Financial markets

They constitute the mechanism or place through which contact is established between the various agents interested in negotiating financial assets, that is, it is the ideal means by which buyers and sellers interact to exchange assets and money, and thus channel society’s savings. towards productive or service sectors, with temporary resource needs.

For a financial market to be efficient, it must fulfill a double function: on the one hand, it provides liquidity to assets, since as the market for a new asset expands and develops, it will be more easily converted into money without loss and, on the other, to reduce to the minimum possible the time that elapses from the moment the operation is agreed to until it is fully settled, that is, to achieve operational agility.

There are various criteria to classify financial markets, although, for this work, those that respond to the way of operation, degree of organization, context in which the operations are carried out, phase in the negotiation of the assets, and characteristics will be taken into account. of traded assets.

Financial markets classification criteria

Because of the way it works.

Direct market: when the exchanges of financial assets are carried out directly between the applicants for financing and the providers of funds, that is, the agents -buyers, and sellers- are in charge of finding their counterpart, with limited information and without the help of specialized agents, although, as a consequence of the existence of a large volume of operations, specialized agents sometimes appear in these markets, brokers -commission agents- and who have the function of relating the suppliers and applicants of assets by charging a commission.
intermediated market: when at least one of the participants in . each asset purchase or sale operation is a financial intermediary. This type of market is essential to develop investment processes in small and medium-sized companies since direct fundraising is more within the reach of the public sector or large companies of recognized solvency. In these markets, the role played by financial intermediaries in their function of placing and even more so of transforming assets is fundamental, converting them -once acquired by them- from primary titles to indirect or secondary titles, issued by themselves, with a series of new benefits that make them more apt and attractive for their acceptance by the surplus units.

Because of its degree of organization.

Organized markets: in which many titles are traded simultaneously, generally in one place and under a specific set of rules and regulations; an example is the stock markets, the foreign exchange market, and the interbank market.
Unorganized markets: those in which, without being subject to strict regulations, assets are exchanged directly between agents or intermediaries, without the need to define the place where the transaction takes place since the price and quantity conditions are freely set by the parties and not the intervention of a mediating agent is required, although it may exist.

Due to the context in which they carry out the operations.

Interbank market: refers to wholesale and primary markets in which operations are only crossed between credit institutions, the central bank, and, in some cases, other financial institutions, to negotiate very short-term assets with a high degree of liquidity. The growing importance of this market today is not only due to the large number of entities that participate in it, and the high volumes traded between them, but also because they undoubtedly constitute the basic reference point for price formation in the various financial markets.
Non-interbank market: the intermediaries that act can be non-banks and banks can also participate since the relationships extend between participants that are not purely banking.

By the phase in the negotiation of the assets.

Primary markets: in which newly created financial assets are exchanged, and secondary markets; in which already existing financial assets are traded, changing their ownership, as many times as allowed for the title’s expiration term.
Secondary market: it does not suppose the existence of new financing for the issuer, but it is of great importance to guarantee the liquidity of the assets, allowing the circulation of these between the agents and the diversification of their portfolio, and contributing to the promotion of savings of the collectivity

Due to the characteristics of the assets traded.

Monetary or money market: it is a short-term market in which (highly liquid, low-risk assets are traded and consequently, lower relative yield, although this has the advantage of being fixed.
Capital market: financial assets are traded in the medium and long term, and their assets can generate fixed or variable returns (depending on the existence and distribution of profits in the issuing entity). Due to the important development achieved in financial innovations in recent times, the derivatives market[1] should be mentioned as part of this classification, which deals with the negotiation of hedging instruments contracts, in the face of possible market risks, since either the variation of interest rates, exchange rates or other types of asset prices. Examples of them: are futures and financial options.

Treasury values

Treasury securities are issued by the US Treasury Department and are backed by the entire trust and credit of the US government. Consequently, market participants view them as having no credit risk. Treasury interest rates are the benchmark rates for the US economy, as well as for international capital markets.

Treasury securities can be classified into: Discounted Securities and Coupon Securities.

