An Introduction to International Capital Markets: Products, Strategies, Participants

An Introduction to International Capital Markets......Page 5
Contents......Page 9
Acknowledgements......Page 17
1.1 Capital and the Capital Markets......Page 19
1.2 The Euromarkets (International Capital Markets)......Page 22
1.3 Modern Investment Banking......Page 23
1.4 The Clients of Investment Banks......Page 26
1.5 About this Book......Page 29
2.2 Domestic Money Markets......Page 33
2.3 US Domestic Markets......Page 34
2.4 The European Central Bank (ECB)......Page 36
2.5 Sterling Money Markets......Page 37
2.7 Systemic Risks and Moral Hazards......Page 38
2.9 Discounting Treasury Bills......Page 39
2.10 US Commercial Paper......Page 42
2.11 Credit Risk on USCP......Page 43
2.13 The Eurocurrency Markets......Page 44
2.14 Eurocurrency Loans and Deposits......Page 45
2.15 Eurocurrency Interest and Day-Count......Page 47
2.16 Eurocurrency Certificates of Deposit......Page 48
2.18 Euro-Commercial Paper......Page 49
2.19 Repos and Reverses......Page 50
2.21 Other Features of Repos......Page 51
2.22 Chapter Summary......Page 52
3.2 Market Structure......Page 55
3.3 FX Dealers and Brokers......Page 56
3.4 Spot Foreign Exchange Deals......Page 57
3.5 Sterling and Euro Quotations......Page 58
3.6 Factors Affecting Spot FX Rates......Page 59
3.7 Spot FX Trading......Page 62
3.8 Spot Position Keeping......Page 63
3.9 FX Risk Control......Page 65
3.10 Cross-Currency Rates......Page 67
3.11 Outright Forward FX Rates......Page 68
3.12 Outright Forward FX Hedge: Case Study......Page 69
3.13 Forward FX Formula......Page 70
3.14 FX or Forward Swaps......Page 71
3.15 FX Swap Two-Way Quotations......Page 73
3.16 Chapter Summary......Page 74
4.2 Introduction to Government Bonds......Page 77
4.3 Sovereign Risk......Page 78
4.4 US Government Notes and Bonds......Page 80
4.5 US Treasury Quotations......Page 82
4.6 US Treasury Strips......Page 84
4.7 Bond Pricing......Page 85
4.8 Pricing Coupon Bonds: Examples......Page 86
4.9 Detailed Bond Valuation: US Treasury......Page 87
4.10 Bond Yield......Page 89
4.11 Reinvestment Assumptions......Page 90
4.12 Annual and Semi-Annual Bond Yields......Page 91
4.13 UK Government Bonds......Page 92
4.15 Eurozone Government Bonds......Page 95
4.16 Chapter Summary......Page 96
5.2 Bond Market Laws......Page 99
5.4 Macaulay’s Duration......Page 101
5.5 Calculating Macaulay’s Duration......Page 102
5.6 Duration of a Zero......Page 103
5.7 Modified Duration......Page 104
5.8 Price Value of a Basis Point......Page 105
5.10 Measuring Convexity......Page 106
5.11 Convexity Behaviour......Page 108
5.12 Portfolio Duration......Page 109
5.13 Dedication......Page 110
5.14 Immunization......Page 112
5.15 Duration-Based Hedges......Page 114
5.16 Convexity Effects on Duration Hedges......Page 115
5.17 Chapter Summary......Page 116
6.2 Real and Nominal Interest Rates......Page 117
6.3 Compounding Periods......Page 118
6.4 The Yield Curve Defined......Page 119
6.5 Theories of Yield Curves......Page 120
6.6 Zero Coupon or Spot Rates......Page 122
6.7 Bootstrapping......Page 124
6.9 Pricing Models Using Spot Rates......Page 126
6.10 Forward Rates......Page 127
6.11 Discount Factors......Page 128
6.12 Chapter Summary......Page 130
7.2 Basics of Credit Spreads......Page 131
7.3 The Role of the Ratings Agencies......Page 133
7.4 Credit Spreads and Default Probabilities......Page 135
7.5 Credit Default Swaps......Page 136
7.6 Index Credit Default Swaps......Page 139
7.7 Basket Default Swaps......Page 140
7.8 Credit-Linked Notes......Page 141
7.9 Securitization and CDOs......Page 142
