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Contents
Chapter 1
Concluding and settling transactions 19
1.1 Concluding transactions 19
J.J.J Exchange zo
J.J.z MuItiIateraI trading faciIity zo
J.J. The OTC market zo
J.J.( Systematic internaIization zz
1.2 Settling transactions 23
J.z.J Money accounts and securities accounts z
J.z.z Sending settIement instructions z(
Chapter 2
Interest calculations and yield curves 27
2.1 Calculation of interest amounts 27
z.J.J The duration of the couon eriod z8
z.J.z Daycount conventions o
2.2 Interest rates for broken periods 34
2.3 Converting interest rates for dierent daycount conventions 35
2.4 Converting interest rates for dierent coupon frequencies 37
2.5 Present value and future value 38
z..J Future vaIue with singIe interest 8
z..z Present vaIue with singIe interest p
z.. Present vaIue and future vaIue with interim couon ayments and
annuaI couon (o
z..( Present vaIue and future vaIue with interim couon ayments and
n couons er year (J
2.6 Yield and pure discount rate 43
z.6.J YieId (
z.6.z Pure discount rate (
z.6. Equations for converting the yieId to ure discount rate and vice
versa ((
2.7 Yield curves 45
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2.8 Forward rates 46
z.8.J Forward rates for forward eriods of Iess than one year (;
z.8.z Forward rates for forward eriods Ionger than one year J
z.8. Stri forwards
z.8.( Forward curve 6
Chapter 3
The money market 59
3.1 Domestic and Euro money markets 59
3.2 Deposit 60
3.3 Money market paper 61
..J CommerciaI aer 6J
..z Treasury BiIIs and bank biIIs 6
.. Certicate of deosit 6
3.4 Repurchase agreements 65
.(.J InitiaI and maturity consideration 66
.(.z GeneraI and seciaI coIIateraI 6p
.(. Transfer of coIIateraI 6p
.(.( SeII]buy back ;o
3.5 Trading on the money market 71
3.6 Money market benchmarks 74
Chapter 4
The Foreign Exchange Market 77
4.1 FX spot rates 77
(.J.J Exchange rates ;;
(.J.z Bid rate, ask rate and two way rices ;p
(.J. Big gure and oints]is 8o
(.J.( Cross rates 8J
(.J. Sot trading ositions 8
4.2 FX forward 84
(.z.J TheoreticaI caIcuIation of an FX forward rate 8
(.z.J Swa oints, remium and discount 86
(.z.z Forward vaIue dates and corresonding FX forward rates 8p
(.z. FX forward cross rates pz
(.z.( VaIue tomorrow and vaIue today FX rates p(
(.z. Time otion forward contracts p;
(.z.6 Osetting FX forwards p8
(.z.; TheoreticaI hedge of an FX forward via FX sot and deosits Joo
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4.3 FX swaps 100
(..J FX swas out of today ] out of tomorrow Jo
(..z Overnight swas and tom]next swas Jo(
(.. Hedging an FX forward via an FX sot and FX swa Jo
(..( ReguIating cash ositions using FX swas Jo6
(.. RoIIing over FX forward contracts using FX swas Jo;
(..6 Arbitrage between the FX swa market and the money
markets Jo8
(..; RoIIing over trading FX ositions using tom]next swas JJz
(..8 Forward forward FX swa JJ
(..p Trading FX Swas JJ(
(..Jo ResuIt and vaIuation of a osition in FX swas JJ6
4.4 Non-deliverable forward 118
Chapter 5
Fixed Income, Zero coupon rates and Duration 119
5.1 Domestic, foreign & euro capital markets 119
5.2 Issuing of xed income securities 120
.z.J Pricing of xed income securities Jzo
.z.z Exchange Iisted xed income securities JzJ
.z. Private Iacement (over-the-counter) Jzz
5.3 The yield of a xed-income security 123
