>Note

Cat: ECO
Pub: 2003
#1614b

Takeshi Fujimaki (藤巻健史)

16705u/18227r

Intensive Course of Practical Financial Market

実践･金融マーケット集中講義

0. Introduction
1. Exchange market:
2. Short-term money market:
3. Long-term government bond market:
4. Interest rate swap market:
5. Open market

0. 序文:
1. 為替マーケット:
2. 短期金融マーケット:
3. 長期国債マーケット:
4. 金利スワップマーケット:
5. オプションマーケット:

English

Reference

>Top 0. Introduction:

• This is a practical lecture of financial market, obtained from various experience as the dealer of JP Morgan.
• Knowledge of finance is indispensable to earn the money. But the importance of financial market related to the overall economy or national activity.

0. 序文:

1. JPモルガン時代のトレーダーの経験
2. 金融の知識は、金儲けだけでなく、経済全般、国家の活動に関連する。

>Top 1. Exchange market:

• Bid rate and Offered rate:
  • 121.25-35 ¥/$: means the highest bid rate of a buyer is 121.25; the lowest TTS (Telegraphic Transfer Selling rate), Middle rate, TTB (Telegraphic Transfer Buying rate:
  • Considering:
• Mine; Yours (121.35 yours); Done (=agreed the transaction)
• EBS (Electronic Brokering Service): a wholesale electronic trading platform to trade FX (Foreign eXchange)
  • ICAP; <Intercapital listed in London Stock Exchange
  • FRB of US is a member of the ICAP, but BOJ is not.
• How to earn a trader of FX?
  • A: Buy FX cheap, and sell it high.
  • C: There will be no low-risk & high-return product.
  • C: The business is $\pm$ interest and exchange rate.
  • Order of the transaction:
    • around $500M at the difference of ¥0.3/$
  • The breakeven will be the sum of $500M×0.3 ¥/$=¥150M
• >Top Futures contract (or futures), or forward contract:
  • The parties agree to buy and sell an asset for a price agreed upon today with delivery and payment occurring at a future point. (derivative product)
    • Currency futures, interest rate futures and stock market index futures.
    • Forward exchange rate is not an estimate after 1 year; which is automatically calculated by interest difference of the spot.
• Spot contract:
  • A: Actual delivery is 2 days later.
• Why exchange rate fluctuate?
  • A: fundamentals (or national power)
  • A: Keynesian beauty contest
  • A: Difference of interest rate
  • A: Balance of payments; trade surplus increase, $ selling pressure increases.
    • C: 1) Goods & services balance+2) Income balance+3) Current capital transfer balance+4) Foreign exchange reserve+5) Errors & omissions
      (Current A/C=1+2, and Capital A/C=3)
    • Japan tends to emphasize the sizeｚof goods balance, underestimating the impact of services balance; recent Japanese are mostly pensioners, whose life is depending on income by the interest and dividend.
• Structure of balance of payments of Japan has changed:
  • In 1985:big surplus of goods balance (trading nation)
  • In 2001: mostly depend of income balance
    • B: there will be no $ selling pressure.
  • Q: Do the foreign investors sell Japanese stock when ¥ becomes weaker?
    • B: Investment profit and risk hedge of exchange are different.
• Repatriation problem:
  • B: Japanese banks mostly procure and operate in $ in transaction in US. They rarely reflux their profit to HQ in Japan changing into ¥.
  • US banks evaluate the transaction by the market value, not by the book value, so they have no incentive to sell assets as of end of the accounting period.
• $ buying in emergency:
• Maxima about the market: buying in the distant war, selling in the near war.
• Internal exchange rate:
• if the internal rate was determined at ¥130/$, Japanese companies tend to sell at the rate slightly higher than the internal rate, considering discount rate of the forward. (say, ¥131 or ¥132)
• >Top Foreign exchange intervention:
• B: J-Government or BOJ are one of participant, who could move the market trend.
• C: but, they could be an adjuster of the ¥ level and its real economy.
  • Their ¥ fund will be procured by issue of FB (Financial Bill);
    • Balance of FB: ¥57T (2003)
  • Sterilized intervention (>)
• C: FX intervention is a powerful carry trade.
• Super-preferential rate?:
• Seller's rate (6mos future) is not preferable.
• Credit risk:
  • Spot exchange inter banks: there is 2 days risk.
  • Future exchange with individual: there is a risk.
• Economic measures (FFE):
  • 1) Fiscal policy, 2) Financial policy, 3) Exchange policy.
  • Plaza accord (1985): to make weaker $.
  • Lourvre accord (1987): to adjust too weaker $.
  • RMB: 1.5 RMB/$ (c1980), now 8.3 RMB/$ (1995-)
    • Weaker exchange rate means; stronger competitiveness (more jobs) and weaker ppp
    • Weaker ¥ is better than dismissal of labor (=hollowing out of industry)
    • Debt in foreign currency denominated: cannot make weaker of the local currency.
    • Asian currency crisis in 1997:
      • Most of Asian countries adopted fix rate or being pegged to $.
      • Fix rate or $ peg is indispensable to induce foreign investment.
    • Capitalism=Market mechanism=Speculators are indispensable.
      • Market is not sustainable only by actual demand.
      • Market system which is attacked by speculators; the system is worse than the speculators.
        • "Speculators are haunting in the market."

