The New York Stock Exchange is probably the best-known example. The NYSE had an average daily volume of over 1 billion shares traded. London and Tokyo also have large exchanges. The NYSE depends on a specialist system, where a firm is charged with maintaining an orderly market for each individual stock traded on the exchange.
The alternative to an exchange is trading by geographically dispersed buyers and sellers, linked by computer. This is known as an over-the-counter (OTC) market. The name originated from pre-computer days when securities and money were literally exchanged over countertops by buyers and sellers. Today OTC markets link buyers and sellers electroncially through dealers. The OTC markets depend on dealers who make a market in various securities. Debt securities are traded in OTC markets (although some bond trading does occur on the NYSE), while stocks are traded on exchanges and large OTC markets, like the NASDAQ. The largest companies typically have their stocks trade on an exchange, but overall the NASDAQ has a larger transaction volume.
ECNs or electronic communication networks offer yet a third option for buyers and seller to find each other directly with no dealer or broker. Examples include Instinet and Archipelago.
In the Spring of 2005 the NYSE announced a merger between the NYSE and Archipelago. It has yet to be approved, but it will be interesting to see how this will affect the specialist system. Some argue it will be phased out in favor of electronic order matching.
Debt vs. Equity vs. Derivative Markets
Recall that debt instruments, like a bond or a bank loan, involve a promise by the borrower (the seller/issuer of the debt instrument) to pay the lender (the owner/buyer of the debt instrument) fixed payments at specified intervals until a final date. The time until all payments are made is known as the maturity of a debt security. For example, most mortgages have a maturity of 30 years when first created. We can further classify the debt market by maturity:
• Short-term debt securities have a maturity of up to 1 year. This part of the debt market is also known as the money market.
• Intermediate-term debt securities have a maturity of between 1 and 10 years.
• Long-term debt securities have a maturity of 10 years or more.
Equity instruments, like shares of common stock, are claims on the earnings and assets of a corporation. If you own 5% of the shares of a company, then you are entitles to 5% of the earnings and assets of that company once creditors are satisfied. Equity securities differ from debt in that
• the size and timing of the payments are not fixed. Some equities securities entitle the owner to periodic payments (known as dividends) but these payments are not guaranteed. This means that equity holders benefit from a firm's profitability in a way that debt holders do not.
• there is no maturity date for equity securities so they are considered long-term securities.
• stock holders are considered residual claimants in the event of bankruptcy. This means that all debt holders must be paid first before stock holders receive anything. This makes equity securities somewhat riskier than debt securities. For example, many internet startups went bankrupt in 2001. The assets were sold but did not even cover all of the debts so stock holders got nothing. zip. zero. nada.
Derivatives markets trade securities that derive there value from other underlying assets. The derivatives markets is primarily a way for buyers and sellers to transfer risks that occur due to fluctuating asset prices. This market has seen tremendous growth in the past two decades.
Financial intermediaries can be subdivided into three categories based on their liabilities (how they get their funds) and their assets (how they use their funds).
These institutions are often collectively referred to as banks. All institutions in this category accept deposits and make loans. We will focus on this group because they play a large role in monetary policy.
Commercial banks' primary liabilities are deposits (checking accounts, savings accounts and CDs) and their primary assets include commercial loans, consumer loans, mortgages, U.S. government bonds, municipal bonds. They are the largest type of financial intermediary, as measured by the total value of their assets. (See table 2, page 36.)
Savings and Loan Associations were created in the 1930s and originally restricted to offering savings accounts and CDs and making mortgage loans. In the 1980s these restrictions were relaxed to allow greater asset and liability choices, making S&Ls very similar to commercial banks. Mutual Savings banks are very similar to S&Ls, with the only distinction being that mutual savings banks are owned by the depositors.
Credit Unions are the smallest of the depository institutions. They take deposits and primarily make consumer loans. Credit unions are distinguished by two features: They are nonprofit and credit union membership is organized around a particular group, such as company employees, a union, or even a church parish.