..J The generaI interest rate IeveI on the caitaI market Jz
..z The quaIity of the issuing entity Jz(
.. The Iiquidity of the bond Jz
5.4 Special types of xed-income securities 126
5.5 The price of a bond 129
5.6 Zero coupon rates 132
5.7 Relationship between bond price and yield, modied duration 136
.;.J CaIcuIation of the modied duration J;
.;.z Factors that determine the IeveI of the modied duration Jp
.;. Convexity Jp
.;.( Adding and subtracting the modied duration of dierent
ortfoIios J(o
.;. Basis oint vaIue BPV J(z
.;.6 Modied duration of FRNs J((
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Chapter 6
Futures 147
6.1 Role of a futures exchange and of a clearing house 147
6.J.J Order tyes J(p
6.J.z RoIe of centraI counterarty J(p
6.J. Margins Jo
6.2 STIR futures 150
6.z.J Prices of STIR futures and imIied forward rates Jz
6.z.z Fixing of the STIR futures settIement rice on the exiry date J(
6.z. Basis J(
6.z.( DaiIy resuIt caIcuIation and margin caIcuIation J
6.z. Hedging imerfections J6
6.z.6 Sread trading Jp
6.z.; Use of STIR futures by comanies J6z
6.3 Bond Futures 163
6..J DeIivery obIigation ] Cheaest to deIiver J6(
6..z Buying the basis ] cash and carry arbitrage J6
6.4 Swapnotes 167
Chapter 7
Forward Rate Agreements 169
7.1 Contract data 169
7.2 The pricing of FRAs 171
7.3 Settlement of FRAs 173
7.4 Use of FRAs by traders; trading and arbitrage 174
;.(.J Straight forward trading in FRAs J;(
;.(.z Arbitraging between FRAs and STIR futures J;6
;.(. CIosing forward cash ositions with FRAs J;;
;.(.( Arbitraging using FRAs and FX swas J;8
7.5 Use of FRAs by clients of the bank 181
7.6 Valuation of FRAs 183
Chapter 8
Interest rate swaps 185
8.1 Contract specications and jargon 185
8.2 Settlement of an IRS 188
8.3 Overnight index swaps 189
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8.4 Trading interest rate swaps 191
8.(.J Trading interest rate swas JpJ
8.(.z Arbitrage between IRS and FRAs or STIR futures Jp(
8.5 Applications of interest rate swaps for clients of the bank 196
8..J Fixing the interest on Ioans with a oating rate Jp6
8..z Fixing the oating rate of an investment ] asset swa Jp;
8.. Changing interest terms Jpp
8..( Synchronising the interest conditions of an IRS zoJ
8.. Forward starting interest rate swas zoz
8.6 Special types of interest rate swaps 203
8.7 The valuation of interest rate swaps 204
8.;.J Modied duration of interest rate swas zop
8.;.z Convexity with interest rate swas zJo
8.;. The basis oint vaIue of interest rate swas zJz
Chapter 9
Cross currency swaps and other swaps 213
9.1 Basis swaps 213
9.2 Cross-currency swaps 214
p.z.J Hedging and ricing a cross currency swa zJ
p.z.z Covered interest arbitrage using cross currency swas zJ6
p.z. VaIuation of a cross currency swa zJp
9.3 Contracts for dierence 221
9.4 Ination swaps 222
Chapter 10
Options 225
10.1 Option terminology 225
10.2 The option premium 228
Jo.z.J Intrinsic vaIue zz8
Jo.z.z Exectations vaIue zo
Jo.z. CaII ut arity z(
Jo.z.( CaIcuIation of forward rices with the use of otion
remiums z
Jo.z. DeIta, gamma, theta, rho and vega: the Greeks z6
Jo.z.6 The BIack-SchoIes modeI (synthetic otion ositions) z(z
10.3 Delta position and delta hedging 246
10.4 Interest rate options 249
Jo.(.J Interest Rate Guarantees ] Cas and FIoors z(p
Jo.(.z Swation z(
