Foreign Exchange (FX) and Money Markets

Day 1 – An Introduction to the Money Markets

Session 1: Overview

The money markets are an essential part of the financial markets, where Banks, Corporates, Governments, Asset Managers and others, access Liquidity, by borrowing and Lending up to one year.

In a rapidly changing market, this session looks at how Money Markets operate today, explaining the impact of the regulatory changes since the Financial Crisis.

• History and current working practice of the Money Markets
• Capital Markets v Money Markets.. what are the differences
• Licensed Deposit Takers
• Call Accounts
• Corporate Loans
• Fixed Term Deposits
• Libor and Euribor… the move away from Libor explained
• IBOR … what this means for the world!
• Short Dates
  • Overnight O/N, to 4 weeks
  • Periods – up to one year
• SOFR … Risk Free Rates
• Benchmark Rates
  • ESTR
  • SONIA
  • Others
  • ISDAs “Fallback Protocol” for Libor issues
• The Role of the Central Bank

Exercise: Calculating simple interest

• Trading the Money Markets
• Gap Positions

Scenario Based case Study: Participants calculate the forward “Gap” interest rate risks in a “life like” scenario

Session 2 : Money Markets - Products, Trading and Settlement

In this session we look at Interest Bearing and Discount products. How they are used for raising funds and for investment purposes. Participants will learn how they are priced and trade in the markets.

• Certificates of Deposit (CDs)
  • Who issues them and why?
  • Understanding the Cash Flow
  • Calculating a Holding Period Return
  • Who issues and why
  • Understanding the cash flows
• Treasury Bills
  • Government Issues
  • Discounting
    • Discounting and Compounding Formulae explained
    • Present Value (PV)

Exercise : Basic calculations of cash flows using discounting and compounding

• Comparing MM and Treasury Yields

• Commercial Paper
  • Quotation Methodology
  • Calculations
  • CP Issuance Programmes

Exercise: Calculating the interest and price of CDs T – Bills and CPs

• Settlement
  • Making Cash Payments
  • Nostros and Ledger Accounting
  • RTGS at the Central Bank

Day 2: Secure Funding

Session 1

Secured borrowing and lending is an important part of the money market and can take different legal forms. This session describes the different forms and the risks associated with such products and how they can be managed.

Repo

• Why Repo has become so important t to the Markets!
• Sale and Repurchase agreements
• Basic repo mathematics: Price and interest calculationsGeneral Master Repo Agreement (GMRA)
  • Beneficial and Legal Ownership
• Examples of the Classic Repo and Reverse Repo trades
• One Day and Term Repo trades
• The mechanics of repo agreements
  • Haircuts
  • Mark to market (MTM)
  • Margining for a Term Repo.

Exercise: Participants must MTM a repo trade and decide if a Margin Call is needed and if so, for how much?

• Specials

• What collateral is eligible?
  • General (GC) and specific (SC) collateral; rights of substitution
• The Reasoning: Cash v security driven transactions
• Comparison of alternative repo mechanisms
  • Classic repo v buy/sell-back
  • Securities lending
• The new US risk-free benchmark rate: SOFR explained
• Identifying and managing the risks in repo transactions:
  • Credit & liquidity exposure on repo
  • Collateral management
  • Custody of collateral: Bilateral, hold in custody (HIC), tri-party repo structures

Session Two: Uses & Applications of Repo

This session discusses some of the applications of repo and securities borrowing and lending, including trading applications and the facilitation of short selling.

• Funding trading positions with repo; advantages and constraints
• Short selling
• Understanding the motivation
  • Overview of the trade mechanics
  • Matched book trading
• Yield enhancement trades:
  • Riding the yield curve
  • Understanding the “bet”
• Securities Borrowing v Repo… what’s the difference?

Exercise: Participants look at current markets and decide what trades to put on and calculate the potential profits!

Day 3: Money Market Derivative Instruments

Session One: Forward Rate Market Instruments: FRAs and STIR Futures

This session describes traditional FRAs and STIR futures contacts referenced three-month ‘ibor rates, before discussing in detail the impact that the new risk-free benchmark interest rates are having on the short-term interest rate derivatives market, detailing the next generation of STIR futures that have been listed by the major global derivative exchanges.

• OTC forward rates: Forward rate agreements (FRAs)
  • FRA terms explained
  • Locking-in a forward rate
  • Credit risks and how they have been addressed post-crisis
• FRAs post Libor:
  • Is the end of the FRA nye?
  • Single Period Swaps (SPSs) are the solution
• Short-term interest Rate (STIR) futures contracts in the ‘ibor world
• Futures STRIPS Calculations
• The three-month tenor contract specifications explained
• From futures price to forward rate: Locking-in a forward rate
• Managing the credit risks:
  • Central clearing
  • Margin explained
• Traditional contracts linked to an overnight rate: Fed Funds futures
• Short-term interest (STIR) futures contracts in the post-Libor world
• The next generation of futures referenced to Alternative Risk-Free Reference Rates:
  • Sonia futures
  • SOFR futures
  • Differences in contract design explained: one-month v three-month

Scenario based case study: Participants are given Money Market interest rates and STIR Futures prices. Analysing the Gap Position, they

Session Two: The OTC Interest Rate Market

The interest rate swap market, where a fixed rate is exchanged for a floating reference rate, is another market which has undergone significant reform following the Financial Crisis and which is also affected by changes in the introduction of the new risk-free benchmark interest rates. This session discusses the impact of market developments following the crisis, notably the impact of collateralisation on the marking-to-market of IRS, and the various issues surrounding the transition from ‘ibor rates to the new risk-free benchmark rates, notably the rise of the overnight index swap (OIS) market and its growing importance, and the impact on the cross-currency basis swap market.