1. 為替マーケット:

• Question?:
• Answer:
1. A: .... Affirmative 肯定的コメント
2. B: .... But then　否定的コメント
3. C: .... Considering　別要素コメント
• Simulation:

• 国際収支=経常収支+資本収支
  • 経常収支:
    • モノサービス収支: 給与ボーナス
    • 所得収支: 利息配当
  • 資本収支: 元本

• FB: Financial Bill, 政府短期証券
  • 外為特別会計 (FX special account)
  • MOF:

  • F-currency reserve

    FB

  • BOJ:

  • FB	Currency issue

  • BS of Monetary Authority

  • D-credit	Currency issue balance ↗
    F-reserve ↗

• 不胎化介入1 (Sterilized intervention):
  為替介入による通貨供給量の相殺
  1. 急な円高→円売介入→円の下落
  2. 通貨供給量増加→金融緩和効果(金利低下)
  3. 売りオペ→市場余剰資金吸収→金利下がらず→為替介入効果薄れる
• 不胎化介入2
1. 急な円安→円買介入→円の上昇
2. 通貨供給量減少→金融引締効果(金利上昇)
3. 買いオペ→市場に資金供給→金利上がらず→為替介入効果薄れる
   
   
• FX Rate:

>Top 2. Short-term Money Market:

• Long-term and short-term interest are decisively different:
  • Long-term interest will be determined by the market.
  • Short-term interest (within 1 year) is determined by BOJ.
• Bank of Japan: Capital, Gov. 55%, Private 45%
• >Top Function of BOJ:
  • Issue of BOJ note: debt of BOJ; formerly convertible note; now managed currency.
  • Financial policy: operate Official Discount Rate (ODR)；Lombard-type lending
  • Bonds/Bills (buying/selling) operation: Credit line
    • Bills operation:
    • Government Bond operation:
    • Treasury Bills operation
    • CP operation
  • Reserve Ratio operation:　　　　　　　　　　　　　　　　　　　
  • Commercial bank must keep the balance of its current account in BOJ.
• BS of BOJ (>Fig.)
  • BOJ currency is guaranteed by NB
• >Top Quantitative easing: to increase the balance of current account of commercial banks in BOJ.
  • BOJ could not adjust ODR, which has been almost zero.
  • Therefore BOJ is adjusting to the balance of current account of the banks.
    • Formerly, a certain limit of balance is required by BOJ
    • Now, it is increasing due to quantitative easing policy.
  • Financial security of BS of BOJ is essential to maintain soundness of ¥.
• >Top LIBOR (London Interbank Offered Rate) and LIBID (London Interbank Bid Rate):
  • E.g.: Offered rate $5\frac{3}{8}%$, while Bid rate $5\frac{1}{4}%$ traded at 11:00 at the London market.
    • Usually a lending bank lend money to a client in a way of "6 month LIBOR plus 1%", etc.; the good rating lending bank can borrow the money from other bank at LIBOR.
    • Convoy system of Japanese banks, where its potential moral hazard; causing Japan premium such as LIBOR plus 1%, etc.
• Financial Futures Market:
  • Market in which participants can buy or sell commodities or financial instrument at a specified price with delivery set in the future.
  • Future market provides a medium for the complementary activities of hedging and speculation.
  • Ex.:
    • 3 month interest 9%: 100-9=91 (transaction rate)
      • if this interest becomes 14%, the transaction rate is 86.
    • How to settle the interest rate form 20 Sept. to 20 Dec. (Today is 20 Jun.)
      1. No action. làssez-faire:
      2. Borrow 6 months, and lend 3 months.
      3. Sell 3 month interest from 20 Sept. at 91.
  • Use as a trading: (hedge trade)
• >Top Minus interest:
• US bank: borrow $10,000 from the market, and
  sell it at spot @¥120, getting ¥1,200,000.
• US bank deposit at current a/c in BOJ.
• 1 year later, US bank needs to return $10,000 × 1.015=$10,150;
  but trades 1 year futures at @¥115.43 (=¥1,171,615)
• The balance (¥28,385) will remain at the current a/c in BOJ.
  • This transaction will be defacto minus interest in a/c of BOJ.