The fundamental difference between the two types is found in the form of the flow of payment that the holder receives, which is reflected in the price at which the securities are issued. Coupon securities pay interest every six months plus principal at maturity. Discounted securities pay only a contractually set amount at maturity, called the maturity value or face value. Discounted instruments are issued below their maturity value, and the investor’s return is the difference between the issue price and the maturity value.

Treasury Notes

Current treasury practice is to issue all securities that have a maturity of one year or less as discounted securities. Such securities are called Treasury notes.

All securities with a maturity of two years or greater are issued as coupon securities. Treasury coupon securities issued with original maturities between two and ten years are called Treasury notes, and those with original maturities greater than ten years are Treasury bonds.

Treasury notes are issued in the primary market based on an auction. Those with a maturity of three to six months are auctioned every Monday, and those with a maturity of one year are auctioned the third week of each month.

Primary agents include various commercial banks and investment banking firms, both domestic and foreign.

The secondary market for treasury securities is an over-the-counter market, where a group of government securities dealers offer bid or ask prices to the general public and other dealers. The secondary market is the most liquid in the world.

The issue auctioned for each maturity is named a current or current coupon issue. Issues auctioned before the current coupon issue are referred to as matured issues and are not as liquid as current issues.

The offer price of Treasury notes.

The offer and proposal pricing convention for treasury notes states that they are quoted based on a bank discount and not based on price, and are calculated as follows:

Y= D/FX360/t.

Where:

Y: annualized yield based on bank discount (expressed in decimal).

D: Discount, which is equal to the difference between the nominal value and the price.

F: Valor nominal.

.t: Amount of time left for expiration.

Example Treasury Note Yield Calculation:

Suppose you buy a Treasury note with 100 days to maturity, a face value of $100,000, and a sales price of $97,569. What is the annualized yield based on a bank discount?

D= Nominal value – Market price.

D= $100 000 – $97 569

D= $2431.

Y= ($2431/ $100 000) X (360/100)

Y= 8,75%.

The annual yield on the Treasury note is 8.75%.

Knowing the yield based on the bank discount, the price of the Treasury note can be calculated as follows:

And:

Y= D/FX360/t.

So clearing D.

D= Y X F t/360

So the price is:

Market price = F-D

For the 100-day Treasury note with a face value of $100,000, if the bank discount yield is quoted at 8.75%, D equals:

D= 0,0875 X $ 100 000 X 100/360

D= $2431

Precio = $100 000 – $2431

Precio = $ 97569

The yield quoted on a bank discount basis is not a meaningful measure of the return on holding a Treasury note for two reasons: 1) the measure is based on an investment of par value, rather than current value, and 2) the Yield is annualized based on a 360-day year, making it difficult to compare the yields earned with Treasury notes and bonds that pay 365-day interest. Despite the drawbacks of this yield measure, this is the method dealers have adopted to price Treasury notes.

The corporate bond market

The corporate bond market can be classified into five sectors:

1) commercial paper markets, 3) bank loan market, 4) bank acceptance market, 5) term certificate market, and 6) mortgage market.

Unlike Treasury securities, corporate bonds expose the investor to credit risk, because the issuer may default on its obligations to the lender. In any given period, the yield offered in the market for a corporate debt instrument varies according to investors’ expectations about the issuer’s probable ability to satisfy its obligations to the lender. The greater the perceived credit risk, the higher the return investors demand.

Commercial paper markets

Commercial Paper: Credit instrument in which an issuer promises to pay a certain amount of money to its holders on the maturity date. These are issued in the short term (between 30, 50, and 270 days) by public limited companies that have previously obtained the corresponding authorization to offer them to the public.

Commercial paper is a short-term unsecured promissory note, issued on the open market, that represents the obligation of the issuing corporation.

The issuance of commercial paper is a bank loan alternative for large corporations (financial and non-financial) with strong credit values.

While the original purpose of the commercial paper was to provide short-term funds for temporary working capital needs, companies have used this instrument for other purposes in recent years. It is very often used as a “bridging loan”. For example, if a corporation needs long-term funds to build a plant or purchase equipment. Rather than obtain the long-term funds immediately, you choose to postpone the offering until more favorable capital conditions prevail in the market. The funds acquired from the issuance of commercial paper are used until the long-term securities are sold.