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Chapter 11
Zero cost option strategies 257
11.1 Synthetic FX forward 257
11.2 Risk reversal 258
11.3 Participating FX forward 260
11.4 Conditional FX forward / FX forward extra 262
11.5 Interest collar 263
11.6 Participating cap 267
11.7 Trigger Swap 268
Chapter 12
Option trading strategies 271
12.1 Bull and bear spread 271
12.2 Straddle 273
12.3 Strangle 276
12.4 Buttery 278
12.5 Condor 281
12.6 Ratio spreads 283
12.7 Calendar spread 286
Chapter 13
Fundamental analysis 287
13.1 Economic growth 287
J.J.J The economic cycIe z88
J.J.z Figures that rovide a icture of the economic growth z88
J.J. The imact of economic growth on the nanciaI markets zpo
13.2 Ination 290
J.z.J The imact of ination and deation on the economy zpJ
J.z. The imact of ination on the nanciaI markets zpJ
13.3 The balance of payments 292
13.4 The role of international organizations 293
13.5 Free market operations and interventions 297
J..J Intervention in the money market ] monetary oIicy zp;
J..z Interventions in the currency market oo
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Chapter 14
Technical analysis 303
14.1 Types of charts 303
J(.J.J Bar chart o
J(.J.z CandIestick o
J(.J. Point and gure chart o
J(.J.( Line chart o6
14.2 Support and resistance 307
14.3 Trends and trading ranges 309
J(..J Dow Theory Jo
J(..z Trend suorting indicator: moving average JJ
J(.. Trading range Jz
14.4 Changing markets / trend reversals 313
J(.(.J Wedge J
J(.(.z Head-shouIder formation J(
J(.(. Momentum indicators J6
14.5 Determination of new support and resistance points after a trend break 318
J(..J Gann AnaIysis J8
J(.. z Fibonacci numbers Jp
14.6 Waves 322
Chapter 15
Market Risk 325
15.1 Determining the size of the market risk 325
J.J.J HistoricaI VaR z6
J.J.z Parametric method z;
J.J. FuII vaIuation method and Monte CarIo simuIations J
15.2 Stress tests 333
15.3 Back tests 334
15.4 Trading limits 334
Chapter 16
Credit Risk 337
16.1 Types of credit risk 337
J6.J.J Debtor risk ;
J6.J.z Pre-settIement risk (reIacement risk) 8
J6.J. SettIement risk (deIivery risk) (o
16.2 Factors that determine the size of the credit risk 341
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16.3 Counterparty Limits 342
16.4 Contractual netting / close-out netting 343
16.5 Collateral 343
16.6 Measures to reduce settlement risk / CLS Bank 345
Chapter 17
Risk Capital 349
17.1 Basel I 349
17.2 Basel II 350
J;.z.J Aroach of the size of the credit risk under BaseI II J
J;.z.z Aroach of the size of the market risk under BaseI II
17.3 Basel III 353
J;..J GeneraI changes in equity requirements
J;..z Introduction of a Ieverage ratio (
J;.. Changes in caitaI requirements for trading activities (
J;..( Introduction of minimum gIobaI Iiquidity standards
17.4 Economic capital, RAROC, Sharpe ratio 355
Chapter 18
External reporting 357
18.1 Purpose, relevant standards and denitions IFRS 357
18.2 IAS 21 359
18.3 IAS 39 360
J8..J Recognition and de-recognition 6o
J8..z VaIuation 6o
J8.. Originated Ioans and receivabIes 6z
J8..( Assets heId to maturity 6z
J8.. FinanciaI assets]IiabiIities at fair vaIue through rot and
Ioss 6
J8..6 AvaiIabIe for saIe 6
J8..; Derivatives 6(
J8..8 FinanciaI IiabiIities 6(
J8..p Imairment 6(
J8..Jo Hedge accounting 6
18.4 IFRS 7 368
18.5 New developments as of February 2011 369