2. 短期金融マーケット:

• BS of BOJ (2001/12 兆円)

• 日銀の機能
  • 紙幣発行
  • 金融政策；公定歩合操作
  • 国債操作
  • 支払準備金操作
    

• 量的緩和
• LIBOR/LIBID

• 金融先物市場
• Yield Curve: (将来金利Upするとき）

• 	Short-term	Long-term
  Borrower	Few	Many
  Lender	Many	Few

>Top 3. Long-term government bond market

• The trend of government bond (JGB) determines long-term interest.
  • the long-term interest is forward looking, and determined by the market.
    • formerly, deposit interest of postal savings to 'The Trust Fund Bureau' of MOF linked to the long-term prime rate.
    • Who decides the LT rate of JGB?
      • Supply & Demand:
      • Fundamentals:
        • Nominal interest=Real interest+Expected interest+Risk premium
        • GDP, Unemployment rate, CPI, WPI (Wholesale Price Index), TANKAN (Short-term economic survey of principal enterprise in Japan)
        • Money supply: Mv=Py (M: money supply, v: velocity, P: price, y=GDP
        • Exchange rate
        • Risk premium
        • Chart
  • Terminology:
    • JGB, Bull market, Bear market
    • Bill ($\leq$1 yr)
    • Note (1< <10yr)
    • Bond (10 yr)
    • Coupon rate: rate ↗, price↘
      • Future=Price × $(1+\frac{r}{100})^n$
• Cash bond market:
• Bond futures market:
• 6% 10yr bond futures on 20SEPT.
  • E.g.: contracted 6% 10yer bond futures of 20 Sept. on 1 Jul.; par value ¥100 at ¥139.06: 1 sheet (=¥100M)
• Features:
  • to gain leverage
  • not to affect BS.
• Settlement of bond futures:
  • reverse transaction
  • deliver the spot bond on the delivery date (20 Sept.):
    
    • Amount=Price on the delivery date (7 d/s before the delivery date) × Conversion factor.
    • E.g.: Amount=¥134.1- × $\frac{1}{100}$ × 0.85 × ¥100M (Par value) × interest accrued.
• Hedge transaction: (>Fig.)
  • A project needed to be funded 10 years after 3 months until 10 years & 3months; the project is estimated to be 10% return.
  • Fund for the project: borrow the fund of 10yr-3mos at 9% pa, and lend it for the first 3 months at 3%. The first 3 months is 6% negative spread, the the fund for the project of 10 years can be borrowed averagely at 9.15%
• >Top Duration: it is a measurement of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows.
  • an important measure for investors to consider, as bonds with higher durations carry more risk and have higher price volatility than bonds with lower duration.
  • PVBP (Price Value of a Basis Point):
    is a measure used to describe how a basis point change in yield affects the price of a bond.
    • $PVBP=\frac{Pd-Pu}{2}$
      Pd= Price calculated by the present yield - 0.01%
      Pu= Price calculated by the present yield + 0.01%
• >Top Budget deficit problem:
  • Government (central & municipal) debt: ¥668T/2003→ ¥1045T/2015
    • Diversified(?) issue of JGB:
      • not only 10 years bond, but also 1 year bond recently.
        • precarious day-to-day operation
        • interest of shorter period bond is cheaper than the longer one.
  • How to annul enormous JGB:
    1. Debt moratorium/cancellation
    2. To raise tax rate: 20% of consumption tax (1% raise=¥2T), or 35%
    3. To increase tax revenue by improving economy; around ¥50T (about 60T in the bubble economy)
       1. if interest rate increase 1%, the interest expense increase about ¥10T
       2. Shorter term JGB is too risky to possible raise of interest rate.
    4. To cause inflation or hyper-inflation: (=reasonable debt moratorium)
  • Nominal interest rate=1) Real interest+2) expected Inflation rate+ 3) Risk premium.
    • Better raise of interest rate: mostly raise of expected inflation rate
    • Worse raise of interest rate: mostly raise of risk premium

