Some markets are domestic (for example transactions in the local currency and under the control of the local central bank) and some are international (for example, a bond denominated in Japanese yen issued in London). There are also money markets, which are short-term (borrowing/lending of money for 1 year or less), and bond markets, which handle longer-term lending.
The Interbank Market
Banks lend money to one another for different periods of time. The deposit rate offered by one bank to another is called the offer rate. Thus, the interbank rates in London are called LIBOR – London Interbank Offer Rate. As London is a huge international market, LIBOR is the most commonly heard of interbank rate. In other wholesale markets, we may hear terms like ‘LIBOR + ¼’, ‘LIBOR + 35 basis points’ etc. The most common maturity period in the interbank market is 3 months.
Money Market Securities
Common money market instruments are –
Treasury Bills – short-term debt instruments issued by governments
Local Authority/Public Utility Bills – also called Munis in the US, issued by local municipalities etc.
Certificates of Deposit – receipts issued by banks for short term deposits by lenders. The advantage to the lender is that the CD can be sold in the secondary market, if they need the money earlier
Commercial Paper – issued by private corporations looking to raise short-term capital
The Bond Market
In some markets the terms bond and note are both used for medium to long-term securities. The US, for instance, has 2, 5 and 10 year Treasury notes and 30 year Treasury bonds.
There are different types of bonds –
Government bonds – These are the most important and often dominate the bond markets. The bonds are typically issued by a central bank or Ministry of Finance and first sold to specialist dealers from where they are sold in secondary markets.
Mortgage and Asset Backed bonds – In some countries, there is a big market for mortgage bonds. In the US, for example, home mortgages are bundled up and used as the backing security for mortgage bonds. The bundle is called Collateralized Mortgages obligations (CMO) or Collateralized Debt securities/obligations (CDS/CDO) .This technique is called securitization of assets and the bonds are called Asset-Backed securities. In theory, securitization can be applied to any stream of income payments.
Corporate bonds –Of course, they are issued by corporates. There are different varieties for example debentures are bond that must be backed by security like land and buildings. Convertibles are bonds that can be converted at a later point (if so chosen) into equity.
Foreign bonds – These are domestic issues by non-residents – ‘bulldogs’ in the UK, ‘yankees’ in the US, ‘matadors’ in Spain, ‘samurai’ in Tokyo and ‘kangaroo’ bonds in Australia! The bonds are domestic bonds in the local currency, only the issuer is foreign. This is different from international or Eurobonds which are binds issued outside their original -country. For example if a non-US firm seeks dollar funding, they can issue bonds in London as Eurobonds or in the US as ‘yankee’ bonds.
Stay tuned for more next week!