7.11 Synthetic CDOs......Page 144
7.12 Chapter Summary......Page 146
8.2 Comparing Corporate Debt and Equity......Page 147
8.3 Additional Features of Common Stock......Page 148
8.4 Hybrid Securities......Page 149
8.5 Equity Investment Styles......Page 150
8.6 Efficient Markets......Page 151
8.7 Modern Portfolio Theory (MPT)......Page 153
8.8 Primary Markets for Common Stock......Page 156
8.9 Subsequent Common Stock Issues......Page 158
8.10 Secondary Markets: Major Stock Markets......Page 160
8.11 Depository Receipts......Page 163
8.12 Stock Lending......Page 164
8.14 Chapter Summary......Page 166
9.2 Principles of Common Stock Valuation......Page 169
9.3 The Balance Sheet Equation......Page 170
9.4 The Income Statement......Page 172
9.5 Earnings Per Share (EPS)......Page 174
9.6 Dividend Per Share (DPS)......Page 175
9.7 Ratio Analysis......Page 176
9.9 Profitability Ratios......Page 177
9.10 Leverage Ratios......Page 179
9.11 Investor Ratios and Valuation......Page 180
9.12 Applying Valuation Multiples......Page 181
9.13 Firm or Enterprise Value Multiples......Page 183
9.14 Chapter Summary......Page 184
10.2 The Basic Dividend Discount Model......Page 187
10.3 Constant Dividend Growth Models......Page 188
10.5 Dividend Yield and Dividend Growth......Page 190
10.6 Price/Earnings Ratio......Page 191
10.8 Two-Stage Model: Example......Page 193
10.9 The Capital Asset Pricing Model (CAPM)......Page 194
10.10 Beta......Page 195
10.12 The Equity Risk Premium Controversy......Page 196
10.13 CAPM and Portfolio Theory......Page 198
10.14 Free Cash Flow Valuation......Page 201
10.15 Forecasting Free Cash Flows......Page 202
10.16 Weighted Average Cost of Capital (WACC)......Page 203
10.17 Residual Value......Page 204
10.18 WACC and Leverage......Page 205
10.19 Assets Beta Method......Page 207
10.20 Company Value and Leverage......Page 208
10.21 Chapter Summary......Page 209
11.2 Forward Rate Agreements (FRAs)......Page 211
11.3 FRA Application: Case Study......Page 212
11.4 Borrowing Costs with an FRA Hedge......Page 214
11.5 FRA Market Quotations......Page 215
11.6 The Forward Interest Rate......Page 217
11.7 Financial Futures......Page 219
11.9 Eurodollar Futures Quotations......Page 221
11.10 Futures Margining......Page 222
11.11 Margining Example: EURIBOR Futures on Eurex......Page 223
11.12 Hedging with Interest Rate Futures: Case Study......Page 226
11.13 Futures Strips......Page 227
Appendix: Statistics on Derivative Markets......Page 229
12.3 The CBOT 30-Year US Treasury Bonds Futures......Page 231
12.4 Invoice Amount and Conversion Factors......Page 232
12.5 Long Gilt and Euro-Bund Futures......Page 234
12.6 Forward Bond Price......Page 235
12.8 The Implied Repo Rate......Page 236
12.9 The Cheapest to Deliver (CTD) Bond......Page 237
12.10 CTD Behaviour......Page 239
12.11 Hedging with Bond Futures......Page 240
12.12 Basis Risk......Page 241
12.13 Hedging Non-CTD Bonds......Page 242
12.14 Using Futures in Portfolio Management......Page 243
12.15 Chapter Summary......Page 244
13.2 Swap Definitions......Page 245
13.3 The Basic Interest Rate Swap Illustrated......Page 246
13.4 Typical Swap Applications......Page 248
13.5 Interest Rate Swap: Detailed Case Study......Page 249
13.6 Interest Rate Swap Terms......Page 251
13.7 Comparative Advantage......Page 252
13.8 Swap Quotations and Spreads......Page 254
13.9 Determinants of Swap Spreads......Page 255
13.10 Hedging Swaps with Treasuries......Page 256
13.11 Cross-Currency Swaps: Case Study......Page 257
13.12 Cross-Currency Swap Revaluation......Page 259
Appendix: Swap Variants......Page 260
14.2 Valuing a Swap at Inception......Page 263