The placement of commercial paper is classified as direct paper or paper through brokers. Straight paper is sold by the issuing company to investors without the help of a broker. Commercial paper through brokers requires the services of an agent to sell an issuer’s paper.

There are several differences between US commercial paper and European commercial paper concerning the market structure and paper characteristics. 1) US commercial paper usually has a maturity of fewer than 270 days, with an expiration order of 30 to 50 days or less; while the European one can be considerably broader, 2) in the US it must have unused bank credit lines, in the European one it can be issued without guarantees, 3) the US issuer can be placed directly or by through agents, the European one is almost always installed through agents and 4) due to the long maturity of the European paper, it is traded more often in the secondary market than in the US.

Bank loan market

Bank loans

An alternative to investing in securities is that a corporation can raise its funds by borrowing from a bank. Bank debt is most widely used as major financing for a leveraged buyout. There are several resource alternatives for a corporation: 1) a domestic bank in the corporation’s home country, 2) a subsidiary of a foreign bank that is established in the corporation’s home country, 3) a foreign bank domiciled in a country where the corporation does business, 4) a subsidiary of a national bank that has been established in a country where the corporation does business, 5) a European or transnational bank.

Bank loans can be classified in different ways, such as:

1) According to the interest rate:

Loans can be fixed or variable interest.

Fixed-interest loans maintain a single interest throughout their lives, previously agreed in the contract negotiated between the parties.

Variable interest loans are the result of adding a fixed margin, predetermined in the contract, to a variable interest rate, agreed as a reference base rate. The variable interest rate is not determined quantitatively in the contract but using a differential rate added to a reference rate specified and known for sure on the interest settlement dates to determine the rates to be paid at any given time, which means that the loan rate is based on a reference rate, for example, the London Interbank Offered Rate (LIBOR) or the rate of certificates of deposit.

In banking practice, when contracting loans, the differential rate is expressed in percentage points and the reference rate can be any interest rate observable in a regulated market, either offered by an entity or an average of those offered by certain entities, or an average published in a market.

The fundamental reason for the implementation of variable interest rates by banks is to share the interest risk with the borrower in medium and long-term operations. The turnover of banks’ liabilities occurs to a greater extent in the short term and, consequently, the costs that they must bear are those of short-term funds, with which the interest rate risk is derived from the variation of the rates at the time of liquidation will be zero if the financing funds of the loan vary in the same direction and with the same periodicity.

About borrowers, the acceptance of variable interest rates in a long-term operation, assuming the interest rate risk, should be a decision based on the assessment of that risk, the awareness of assuming fixed costs for the coverage of the same, and the return on investment that this financing will allow.

2) According to the form of amortization:

Loans with a lack of amortization and loans with a lack of installments.

Loans with a lack of amortization are those in which the payment of the part corresponding to the amortization of the principal is deferred for some periods.

The need to defer the repayment of a loan is conditioned by the requirements of the projected cash flows of the borrower. It is necessary to emphasize that the lack of amortization has nothing to do with interest payments, which continue to be made, regardless of the deferral of the amortization amounts.

The periods in which it is agreed to defer the amortization payment can be in three temporary positions: in the initial moments of the life of the loan, at the end of the operation or they can be in intermediate periods.

Loans with no installments are those in which the borrower does not make any payment during a series of established periods.

In loans with no installments, the lender grants the borrower the deferral of payment of any amount but does not consent to the exemption of interest. Therefore, even though interest payments are not made, the borrowed principal is increased by the part corresponding to accrued and unpaid interest, with which the amount amortized at the end of the loan does not coincide with the loan granted to the start, but will be higher by an amount equal to the unpaid interest.

3) Loans from unionized banks

A syndicated bank loan is one where a group (or syndicate) of banks provides funds to the borrower. The need for a pool of banks arises because the amount sought by a borrower may be too large for just one bank to expose itself to that borrower’s credit risk. Therefore, the syndicated loan market is used by those seeking to raise a large amount of funds in the loan market, rather than through the issuance of securities.

