types or categories we can begin to look at the fundamental
differences associated with each, explore the characteristics of the
markets themselves and the products, which will determine the way
in which the operations teams deal with them.
The wholesale and retail markets have different products, processes,
procedures and participants. Often the retail market utilizes a
combination of wholesale market products so that, for instance, a
guaranteed equity index bond offered to the public will utilize the
corporate bond market to give the financial return to allow the
investors’ subscriptions to be returned, and the derivatives market for
the option contract on the index to guarantee the increase in the
index value. We look at retail markets and products in more detail
later in the book. The wholesale markets and distribution businesses
of banks are constantly providing and utilizing products to satisfy the
needs of financial management and capital generation for corporate
clients and investment opportunities for institutions and private
clients.
Corporate finance teams provide services to ensure that a client can
raise funds to finance trading, research and development and use
capital to acquire other businesses as well as defend a client against
the predatory instincts of someone else. It is an often-complex
process requiring great skill in relationship management, confidentiality,
and a broad base of contacts. Raising millions of euros,
dollars or pounds may sound easy but the instrument used to achieve
this must be beneficial to both the client and the investor. Most
importantly, it must be competitive with other types of investment
opportunities and attractive. Thus we have different markets within
the financial markets, all competing for an investor’s money as they
provide the capital sources that keep industry, commerce and
governments working.
Taking debt and money markets first, we can safely assume that here
we have products which are clearly defined, i.e. they represent a debt.
However, within this category are various types of debt instruments
ranging from simple debt to a debt with conditions attached to it. In
all cases an organization is borrowing money for a period of time. In
the case of ‘debt markets’ this is usually for a period longer than 12
months. If a debt is for a shorter period of time it is often referred to
as a money market instrument.
So we have common debt instruments like bonds (or loan stocks), bills
and notes, for instance. A bond is issued by a borrower to a lender and
in its simplest form is set for a period of time and carries a fixed rate
of interest, payable at set times during the life of the bond. Then we
have redemption, the return of the principal amount (the amount
lent) and interest payments at periodic intervals, i.e. semi-annually or
annually. In common with all financial markets there is a language
that is used and it is important that this language or terminology is
understood or problems will undoubtedly occur. So when we talk
about interest on a bond we could also refer to the coupon of the
bond. Why? Well, bonds are often in bearer form and like a £10
banknote or a $1 bill whoever bears or has it in their hand owns it. If
a bond is in bearer form (Figure 2.2) then the borrower has no means
of knowing to whom the interest should be paid unless there is a
facility, in this case a coupon attached to the bond, that can be
detached, presented at the appropriate time to the paying agent of the
borrower and the interest amount received in exchange.
The alternative to a bearer instrument is a registered instrument
where a central register is kept of the owners of the instrument or
security. The issuer of a registered security always knows who owns
the debt but if the holder sells it, then the register must be updated
to reflect the change in ownership. Typically bonds will be issued
with a life or duration of anything from 3 years to 30 years or more
and, unsurprisingly, are referred to as ‘short’, ‘medium’ and ‘long’
bonds.
In operations terms the issues are about:
- The type of bond, i.e. bearer or registered
- The frequency of the interest payments
- The rate of interest
- The date of redemption or duration of the bond
Additional information will include the paying agent, method of
claiming interest and redemption amounts and whether there is any
other condition, option or action that might occur with the bond on
or before maturity.
Bonds with a predetermined rate of interest are known as fixed-rate
or fixed-interest bonds. But bonds may also be issued with a floating
or changeable rate of interest and these can be called floating-rate notes
or FRNs. The precise terms of the interest, redemption and any other
condition are decided when the instrument is issued, but exactly
what the actual amounts or actions are will be determined at the
appropriate times.
Read More : Debt and money markets