Life insurance companies receive premiums in return for protection from the risk of death. Mortality rates are predictable, so the timing and size of payouts for these companies are also predictable. Life insurance companies also sell a variety of investment products as well, such as annuities and guaranteed investments contracts (GICs). Life insurance companies are the largest buyer of corporate bonds, and invest heavily in mortgages as well. They hold very little stock or municipal bonds.
Fire and casualty insurance companies receive premiums in return for protection from the risk of property damage/loss, liability, and disability. The size and time of their payouts are less predictable, since natural disasters such as a major earthquake or bad hurricane season can greatly affect the amount of property damage that occurs in a given year. Because of this, their assets are more liquid than life insurance companies. They hold municipal bonds, corporate bonds, stocks, and U.S. government bonds.
Pension funds may be privately-sponsored or government-sponsored, but in either case they provide retirement income in return for contributions from employees and employers during their working years. Pension funds receive very favorable tax treatment at the federal level. Again, the payouts are predictable, so assets are long term such as corporate bonds and stocks.
Finance companies have taken much of the consumer and commercial loan business away from depository institutions. These companies raise funds by issuing commercial paper (they do NOT accept deposits). They then use these funds to make business loans, construction loans, auto loans and other consumer loans. For example, all 3 major U.S. auto companies, GM, Ford, and Chrysler have finance companies to help consumers finance auto purchases. Other finance companies specialize in credit cards.
Securties firms include brokers, investment banking/underwriting and mutual funds. Mutual funds sell shares to individuals and use those funds to purchase and manage a diversified portfolio of stocks and/or bonds. The value of the shares fluctuates with the value of the underlying portfolio. Why not just buy stock directly? Because through mutual funds, investors can diversify with little initial capital, receive professional management of their investments, and save on transactions costs. These advantages explain why the number of mutual funds has grown from less than 500 in 1980 to over 6000 today. Mutual funds vary according to their investment objectives and the type of securities they hold. Some funds focus on a particular sector, like technology or health care, while some focus on U.S. government bonds or municipal bonds. Money market mutual funds have features like both a mutual fund and a checking account. These funds sell shares, fixed at a price of $1, and use those shares to buy money market instruments. These funds then pay regular dividends in the form of additional shares. These funds also have restricted check writing privileges. They operate like an interest bearing checking account with a large minimum deposit. They have taken away funds from banks by competing for depositors.
GSEs or Government-sponsored enterprises are federal credit agencies that were created to supply credit to farmers or home buyers or even for student loans. Examples of these include Fannie Mae (home mortages) and Sallie Mae (studens loans). Note that these two enterprises are not government agencies, but are privately held firms created through government charters and special access to government services.
WHAT IS SHARE MARKET?
A share market is where shares are either issued or traded in.
A stock market is similar to a share market. The key difference is that a stock market helps you trade financial instruments like bonds, mutual funds, derivatives as well as shares of companies. A share market only allows trading of shares.
The key factor is the stock exchange – the basic platform that provides the facilities used to trade company stocks and other securities.
A stock may be bought or sold only if it is listed on an exchange. Thus, it is the meeting place of the stock buyers and sellers. India's premier stock exchanges are the Bombay Stock Exchange and the National Stock Exchange.
THERE ARE TWO KINDS OF SHARE MARKETS – PRIMARY AND SECOND MARKETS.
This where a company gets registered to issue a certain amount of shares and raise money. This is also called getting listed in a stock exchange.
A company enters primary markets to raise capital. If the company is selling shares for the first time, it is called anInitial Public Offering (IPO). The company thus becomes public.
Once new securities have been sold in the primary market, these shares are traded in the secondary market. This is to offer a chance for investors to exit an investment and sell the shares. Secondary market transactions are referred to trades where one investor buys shares from another investor at the prevailing market price or at whatever price the two parties agree upon.
Normally, investors conduct such transactions using an intermediary such as a broker, who facilitates the process.
WHAT ARE THE FINANCIAL INSTRUMENTS TRADED IN A STOCK MARKET?
Now that we have understood what a stock market is, let us understand the four key financial instruments that are traded:
Companies need money to undertake projects. They then pay back using the money earned through the project. One way of raising funds is through bonds. When a company borrows from the bank in exchange for regular interest payments, it is called a loan. Similarly, when a company borrows from multiple investors in exchange for timely payments of interest, it is called a bond.