The interest rate on a syndicated loan is variable.

The maturity of the loan term is fixed and is often structured to be amortized according to a predetermined schedule, with principal repayment generally beginning after a specified number of years (less than or equal to 6 years).

Syndicated loans are distributed in two ways:

Transfer method: In this procedure, the seller assigns all rights completely to the holder of the transfer, now called an attorney-in-fact.
Participation method: In this procedure, the privacy of the contract is not conferred on the holder of the participation, since he does not become a party to the loan agreement and has no relationship with the borrower, but rather with the seller of the participation.

Banker’s Acceptance Market

A corporation seeking to raise short-term funds can issue short-term securities by using a commercial paper program to disseminate, through an agent, the securities to investors. The risk it faces is that when the paper reaches maturity and additional financing is required, market conditions may be such that the corporation fails to sell its new paper.

To eliminate this risk, the facility for issuing acceptances was developed.

An acceptance issuance facility (or note) is a contract between a borrower and a group of banks (syndicate), in which the banks ensure that the borrower can issue short-term notes (usually with maturities of three to six months). ), over a set period in the future, called banker’s acceptances.

The bank syndicate ensures that the borrower can raise funds on short notice by agreeing to extend credit to the borrower or to purchase the acceptances issued by the borrower if they cannot be sold at a predetermined minimum price. The term of the agreement is normally five to seven years. The bank union receives a commission for this task.

The use of bank acceptance has decreased as capital requirements have been imposed on banks that underwrite a note issuance facility and because those multinational corporations that have strong credit values feel that this support facility was unnecessary and only increased the cost of raising funds in the short term, due to the commitment fee that had to be paid. Consequently, instead of using the note issuance facilities, they relied more on the European commercial paper market to raise short-term funds.

Seen more simply, a bank acceptance is a vehicle created to facilitate the transactions of commercial operations. The instrument is called bank acceptance because a bank accepts the ultimate responsibility of repaying a loan to its holder. The use of a banker’s acceptance to finance a business transaction is called “financial acceptance.”

Example:

Bucanero SA is a Cuban mixed company dedicated to the production of Beers and Malts, this entity establishes a purchase-sale contract with FEMSA, a company dedicated to the production and sale of beer containers. Buccaneer SA. It offers $68,500 for a thousand of the set of lids and cans. The credit terms are that payment will be made 90 days after the shipment of said materials. Suppose that FEMSA agrees to the terms and conditions of the contract, but is concerned about Bucanero SA’s ability to make the promised payments.

Due to the above, Bucanero SA agrees with its bank, Banco Financiero Internacional (BFI) to issue a letter of credit, which expresses that BFI will finance the payment of $68,500 that Bucanero SA must make to FEMSA, 90 days after shipment.

The term letter of credit or bill of exchange will be sent by BFI to FEMSA’s bank, which is Banco de Comercio de México (BANCOMER).

When BANCOMER receives the letter of credit, it will notify FEMSA, which will ship the thousands of materials described above.

After the materials are shipped, FEMSA presents the shipping documents to BANCOMER and receives the present value of $68,500, for which it exits the negotiation.

BANCOMER presents a term bill of exchange (according to the days remaining for the 90 days) to the BFI, the latter will stamp “Accepted” on the term bill of exchange, thereby creating a bank acceptance. This means that the BFI agrees to pay the holder of the banker’s acceptance $68,500 on the due date.

Bucanero SA will sign an agreement with BFI, with which it will receive the shipping documents and materials.

At this moment, the holder of the bank acceptance is the BFI and it has two decisions: 1) to continue supporting the bank acceptance in its loan portfolio and 2) to request BANCOMER to make the payment of the same at the present value of $68,500. Suppose BACOMER accepts.

Now the holder of the bank acceptance is BANCOMER, which has two alternatives: 1) continue holding the bank acceptance in its loan portfolio and 2) sell the bank acceptance to an investor at the present value of $68,500.