14.3 Valuing the Swap Components......Page 264
14.4 Swap Revaluation......Page 265
14.5 Revaluation Between Payment Dates......Page 266
14.6 The Forward Rate Method......Page 267
14.8 Swap Rates and LIBOR Rates......Page 269
14.9 Pricing a Swap from Futures......Page 270
14.10 Hedging Interest Rate Risk on Swaps......Page 274
14.11 Chapter Summary......Page 275
15.2 Index Futures......Page 277
15.3 Margining Procedures......Page 278
15.4 Final Settlement and Spread Trades......Page 280
15.5 Hedging with Index Futures: Case Study......Page 281
15.6 Hedge Efficiency......Page 282
15.7 Other Uses of Index Futures......Page 283
15.8 Pricing an Equity Forward Contract......Page 284
15.9 Index Futures Fair Value......Page 285
15.10 The Basis......Page 286
15.11 Index Arbitrage Trade......Page 287
15.12 Running an Arbitrage Desk......Page 288
15.13 Features of Index Futures......Page 289
15.14 Equity Swaps......Page 290
15.15 Managing the Risks on Equity Swaps......Page 291
15.16 Structuring Equity Swaps......Page 292
15.17 Benefits and Applications of Equity Swaps......Page 293
15.18 Chapter Summary......Page 294
16.2 Definitions......Page 295
16.3 Basic Option Trading Strategies......Page 296
16.4 Long Call: Expiry Payoff Profile......Page 297
16.5 Short Call: Expiry Payoff Profile......Page 299
16.6 Long Put: Expiry Payoff Profile......Page 300
16.8 Summary: Intrinsic and Time Value......Page 302
16.9 CBOE Stock Options......Page 303
16.10 CME S&P 500 Index Options......Page 304
16.11 Stock Options on LIFFE......Page 305
16.12 FT-SE 100 Index Options......Page 306
Appendix: Exotic Options......Page 307
17.2 Fundamental Principles: European Options......Page 311
17.3 Synthetic Forwards and Futures......Page 313
17.4 American Options and Early Exercise......Page 314
17.5 Binomial Trees......Page 315
17.6 Expanding the Tree......Page 318
17.7 Black-Scholes Model......Page 320
17.9 Chapter Summary......Page 323
Appendix: Measuring Historic Volatility......Page 324
18.2 Intrinsic and Time Value Behaviour......Page 327
18.3 Volatility Assumption and Option Pricing......Page 329
18.4 Delta (Δ or δ)......Page 330
18.5 Delta Behaviour......Page 331
18.6 Gamma (Γ or γ)......Page 332
18.7 Readjusting the Delta Hedge......Page 333
18.8 Gamma Behaviour......Page 334
18.9 Theta (Θ)......Page 336
18.11 Rho (ρ) and Summary of Greeks......Page 337
18.12 Chapter Summary......Page 339
Appendix: Delta and Gamma Hedging......Page 340
19.2 Hedging with Put Options......Page 343
19.3 Covered Call Writing......Page 347
19.4 Collars......Page 348
19.5 Bull and Bear Spreads......Page 350
19.6 Other Spread Trades......Page 352
19.7 Volatility Revisited......Page 354
19.8 Volatility Trading: Straddles and Strangles......Page 356
19.9 Current Payoff Profiles......Page 357
19.10 Profits and Risks on Straddles......Page 359
19.11 Chapter Summary......Page 361
20.2 OTC and Exchange-traded Currency Options......Page 363
20.3 Hedging FX Exposures with Options: Case Study......Page 364
20.4 Pricing Currency Options......Page 366
20.5 Interest Rate Options......Page 367
20.6 Exchange-Traded Interest Rate Options......Page 368
20.7 Caps, Floors, and Collars......Page 370
20.8 Interest Rate Cap: Case Study......Page 371
20.9 Pricing Caps and Floors: Black Model......Page 373
20.10 Swaptions......Page 375
20.11 Interest Rate Strategies......Page 377
20.12 Convertible Bonds......Page 378
20.13 CB Measures of Value......Page 379
20.14 Conversion Premium and Parity......Page 381
20.15 Convertible Arbitrage......Page 382
20.16 Chapter Summary......Page 384
Glossary of Financial Terms......Page 387
Index......Page 433