For example, imagine you want to start a project that will start earning money in two years. To undertake the project, you will need an initial amount to get started. So, you acquire the requisite funds from a friend and write down a receipt of this loan saying 'I owe you Rs 1 lakh and will repay you the principal loan amount by five years, and will pay a 5% interest every year until then'. When your friend holds this receipt, it means he has just bought a bond by lending money to your company. You promise to make the 5% interest payment at the end of every year, and pay the principal amount of Rs 1 lakh at the end of the fifth year.
Thus, a bond is a means of investing money by lending to others. This is why it is called a debt instrument. When you invest in bonds, it will show the face value – the amount of money being borrowed, the coupon rate or yield – the interest rate that the borrower has to pay, the coupon or interest payments, and the deadline for paying the money back called as the maturity date.
The share market is another place for raising money. In exchange for the money, companies issue shares. Owning a share is akin to holding a portion of the company. These shares are then traded in the share market. Consider the previous example; your project is successful and so, you want to expand it.
Now, you sell half of your company to your brother for Rs 50,000. You put this transaction in writing – ‘my new company will issue 100 shares of stock. My brother will buy 50 shares for Rs 50,000.' Thus, your brother has just bought 50% of the shares of stock of your company. He is now a shareholder. Suppose your brother immediately needs Rs 50,000. He can sell the share in the secondary market and get the money. This may be more or less than Rs 50,000. For this reason, it is considered a riskier instrument.
Shares are thus, a certificate of ownership of a corporation.
Thus, as a stockholder, you share a portion of the profit the company may make as well as a portion of the loss a company may take. As the company keeps doing better, your stocks will increase in value.
These are investment vehicles that allow you to indirectly invest in stocks or bonds. It pools money from a collection of investors, and then invests that sum in financial instruments. This is handled by a professional fund manager.
Every mutual fund scheme issues units, which have a certain value just like a share. When you invest, you thus become a unit-holder. When the instruments that the MF scheme invests in make money, as a unit-holder, you get money.
This is either through a rise in the value of the units or through the distribution of dividends – money to all unit-holders.
The value of financial instruments like shares keeps fluctuating. So, it is difficult to fix a particular price. Derivatives instruments come handy here.
These are instruments that help you trade in the future at a price that you fix today. Simply put, you enter into an agreement to either buy or sell a share or other instrument at a certain fixed price.
WHAT DOES THE SEBI DO?
Stock markets are risky. Hence, they need to be regulated to protect investors. The Security and Exchange Board of India (SEBI) is mandated to oversee the secondary and primary markets in India since 1988 when the Government of India established it as the regulatory body of stock markets. Within a short period of time, SEBI became an autonomous body through the SEBI Act of 1992.
SEBI has the responsibility of both development and regulation of the market. It regularly comes out with comprehensive regulatory measures aimed at ensuring that end investors benefit from safe and transparent dealings in securities.
Its basic objectives are:
• Protecting the interests of investors in stocks
• Promoting the development of the stock market
• Regulating the stock market
Types of Financial Instruments
Money Market Instruments The major purpose of financial markets is to transfer funds from lenders to borrowers. Financial market participants commonly distinguish between the "capital market" and the "money market". The money market refer to borrowing and lending for periods of a year or less.
Treasury bills Treasury bills are short-term securities issued by the U.S. Treasury. The Treasury sells bills at regularly scheduled auctions to refinance maEagleTraders.comg issues. It also helps to finance current federal deficits. They further sell bills on an irregular basis to smooth out the uneven flow of revenues from corporate and individual tax receipts.
Certificates of deposit A certificate of deposit is a document evidencing a time deposit placed with a depository institution. The following information appears on the certificate:
• the amount of the deposit;
• the date on which it matures;
• the interest rate; and
• the method under which the interest is calculated.
Large negotiable CDs are generally issued in denominations of $1 million or more.