Term deposit market

Term Deposit Certificates (TDC): It is a freely negotiable title with which a person, natural or legal, may deposit an amount of money, to withdraw it after a certain time, obtaining as a benefit a return on their investment. The terms can be from 30 days onwards, the most common being 30, 60, 90, 180, and 360 days. They can be issued by commercial banks, savings corporations, financial corporations, etc. The rate of return for your deposit is determined by the amount, the term, the responsible corporation, and the existing market conditions at the time of its constitution. They are nominative, that is, their value is the one that appears in the document, and they cannot be redeemed before their expiration.

They can also be defined as a document accrediting a fixed-term imposition and transferable by endorsement. Sometimes the intervention of the entity that makes use of the deposit is necessary. The supporting document shows the holder of the fixed-term deposit, the expiration date, the interest rate, and the interest payment method. In this way, if the depositor needs liquidity before the expiration of the fixed term, he can sell the certificate of deposit without having to cancel the underlying term deposit contract.

Suppose that a deposit of one million dollars is made in a commercial bank for 180 days at 10% annual interest. If the nominal interest rate is 10% and with monthly interest settlement, how much does the interest amount, using the American amortization method?

Table:

As can be seen, the interests amount to $600,000.00.

Mortgage market

The mortgage market is a collection of markets that includes a primary (or granting) market, and a secondary one where mortgages are traded.

By definition, a mortgage is a property guarantee to ensure the payment of a debt, without the property leaving its owner’s possession. If the debtor does not pay, breaching the guaranteed obligation, the creditor may request the sale of the asset and collect what is owed with the amount of the sale, which is called foreclosure (the procedure by which, and in the event of non-payment of a debt, the creditor calls for the public sale of the debtor’s mortgaged property).

The elements involved in a mortgage are:

Mortgage Borrower: Borrower on a mortgage loan.
Mortgagee: Lender/investor in a mortgage loan.
Debt.
Real estate ownership.

When an investor grants a loan to a buyer of a house, which is taken as collateral, it is a typical example of a mortgage.

The buyer of the house is the mortgagor, the seller is the mortgagor, the house is the real estate property, and the loan granted is the debt.

Two types of real estate properties are recognized: 1) residential properties and 2) non-residential properties.

Residential properties can be subdivided into single-family structures (one to four families) and multi-family structures (apartment buildings in which more than four families reside).

On the other hand, non-residential properties include houses, cooperatives, apartments, and commercial and agricultural properties.

Generally, property refers to real estate, which in a broad sense is: land and everything that is attached to it: lots, buildings, factories, etc., which are the object of transactions in the real estate market.

The main grantors of residential mortgage loans are savings institutions, commercial banks, and mortgage banks.

Grantors can generate income from mortgage activity in several ways: First, they charge an origination fee, which is expressed in terms of points, with each point representing 1% of the funds lent. For example, an origination fee of two points on a $100,000 home loan is $2,000. The second source is the profit that can be generated by selling a mortgage at a price higher than the original cost.

This profit is obtained in the secondary market. If the mortgages go up, the grantor will make a loss when they are sold on the secondary market. The third is a potential source and consists of servicing the mortgages that they granted, for which they obtain a service commission, which consists of collecting the monthly payments from the mortgage debtors and issuing the income to the owners of the mortgages. loans, send payment notices to mortgagors, remind mortgagors when payments are due, maintain mortgage balance records, provide tax information to mortgagors, manage an account for real estate taxes and for insurance purposes, and if necessary, start the foreclosure procedure.

The grantor can sell the mortgage services to another party, who will then receive the fee for the services. The fourth potential source is that the grantor can hold the mortgage in its investment portfolio and speculate on the gaps of an imperfect market.

Someone who wants to borrow funds to buy real estate will apply for a loan from a mortgage lender. The prospective homeowner fills out the application, provides the applicant’s financial information, and pays an application fee, then the mortgagee conducts a credit assessment of the applicant. The two primary factors in determining whether funds will be loaned are 1) the monthly payment-to-income ratio, which measures the borrower’s ability to make monthly payments, and 2) the loan-to-value ratio, which consists of the ratio of the market value of the property and the purchase price of the real estate.

For example, if an applicant wants to borrow $150,000 on a property with an appraisal of $200,000, the loan-to-value ratio is 75% (150,000/200,000).