• Introduction to the interest rate swap market
• Current market conventions
  • Understanding IRS Quotes
  • Buy and sell v Fixed payer and receiver
• Market developments since the financial crisis
• Introduction of collateralisation and central clearing through CCPs and their implications
  • Standardised Contracts
    • How they work
    • SNAC / SEC

Exercise: Participants look at a Bloomberg screen and recognise the important information, such as rates, payment dates, term etc.

• Pricing an IRS
  • The Forward Curve explained
  • Zero Rate Curves
  • Calculating the Fixed price from Forward Rates.

Case study : We use excel to price an IRS and value the position after interest rates in the market move!

• Marking-to-market IRS in the new environment
• Market development following the introduction of the new risk-free benchmark rates
  • Transitioning from IRS to OIS
  • Overnight index swap (OIS) mechanics explained
  • The relationship between the OIS and term Libor rates pre- and post- the financial crisis
• Implications for forward rates and interest rate swap instruments
• Basis swaps explained
• The cross-currency basis swap
  • The Interbank Market
  • Structure of XCS
  • XCS Uses
    • Bond Issuance
    • Borrowing in Foreign Currencies
  • Understanding the Risks
• Swap futures contracts

Day 4 The Foreign Exchange Markets

Session One: The Spot FX Market

The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies, and in terms of volumes traded, it is by far the largest market in the world. The foreign exchange market operates primarily through financial institutions (dealers), and trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars.

The primary reason for the foreign exchange market is to assist international trade and investments. For example, it permits a business in the United States to import goods from Eurozone members, and pay Euros, even though its income is in United States dollars. However, it also supports direct speculation in the relative value of currencies, and indeed, this activity greatly exceeds transactions based on trade flows.

This session explores how the FX market functions, including the market conventions for quoting rates. In addition, the dealers’ perspective is discussed, and describes how they manage their positions.

We discuss how the market has become digitalised, with much trading done by algorithms on electronic order books! What impact is this having?

• Market organization
  • The Players
• Spot Market
  • Bid Offer Spreads
  • Market Conventions
    • Base v Quoted Currency
    • Nickname Quiz… what’s Cable…what’s the Loonie???
  • Size of the market and major currencies
• Quoting spot FX rates
• Indirect v direct quotes
• Market conventions
• Reciprocal rates
• Calculating the cross rate
• Managing and monitoring the FX spot book: Position keeping

Exercise: Calculating the Profit and Loss of a Spot traders book. Realised and Unrealised.

• Economics
• Why Markets Move
• Q&A Session

Scenario Based case study; FX Market Simulation

• Participants work in pairs to deal with clients in spot FX
• Cover the position in the market
• Calculate positions and P/L

Session Two: Linking Money Market Instruments and the FX Market

The forward FX and FX swap markets are inextricably linked to the short-term interest rate market, and the introduction of the new risk-free benchmark rates has had a material effect on the FX market. This session introduces forward FX and FX swaps, how they are traded and what are the key reasons for using them.

• Forward value dates: Alignment with money market instruments
• Quoting forward points
• The FX swap market and how swap rates are calculated

Exercise; Calculating the Swap price. Participants will find that this is easy once you know the basics. They will price various FX swaps

• FX Swap Points formula
• Which rates to use?
  • Libor v OIS
• Cash flows in a matched FX Swap… calculating the profit!
• Corporates and Outright trades
• How banks use FX swaps rather than outright forwards: hedging outright forward transactions
• Swaps as Funding Rates
  • Understanding the sensitivity of FX swaps to changes in rates
  • Managing the risk: Mis-matched FX swaps
  • The mis-understood risk in FX swap trading!
  • Rounding
• Exchange Controls
• NDFs (Non Deliverable Forwards)

Exercise: Calculating the profit from an NDF trade and proving that the NDF works well as a currency hedge for Corporates.

• Understanding the relationship between FX swaps and currency swaps
• The role of cross-currency swaps revisited
• Long-dated forward FX rate quotes
• Using FX swaps for funding purposes
  • Short date forwards
  • Introducing the terms
  • Calculating an FX swap over today and tom

Scenario Based Case study: Teams use NDFs to hedge FX risk in various client scenarios. They calculate the hedge effectiveness. Proving if the hedge worked

• Interest Arbitrage
• Internal Trades at the Bank

Scenario Based Case Study: Arbitrage and Raising Cheap Funding

• Teams look at Money Market Rates and FX Swaps and calculate the potential arbitrage (risk free profit) that can be made
• Teams look at the opportunity to borrow money in a foreign currency and swap cheaply into the desired currency. They calculate the savings.
• Teams present back to the trainer, who gives feedback and clarifies any issues.