Commercial Paper Commercial paper is a short-term unsecured promissory note issued by corporations and foreign governments. It is a low-cost alternative to bank loans, for many large, credit worthy issuers. Issuers are able to efficiently raise large amounts of funds quickly and without expensive Securities and Exchange Commission (SEC) registration. They sell paper, either directly or through independent dealers, to a large and varied pool of institutional buyers. Investors in commercial paper earn competitive, market-determined yields in notes whose maturity and amounts can be tailored to their specific needs.
Bankers Acceptances/Letters of credit )
A bankers acceptance, or BA, is a time draft drawn on and accepted by a bank. Before acceptance, the draft is merely an order by the drawer to the bank to pay a specified sum of money on a specified date to a named person or to the bearer of the draft, it is not an obligation of the bank. Upon acceptance, which occurs when an authorized bank employee stamps the draft "accepted" and signs it, the draft becomes a primary and unconditional liability of the bank. If the bank is well known and enjoys a good reputation, the accepted draft may be readily sold in an active market.
Eurodollars Eurodollars are bank deposit liabilities denominated in U.S. dollars. It's not subject to U.S. banking regulations. For the most part, banks offering Eurodollar deposits are located outside the United States. However, since late 1981 non-U.S. residents have been able to conduct business free of U.S. banking regulations at International Banking Facilities (IBFs) in the United States. Individuals, corporations, or governments from anywhere in the world may own Eurodeposits. The exception are that only non-U.S. residents can hold deposits at IBFs.
Repurchase Agreements (RPs) and Reverse RPs The terms repurchase agreement (repo or RP) and reverse repurchase agreement refer to a type of transaction in which a money market participant acquires immediately available funds byselling securities and simultaneously agreeing to repurchase the same or similar securities after a specified time at a given price, which typically includes interest at an agreed-upon rate. A transaction viewed from the perspective of the supplier of securities (the party acquiring funds) is called a repo, and it's a reverse repo or matched sale-purchase agreement when described from the point of view of the supplier of funds.
A Guarantee by Bank (banker's guarantee) is a written undertaking wherein the bank agrees to make stipulated payments on your behalf should you fail to fulfill or carry out specified terms of a contract. Guarantees may also be issued in respect of the purchase of fixed property and against cash cover.
The bank's liability is restricted to the payment of a sum of money and under no circumstances accepts responsibility for the completion of the customer's contract.
• Guarantees may be continuing or for a specified period - wherever possible a definite or determined expiry date or a clause specifying a period of notice or withdrawal is to be included in the guarantee.
• The party in whose favor the guarantee is issued is entitled to specify the wording of the document. (At your request the bank can draft the wording of the document.)
• Any demands for payment under a guarantee are to be made in writing.
• You can avoid having to pay in advance or lodging cash cover to secure a purchase or contract thereby saving interest on your funds. If cash cover is lodged with the bank under pledge you will be paid interest on the investment.
• Enables you to bid for contracts which call for guarantees and to purchase fixed property where a guarantee is usually a prerequisite.
Bonds A bond is a debt security, similar to an I.O.U. You are lending money to a government, corporation, municipality, federal agency or other entity known as the issuer, when you purchase a bond.
In return for the loan, the issuer promises to repay the face value of the bond (the principal) when it "matures" or comes due and to pay you a specified rate of interest during the life of the bond. You can choose among the following types of bonds: U.S. government securities, corporate bonds, federal age securities, municipal bonds, mortgage and asset-backed securities and foreign government bond.
Corporate bonds Corporate bonds (also called corporates) are debt obligations, or IOUs, issued by private and public corporations. They are typically issued in multiples of $1,000 and/or $5,000. The funds raised by companies from selling bonds are used for a variety of purposes, from building facilities to purchasing equipment to expanding the business. When you buy a bond, you are lending money to the corporation that issued it, which promises to return your money, or principal, on a specified maturity date. Until that time, it also pays you a stated rate of interest, usually semiannually. The interest payments you receive from corporate bonds are taxable. Unlike stocks, bonds do not give you an ownership interest in the issuing corporation.