3. 長期国債マーケット:

• 国債の金利が長期金利を決める。

• Simple interest & Compound interest:

• 現物債マーケット:
• 債券先物マーケット:
• 債券先物をヘッジに使う
• Yield Curve (10yr 3mos):

• Project & its fund:

• Duration: by Investopedia
• 
• Supply & Demand of Funds:

• 	HH	Corp.	Gov.
  Former	+	-	0
  Now	+	+	--

• Local Grant Tax (地方交付税):
• 

>Top 4. Interest rate swap market:

• JP Morgan, Weatherstone, 15 years ago, said, "the profit from interest rate swap attains 40%."
  • Interest rate swap is as important as bond futures.
  • Derivative transactions include, interest swap, bond futures, forward and option transactions.
    • No actual money is needed but deposit money and rather big buffer named risk capital.
    • Change of BS affects ROA; thus off-balance transaction is popular.
  • In Japan, there had been separation policy of long-term and short-term lending among banks.
• Interest swap:
  • Exchange swap: swap of fixed rate ¥ and floating rate $
  • Interest rate swap: swap of fixed rate ¥ and floating rate¥
  • E.g..: (>Fig.) IBJ swap with JP Morgan:
    • lend to Toshiba with 5 yr loan, 6mo LIBOR+1%
    • borrow from JP Morgan with 5 yr interest-bearing bond at 7.9%
    • IBJ can borrow long-term and lend it short-term loan, using swap
    • transaction.
• >Top Book-value accounting is risky:
  • E.g..: Long-term bond 10 year 3%; and LIBOR 6 month 1%
    • A dealer may procure short-term and sell it long-term, earning the interest margin 2% for the first 6 months; then the next 6 months still earn 1% though LIBOR raised 2%.
    • Then after one year, the trader quit the company getting enormous bonus.
      • The problem is the book-value accounting system of the company, because the trader continued to buy long-term bond though the raise of LIBOR is expected.
      • When the raise of interest is expected, one should borrow the long-term loan, never lend it with the long-term fixed interest.
  • 'Receive' or 'Pay':
    • Interest swam is essentially a trade of long-term interest; whether they want to receive (the long-term fix interest) or to pay.
    • It is suicidal act to accumulate the 'receive' in the raising phase of interest.
      • What happens when 10y long-term bond 3% while 6mo LIBOR 1%; the first 6mos is no problem, getting 2% margin, but after the quit of the trader, the LIBOR may raise 4%, causing -1% margin.
      • In such rasing phase of the interest, the bank should do 'pay' expecting the raise of long-term interest, though the long-term interest gradually raises.
      • Japanese banks may to adopt completely market-value accounting in the trade of interest swap unlike US banks, (6-7 year delay of adoption) which may affect the profit mechanism of Japanese banks in middle-long term basis.
• News report about interest swap (E.g..: Nikkei Shimbun on 2001/6/14) saying that:
  • Long-term interest is showing lower due to the interest swap initiatives.
  • 10 year interest swap updated the annual record as low as 1.2% levels.
  • Banks activated 'receive' trade of fixed rate as long as 7 years, aiming to earn the margin between long and short-term interest.
  • The market is observed that banks feels the difficulty of trade operations in addition to further financial easing.
  • The margin of interest between swap and JGB is showing the historical minimum. (Swap interest become lower by receiving more fixed rate bond.)
  • It occurs that excessive spread transaction, buying JGB paying swap.
  • A some city bank dearer estimate the interest becomes lower reflected by minus real growth in Jan-Mar quarter.
    • The essence is the interest swap is trade of long-term interest product, not the swap trade of long-term and short-term interest.
• Glossary:
  • Mark-to-market: current value accountings