If the lender decides to lend the funds, it will send a commitment letter to the applicant, in which it agrees to provide funds to the applicant, in a period that varies from 30 to 60 days. As of the date of the letter, the lender will require the applicant to pay a commitment fee. It is important to understand that this letter obliges the lender, not the applicant, to perform. The commitment commission that the applicant must pay is lost if the applicant decides not to purchase ownership of the property.

On the date that the application is signed, the grantor of the mortgage will give the applicant a choice between several types of mortgages. The choice is between a fixed-rate mortgage (commonly called a traditional mortgage) or an adjusted-rate mortgage.

In the traditional or fixed-rate mortgage, the home loan is based solely on the credit of the borrower and the guarantee of the mortgage. The idea of this type of mortgage is that the borrower pays the interest (granting commission) and repays the principal in equal installments over an agreed period. Payment frequency is typically monthly and the prevailing mortgage term is 15 to 30 years.

Example:

The BPA grants a mortgage loan for $100,000 to Compañía Tierra Roja SA., for the purchase of apartment buildings in Ciudad del Niquel, with a mortgage rate of 9.5% per year for 30 years with the liquidation of interest and amortization of the monthly principal, calculated by the French amortization method. Do not consider commissions. Calculate the monthly installments and the interest paid at the end of the mortgage.

Table:

The French method tries to repay the loan through constant installments, identical for each of the settlement periods. The capital that is granted at the beginning is amortized through increasing amortization installments, based on a geometric progression of ratio (1 + i). On the contrary, the interest payments decrease as the life of the loan progresses. However, the sum of the amortization and interest installments must be equal to the amortization installment or term, which is calculated in advance.

The amount of the annuity is calculated by the mathematical formula that will be shown later or with the help of financial tables. The amount of interest is determined by applying the interest rate to the outstanding capital at each moment and the amortization rate is the difference between the amortization term and the interest rate. The outstanding capital is calculated as the outstanding capital in the previous period minus the part that has been amortized during that period.

To calculate the installment or amortization term, the following formula is used:

TA= Co X i/ [1-(1+i)-j]

TA= $100 000 X 0,007916667/[1-(1+0,007916667)] -360

TA = $840.85

Two risks are attached to mortgages: price risk and precipitation risk.

Mortgages run price risk, when there are adverse effects on the value of the mortgage, if mortgage rates rise and the grantor has made a commitment to a lower rate, the mortgages will have to be sold when they approach the lower value of the funds lent to property owners, or retain the mortgage as a portfolio investment, earning a lower-than-market rate.

Precipitation risk occurs when the mortgage grantor gives the potential borrower the right but not the obligation to cancel the agreement. The main reason potential borrowers may withdraw their mortgage application is that mortgage rates have dropped enough to make it economical to seek alternative funding sources.

Grantors have several alternatives to protect themselves against these risks. For example, they can obtain a commitment from an agency or a private conduit, to sell you the mortgage at a future time. This kind of commitment is effectively a forward contract, as the grantor agrees to send a mortgage at a future date, and another party (the agency) agrees to purchase the mortgage at that time at a predetermined price.

However, consider what happens if the mortgage rate drops and borrowers choose to cancel the agreement. The mortgage grantor agrees to submit a mortgage at a specified mortgage rate. If the prospective client does not close and the grantor made a commitment to deliver the mortgage to a private agency or conduit, the grantor cannot evade the transaction. For this reason, you will record a loss, since you must send a higher mortgage in an environment of lower mortgage rates. This is a precipitation hazard.

Mortgage grantors can protect themselves against the risk of precipitation by agreeing with an agency or private conduit for optional rather than mandatory mortgage remittance. With such an agreement, the mortgagee is purchasing an option that gives them the right, but not the obligation, to remit the mortgage.

In the presence of high and variable inflation, fixed or traditional rate mortgages suffer from two deficiencies: the lag problem and the skew problem.

The mismatch problem arises because mortgages and very long-term assets are generally financed by institutions that accept very short-term primary deposits and very long-term loans (15 to 30 years), therefore there is a mismatch of the maturity of assets (mortgages) and liabilities obtained to provide funds to the former, which results in the same thing happening when inflation rises in interest rates.