The Money Market Instruments
Instrument Principal Borrowers
Discount Window Banks
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Explain detail about syndicated loan
A loan offered by a group of lenders (called a syndicate) who work together to provide funds for a single borrower. The borrower could be a corporation, a large project, or a sovereignty (such as a government). The loan may involve fixed amounts, a credit line, or a combination of the two. Interest rates can be fixed for the term of the loan or floating based on a benchmark rate such as the London Interbank Offered Rate (LIBOR).
Typically there is a lead bank or underwriter of the loan, known as the "arranger", "agent", or "lead lender". This lender may be putting up a proportionally bigger share of the loan, or perform duties like dispersing cash flows amongst the other syndicate members and administrative tasks.
Also known as a "syndicated bank facility".
The main goal of syndicated lending is to spread the risk of a borrower default across multiple lenders (such as banks) or institutional investors like pensions funds and hedge funds. Because syndicated loans tend to be much larger than standard bank loans, the risk of even one borrower defaulting could cripple a single lender. Syndicated loans are also used in the leveraged buyout community to fund large corporate takeovers with primarily debt funding.
Syndicated loans can be made on a "best efforts" basis, which means that if enough investors can't be found, the amount the borrower receives will be lower than originally anticipated. These loans can also be split into dual tranches for banks (who fund standard revolvers or lines of credit) and institutional investors (who fund fixed-rate term loans).
Types of Syndications[
Globally, there are three types of underwriting for syndications: an underwritten deal, best-efforts syndication, and a club deal.
An underwritten deal is one for which the arrangers guarantee the entire commitment, then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to absorb the difference, which they may later try to sell to investors. This is easy, of course, if market conditions, or the credit’s fundamentals, improve. If not, the arranger may be forced to sell at a discount and, potentially, even take a loss on the paper. Or the arranger may just be left above its desired hold level of the credit.
Arrangers underwrite loans for several reasons. First, offering an underwritten loan can be a competitive tool to win mandates. Second, underwritten loans usually require more lucrative fees because the agent is on the hook if potential lenders balk. Of course, with flex-language now common, underwriting a deal does not carry the same risk it once did when the pricing was set in stone prior to syndication.
A best-efforts syndication is one for which the arranger group commits to underwrite less than or equal to the entire amount of the loan, leaving the credit to the vicissitudes of the market. If the loan is undersubscribed, the credit may not close—or may need significant adjustments to its interest rate or credit rating to clear the market. Traditionally, best-efforts syndications were used for risky borrowers or for complex transactions. Since the late 1990s, however, the rapid acceptance of market-flex language has made best-efforts loans the rule even for investment-grade transactions.
A club deal is a smaller loan—usually $25–100 million, but as high as $150 million—that is premarketed to a group of relationship lenders. The arranger is generally a first among equals, and each lender gets a full cut, or nearly a full cut, of the fees.
The Syndications Process[
Leveraged transactions fund a number of purposes. They provide support for general corporate purposes, including capital expenditures, working capital, and expansion. They refinance the existing capital structure or support a full recapitalization including, not infrequently, the payment of a dividend to the equity holders. They provide funding to corporations undergoing restructurings, including bankruptcy, in the form of super senior loans also known as debtor in possession (DIP) loans. Their primary purpose, however, is to fund M&A activity, specifically leveraged buyouts, where the buyer uses the debt markets to acquire the acquisition target’s equity.
A buyout transaction originates well before lenders see the transaction’s terms. In a buyout, the company is first put up for auction. With sponsored transactions, a company that is for the first time up for sale to private equity sponsors is a primary LBO; a secondary LBO is one that is going from one sponsor to another sponsor, and a tertiary is one that is going for the second time from sponsor to sponsor. A public-to-private transaction (P2P) occurs when a company is going from the public domain to a private equity sponsor.
As prospective acquirers are evaluating target companies, they are also lining up debt financing. A staple financing package may be on offer as part of the sale process. By the time the auction winner is announced, that acquirer usually has funds linked up via a financing package funded by its designated arranger, or, in Europe, mandated lead arranger (MLA).
Before awarding a mandate, an issuer might solicit bids from arrangers. The banks will outline their syndication strategy and qualifications, as well as their view on the way the loan will price in market. Once the mandate is awarded, the syndication process starts.
