The Money Market. Juan Barragan ECP January 2009

The Money Market Juan Barragan ECP January 2009

The Money Market

Central Banks They drive the Money Market. They make funds available to commercial banks. They ensure liquidity. Funds available for a short term: ON, 1W, 1M, 3M. Examples: FED in the USA, ECB in Europe, Bank of England in the UK.

Economy and Rates Macroeconomic as well as Financial factors determine rates. Good Macroeconomics push rates. Bad Macroeconomics down rates. Capital Inflows, Trade, Inflation and Foreign Exchange do make pressure on rates.

The Money Market On the Money Market, commercial banks lend one to each other. These lends are based on confidence and trust as they are unsecured. Usually the lends trade with a slight spread from the Central Banks driving rate. These lendings are collected for defining rate benchmarks such as LIBOR.

LIBOR LIBOR (London Inter-Bank Offered Rate) is a mean of the rates at which banks borrow from each other at the London Interbank Market. Lot of currencies are traded, not only Sterling: USD, GBP, JPY, CHF, CAD, AUD, NZD, DKK. For the EUR, there exist the EONIA -for Overnight lends- and EURIBOR. Only offered (bid) rate is taken into account. Offered rate is different from asked rate.

LIBOR schedules Important dates: Today or trade date: the date were trading is taking place. Spot: roughly the date where the deal will run effective. Maturity: the date where the deal is end. Tenor Today Spot Maturity

LIBOR Tenors Lending maturities runs like: ON, Overnight. From today to next business day. TN, From Tomorrow to next business day. SN, From Spot day to next business day. SW, From Spot to one Week ahead. 1M. From Spot to one month ahead, 2M, 3M, 6M, 9M, 1Y. Idem, from Spot to the respective maturity ahead.

Terms & Conditions Short Terms Deposits on the Money Market are entirely defined by their terms & conditions. The Terms and Conditions are financial terms as well as legal. They express days to settlement, dates, tenors, interest calculations modes, time calculation mode and so on. We are to keep only some of them:

Terms & Conditions Days to settlement. From zero to three days (Some countries even more) Maturity Tenor. One business day, One week, one, two, three, six and nine Months. Rate Calculation Mode. We are going to consider linear always: interest = Tr. Time calculation Mode: usually Actual/360 or Actual/365 Date Rolling Convention.

Terms & Conditions Examples UK ON Days to Settlement: 0 Maturity Tenor: one business day. Rate Calculation Mode: Linear. Time Calculation Mode: Actual/365. Date Rolling Convention: none. UK SW Days to Settlement: 0 Maturity Tenor: seven days. Rate Calculation Mode: Linear. Time Calculation Mode: Actual/365. Date Rolling Convention: Following.

Terms & Conditions Examples UK 1M, 9M EUR ON Days to Settlement: 0 Days to Settlement: 0 Maturity Tenor: X months. Maturity Tenor: One business day. Rate Calculation Mode: Linear. Rate Calculation Mode: Linear. Time Calculation Mode: Actual/365. Time Calculation Mode: Actual/360. Date Rolling Convention: Modified Following. Date Rolling: none.

Terms & Conditions Examples EUR 1W EUR 1M, 9M Days to Settlement: 2 Days to Settlement: 2 Maturity Tenor: seven days. Maturity Tenor: X months. Rate Calculation Mode: Linear. Rate Calculation Mode: Linear. Time Calculation Mode: Actual/360. Time Calculation Mode: Actual/360. Date Rolling Convention: Following. Date Rolling Convention: Modified Following.

Deposits Use cases UK ON. UK 1M Today is 16JAN2009. Today is 15JAN2009 ON deposit is 3.5%. 1M deposit is 3.75% Next business day is 19JAN2009. Maturity date is 16FEB2009 So 1 deposit gives So 1 deposit gives 1+3*3.5%/365 = 1.000288. 1+32*3.75%/365 = 1.003288

Deposits Use cases EUR 1W EUR 3M Trade date 20NOV2008 Trade date 26NOV2008 1W deposit is 4.5% 3M deposit is 4.87% Settlement date: 24NOV2008 Settlement date: 28NOV2008 Maturity Date 01DEC2008 Maturity Date: 27FEB2009 So 1 gives So 1 gives 1+7*4.5%/360 = 1.000875. 1+91*4.87% /360 = 1.012310.

Pricing Deposits Deposits are priced by quoting the associate rate. Brokers use their internal Rate Curve for calculating this rate. Suppose the Terms and Conditions of a Deposit are given, Settlement at T0, Start Date at T1, Maturity at T2 and Time Tenor T (Measured in the corresponding Money Market Settings), Suppose A Zero Coupon Term Structure is given, Z(t,T).

Pricing Deposits T T0 T1 T2 Then, the price of this deposit is

Pricing Deposits: Example Given the EUR Zero Coupon Curve in Continuous/365 mode: Start Date 18DEC2008 19DEC2008 0.0223049 29DEC2008 0.0237497 22JAN2009 0.0299522 23FEB2009 0.0327278 23MAR2009 0.0338371 22JUN2009 0.0351033 Calculate the price of a 3M EUR deposit with trade date, T0 = 18DEC2008. Settlement. Two business days from trade: 22DEC2008 Maturity. From settlement, three months ahead with modified following date: 23MAR2009 Time in Money Market EUR settings, Act/360 = 91/360 = 0.252778.

Pricing Deposits: Example We need the Zero Coupon at 22DEC2008: We use interpolation on the rate curve. Interpolated rate at 22DEC2008 = 0.022738. Z(22DEC2008) = exp(-4/365 * 0.022738 ) = 0.999751. Then we need the Zero Coupon at 23MAR2009: Z(23MAR2009) = exp( -95/365*0.0338371) = 0.991232. So according to the above formula: r = 360/91 * (0.999751/0.991232-1 ) = 0.034.

Project Goal: IRIS Within the IRIS DLL, add C++ classes for performing calculations on Deposits. Care to the terms and conditions: Trade Date, Days To Settlement, Maturity Tenor, Market Price Market Calendar and Day Counting Convention. Add a method for calculating the cash flow a 1 investment originates. Add a method for getting its price with a Zero Coupon Curve Z(t,T) as Parameter.