Another way to describe the mismatch problem is in terms of the balance sheet, rather than the income statement. The differences between active and passive interest rates will cause the lending institution to become technically insolvent, in the sense that the market value of its assets will be insufficient to cover its liabilities.

Tilt refers to what happens to the problem of mortgage payments over the life of the mortgage as a result of inflation. If the general price level rises, the real value of mortgages will fall over time. Thus, the mortgage obligation represents a greater problem in real terms for the real estate owner in the early years. In other words, the actual burden is “biased” toward the early years.

One way to solve the mismatch problem is to redesign the fixed-rate or traditional mortgage to produce an asset whose return matches short-term market rates, thus better matching the cost of liabilities. One instrument that has gained popularity is the so-called adjustable rate mortgage.

The adjustable-rate mortgage asks to adjust the interest rate periodically according to an appropriately chosen index, reflecting short-term market rates, which allows investors to better match their yields to the cost of their funds, adjusting the interest rate over time (six months, one year, two or three years, etc.). The interest rate on the adjustment date is equal to the benchmark index, plus a margin of between 100 and 200 basis points.

Mortgage rates generally include periodic caps that limit the amount the interest rate can increase(ceiling) or decrease(floor) on the reset date.

Treasury promissory note exercises :

Assume the price of the 90-day Treasury note with a face value of $1,000,000 is $980,000. What is the yield based on a bank discount?

Bid and call yields on a Treasury note due January 31, 2006, are quoted by a broker as 5.91% and 5.89%, respectively. Should the bid yield be less than the bid yield, since the bid yield indicates how much the dealer is willing to pay and the bid yield is what the dealer is willing to sell the treasury note?

Exercises on Commercial paper.

Why is commercial paper a short-term bank borrowing alternative for a corporation?

What is the difference between straight-laid paper and runner-laid paper?

What is the European commercial paper?

Exercise on bank acceptances.

Unico SA is a company dedicated to the production of Nickel plus cobalt, this entity establishes a purchase-sale contract with Volvo SA, a company dedicated to the production and sale of automotive equipment for the transportation of minerals. Unico SA offers $70,000 per team. The credit terms are that payment will be made 90 days after the shipment of said materials. Suppose that Volvo SA. agrees to the terms and conditions of the contract, but is concerned about Unico SA’s ability to meet the promised payments. The banks of Unico SA and Volvo SA are the BFI and the Swiss National Bank. Explain the mechanism of bank acceptance that would occur.

Exercises on loans.

What is a syndicated bank loan?

What is the benchmark rate typically used for a syndicated bank loan?

What is the difference between an amortized bank loan and a single amortization bank loan?

Explain the ways a bank can sell its position in a syndicated loan.

Exercises on term deposits.

Suppose a deposit of $200,000 is made in a commercial bank for 90 days. If the nominal interest rate is 10% and with monthly interest payments, how much does the interest amount, using the constant amortization method?

Mortgage exercises :

Suppose that the BPA grants you a mortgage loan for $4000, for the purchase of a PANDA television, with a mortgage rate of 5% per year for 4 years with monthly interest and principal repayment, calculated by the French amortization method. Do not consider commissions. Calculate the monthly installments and the interest paid at the end of the mortgage.

Suppose that the BPA grants you a mortgage loan for $10,000 to buy an apartment in Ciudad del Níquel, with a 5-year 6% annual mortgage rate, paying interest and paying off the monthly principal, calculated using the method of French amortization. Do not consider commissions. Calculate the monthly installments and the interest paid at the end of the mortgage.

Consider the following fixed-rate payment level mortgage:

Maturity: 360 months.

Loan amount: $100,000.

Annual mortgage rate: 10%.

Monthly mortgage payment: $877.57.

a) Build an amortization schedule for the first 10 months.

b) What will the mortgage balance be at the end of month 360?

[1] Financial derivatives are instruments that “derive” their prices from the returns recorded by the underlying assets in the money, currency, and stock markets.