4. 金利スワップマーケット:

• Eg: Interest Swap transaction:
  Off balance trade
• 
• Eg.: Interest Swap transaction-2:
  IBJ - JP Morgan:
• 
• Eg.: Interest Swap transaction-3:
  Float to fix:
• 

>Top 5. Option Market:

• Consider option sales of apples:
  • Call/Put option: an option to buy/sell assets at an agreed price on or before a particular date.
  • (>Fig.): No option sales (red line); A grocery shop buys an apple at ¥100 and sell it at ¥110; the profit is ¥10; the gradient is 45º.
  • Then the grocery shop buys put option of ¥90 at ¥5.
    • While the market price of an apple is at ¥90 or more, such put option is worthless, or no value. (Blue line)
    • When the market price of apples become less than ¥90, then the put option is useful; they can buy an apple from the market then sell it ¥90 using the put option, losing ¥15 at most (¥10 sales loss + ¥5 option fee=premium) (Green line)
    • Put option deal makes the lower limit of loss, just liken an insurance.
• Bond Futures:
  • A person who buys ¥1M Bond Future at ¥135 (option money ¥0.4M)
  • If the bond rises ¥1, the person earns ¥1M. (¥10K per 1 basis point)
  • If the bond price becomes ¥134, then the person sell it at ¥134, earning ¥1M less option fee ¥0.4
  • The person is profitable as long as the bond price become ¥135.40 or more.
• Reuter Trader's Screen: (Left is Call option; Right is Put option,)
• 
  • Strike price of ¥135 of Jun. Futures: Call option is 0.86 per ¥100.
  • Look at ¥135 JUN9 line: Ask means the market offers to sell at 0.84, and to buy at 0.82; the latest trade was 0.86.
  • Look at ¥134 JUN9 line:
  • OI=Open Interest means remained contract
  • Call option of ¥134 is not ¥1.52, where ¥1.00 is intrinsic value, and ¥0.52 is time value.
• Top Hedge Fund:
  • Hedge fund transaction is yearning job for a trader.
    • Bonus by the earning is usually 80% owner and 20% dealer; thus hedge fund traders is a popular business.
    • Qualification of traders: 1) good past track record, 2) input of own money (common destiny), say 70-80% of own asset.
    • Hedge traders are confidential, because of privately placed investment trusts.
    • In US, there had been major fund; such as Tiger Fund, Solos Fund, Moore Capital, LTCM, but now the scale is shrinking.
      • Actions of such traders are known by the trading banks, who suspect the similar trade could be done with other banks.
      • The first action of Solos may affect the market trend at once.
      • Solos Fund Management (founded in 1969 by George Solos) was operated by Stanley Druckenmiller (having asset $3B) and Nicholas Roditi.
    • In Japan, there has been neither culture nor training opportunity of risk-taking by entrusting the fund.
      • Long-short trade is rather popular in Japan, such as selling Nissan share and buying Honda share concurrently.
      • But a kind of small profits and quick returns may be risky.
• Difference of a bank and a security company;
  • Bank is a principal, but security company is an agent for brokering business.
  • Bank is BS trader, while security company is off-BS (flow business) trader.

5. オプションマーケット

• Option Market:
• 
• Bond Futures:
• 
• Option P/L:

Comment

• Top What a lively textbook of the financial trade!
• We should recognize anachronism of the convoy banking system as well as book-value accounting system guided by J-government.
• We must change our mindset from transaction of visible product to invisible and changeable trade including finance and risk factors.

• 金融取引に関する活きた教科書である。
• 簿価会計基準のみならず日本政府主導の銀行護送船団方式の時代錯誤を認識すべき。
• 見えるモノの製品取引から見えないかつ変化する金融やリスク要因の取引への意識を変える必要がある。