In Europe, where mezzanine capital funding is a market standard, issuers may choose to pursue a dual track approach to syndication whereby the MLAs handle the senior debt and a specialist mezzanine fund oversees placement of the subordinated mezzanine position.
The arranger will prepare an information memo (IM) describing the terms of the transactions. The IM typically will include an executive summary, investment considerations, a list of terms and conditions, an industry overview, and a financial model. Because loans are unregistered securities, this will be a confidential offering made only to qualified banks and accredited investors. If the issuer is speculative grade and seeking capital from nonbank investors, the arranger will often prepare a “public” version of the IM. This version will be stripped of all confidential material such as management financial projections so that it can be viewed by accounts that operate on the public side of the wall or that want to preserve their ability to buy bonds or stock or other public securities of the particular issuer (see the Public Versus Private section below). Naturally, investors that view materially nonpublic information of a company are disqualified from buying the company’s public securities for some period of time. As the IM (or “bank book,” in traditional market lingo) is being prepared, the syndicate desk will solicit informal feedback from potential investors on what their appetite for the deal will be and at what price they are willing to invest. Once this intelligence has been gathered, the agent will formally market the deal to potential investors.
The executive summary will include a description of the issuer, an overview of the transaction and rationale, sources and uses, and key statistics on the financials. Investment considerations will be, basically, management’s sales “pitch” for the deal.
The list of terms and conditions will be a preliminary term sheet describing the pricing, structure, collateral, covenants, and other terms of the credit (covenants are usually negotiated in detail after the arranger receives investor feedback).
The industry overview will be a description of the company’s industry and competitive position relative to its industry peers.
The financial model will be a detailed model of the issuer’s historical, pro forma, and projected financials including management’s high, low, and base case for the issuer.
Most new acquisition-related loans are kicked off at a bank meeting at which potential lenders hear management and the sponsor group (if there is one) describe what the terms of the loan are and what transaction it backs. Management will provide its vision for the transaction and, most importantly, tell why and how the lenders will be repaid on or ahead of schedule. In addition, investors will be briefed regarding the multiple exit strategies, including second ways out via asset sales. (If it is a small deal or a refinancing instead of a formal meeting, there may be a series of calls or one-on-one meetings with potential investors.)
In Europe, the syndication process has multiple steps reflecting the complexities of selling down through regional banks and investors. The roles of each of the players in each of the phases are based on their relationships in the market and access to paper. On the arrangers’ side, the players are determined by how well they can access capital in the market and bring in lenders. On the lenders’ side, it is about getting access to as many deals as possible.
There are three primary phases of syndication in Europe. During the underwriting phase, the sponsor or corporate borrowers designate the MLA (or the group of MLAs) and the deal is initially underwritten. During the sub-underwriting phases, other arrangers are brought into the deal. In general syndication, the transaction is opened up to the institutional investor market, along with other banks that are interested in participating.
In the U.S. and in Europe, once the loan is closed, the final terms are then documented in detailed credit and security agreements. Subsequently, liens are perfected and collateral is attached.
Loans, by their nature, are flexible documents that can be revised and amended from time to time after they have closed. These amendments require different levels of approval. Amendments can range from something as simple as a covenant waiver to something as complex as a change in the collateral package or allowing the issuer to stretch out its payments or make an acquisition.
Loan Market Participants[
There are three primary-investor constituencies: banks, finance companies, and institutional investors; in Europe, only the banks and institutional investors are active.
In Europe, the banking segment is almost exclusively made up of commercial banks, while in the U.S. it is much more diverse and can involve commercial and investments banks, business development corporations or finance companies, and institutional investors such as asset managers, insurance companies and loan mutual funds and loan ETFs. As in Europe, commercial banks in the U.S. provide the vast majority of investment-grade loans. These are typically large revolving credits that back commercial paper or are used for general corporate purposes or, in some cases, acquisitions.
For leveraged loans, considered non-investment grade risk, U.S. and European banks typically provide the revolving credits, letters of credit (L/C's), and—although they are becoming increasingly less common—fully amortizing term loans known as "Term Loan A" under a syndicated loan agreement while institutions provide the partially amortizing term loans known a "Term Loan B".
Finance companies have consistently represented less than 10% of the leveraged loan market, and tend to play in smaller deals—$25–200 million. These investors often seek asset-based loans that carry wide spreads and that often feature time-intensive collateral monitoring.
Institutional investors in the loan market are principally structured vehicles known as collateralized loan obligations (CLO) and loan participation mutual funds (known as “prime funds” because they were originally pitched to investors as a money-market-like fund that would approximate the prime rate) also play a large role. Although U.S. prime funds do make allocations to the European loan market, there is no European version of prime funds because European regulatory bodies, such as the Financial Services Authority (FSA) in the U.K., have not approved loans for retail investors.
In addition, hedge funds, high-yield bond funds, pension funds, insurance companies, and other proprietary investors do participate opportunistically in loans. Typically, however, they invest principally in wide-margin loans (referred to by some players as “high-octane” loans), with spreads of 500 basis points or higher over the base rate.
CLOs are special-purpose vehicles set up to hold and manage pools of leveraged loans. The special-purpose vehicle is financed with several tranches of debt (typically a ‘AAA’ rated tranche, a ‘AA’ tranche, a ‘BBB’ tranche, and a mezzanine tranche with a non-investment grade rating) that have rights to the collateral and payment stream in descending order. In addition, there is an equity tranche, but the equity tranche is usually not rated. CLOs are created as arbitrage vehicles that generate equity returns through leverage, by issuing debt 10 to 11 times their equity contribution. There are also market-value CLOs that are less leveraged—typically three to five times—and allow managers more flexibility than more tightly structured arbitrage deals. CLOs are usually rated by two of the three major ratings agencies and impose a series of covenant tests on collateral managers, including minimum rating, industry diversification, and maximum default basket.
In U.S., before the financial crisis in 2007-2008, CLOs had become the dominant form of institutional investment in the leveraged loan market taking a commanding 60% of primary activity by institutional investors by 2007. But when the structured finance market cratered in late 2007, CLO issuance tumbled and by mid-2008, the CLO share had fallen to 40%. In 2014 CLO issuance has demonstrated a full recovery with issuance of $90 billion by August, an amount that effectively equals the previous record set in 2007. Projections on total issuance for 2014 are as high as $125 billion.
In Europe, over the past few years, other vehicles such as credit funds have begun to appear on the market. Credit funds are open-ended pools of debt investments. Unlike CLOs, however, they are not subject to ratings oversight or restrictions regarding industry or ratings diversification. They are generally lightly levered (two or three times), allow managers significant freedom in picking and choosing investments, and are subject to being marked to market.
In addition, in Europe, mezzanine funds play a significant role in the loan market. Mezzanine funds are also investment pools, which traditionally focused on the mezzanine market only. However, when second lien entered the market, it eroded the mezzanine market; consequently, mezzanine funds expanded their investment universe and began to commit to second lien as well as payment-in-kind (PIK) portions of transaction. As with credit funds, these pools are not subject to ratings oversight or diversification requirements, and allow managers significant freedom in picking and choosing investments. Mezzanine funds are, however, riskier than credit funds in that they carry both debt and equity characteristics.
Retail investors can access the loan market through prime funds. Prime funds were first introduced in the late 1980s. Most of the original prime funds were continuously offered funds with quarterly tender periods. Managers then rolled true closed-end, exchange-traded funds in the early 1990s. It was not until the early 2000s that fund complexes introduced open-ended funds that were redeemable each day. While quarterly redemption funds and closed-end funds remained the standard because the secondary loan market does not offer the rich liquidity that is supportive of open-end funds, the open-end funds had sufficiently raised their profile that by mid-2008 they accounted for 15-20% of the loan assets held by mutual funds.
As the ranks of institutional investors have grown over the years, the loan markets have changed to support their growth. Institutional term loans have become commonplace in a credit structure. Secondary trading is a routine activity and mark-to-market pricing as well as leveraged loan indexes have become portfolio management standards.