DEALING SESSIONS – TIPS AND SUGGESTIONS

This document is any attempt to put into writing all of the information conveyed
during the Practice Sessions. It also contains additional information that was not
covered during those sessions. Whether you attended a Practice Session or not, it is
important that you read this document very carefully and ask questions (I suggest the
Learning Hub Discussion Board) if there is any remaining doubt or uncertainty.

Overview of the dealing process

The purpose of the dealing session is to learn about trading in (in this case) money
market instruments. You will be trading overnight cash, 7-day cash and bank bills
with maturities from 30 to 180 days.

During the session you are expected to make and receive phone calls, ask for and
receive quotations of yields for these instruments, and enter into transactions. The
following are examples of calls that will take place:

Corporate to Bank: In this case the corporate is the price-taker and the bank
is the price-maker. The corporate asks the bank for a 2-
way quote for a particular instrument. The bank must
provide a 2-way quote if asked to do so.

After the bank gives the 2-way quote to the corporate,

the corporate can say Thank You and end the
conversation, or it can indicate its desire to enter into a
transaction at the quoted rate. If the corporate wants to
go ahead with a transaction in the same telephone call,
the bank must go ahead at the rate that has been
quoted.

The corporate can borrow or lend (in the case of cash) or

buy or sell (in the case of bills) – the choice is theirs.
When the corporate informs the bank of the size of the
transaction and whether it wants to borrow or lend
(cash) or buy or sell (bills), this will determine the
relevant side of the quote at which the deal will proceed
(bid or offer). The parties should confirm with each
other which side of the quote (the bid or offer) is
relevant to that particular transaction, to help avoid
mistakes. Both parties record the transaction manually
and then enter it into the Generator.

Bank to Bank: Banks may well call other banks to find out where the
market is at that particular point in time, but they can
also enter into a transaction at the quoted rate. In this
case the calling bank acts as the price-taker, has the
same choices and acts exactly the same as the corporate
 in the above example. The quoting bank is the price-
maker and acts the same as the bank in the above
example. It must quote if asked and it must go ahead if
the calling wants to enter into a transaction.

If you are a bank, you should never quote a rate that you
are not happy to go ahead with. You should structure
your quotes accordingly. If you don’t want to trade in a
particular instrument, make your quote very unattractive
(so that if the other party does proceed you will make a
handsome profit. If you want to trade in a particular
instrument, make your quotes very competitive and
attractive. You might give up a little potential profit, but
you will make more profit in the long run if you can, as
the price-maker, get people to enter into the transactions
you want. The alternative would be to get those
transactions as a price-taker, which will not result in
rates that are as beneficial.

Corporate to Corporate: If one corporate calls another, the calling corporate is

the price-taker, and has exactly the same choices and
options as the corporate in the first example above.
However, the corporate being asked for a quote does
NOT have to quote if they don’t want to. They also
have the option of quoting a 1-way price – eg. indicating
that they want to buy but not sell, or borrow but not
lend. If they do choose to quote a 2-way price they act
as the price-maker when it comes to determining which
side of the quote is relevant to the transaction.

Bank to Corporate:
This would not normally occur in the real world.
However, if business is slow you, as a bank, might want
to call a corporate and offer your rates in an attempt to
“drum up” business. However, it must be made clear
that in this case the bank is still the price-maker and the
corporate is the price-taker in this sort of call.

To summarise, the minimum marketable size transaction is $5 million, and the

maximum transaction size is $20 million. If you are a bank, and someone asks for a
quote, you must provide a 2-way quote, and if the price-taker wants to borrow or lend
between $5m and $20m, or buy or sell bank bills with a face value between $5m and
$20m, then you must go ahead with the transaction.

If the price-taker, after receiving a quote, wants to transact less than $5m, you are
entitled to adjust your quote to make it worth your while entering into a non-
marketable size transaction.

If the price-taker hangs up and calls back, your quote can change, but if they go ahead
in the same conversation you must honour your quote.
Counterparty limits

This is important and we didn’t have time to cover it in the practice sessions (which
were already an example of information overload). Please read carefully. If you get
this wrong you will lose marks on your report.

As it says in your scenario, you must work out your own counter party limits. A
counterparty limit is the maximum amount you are prepared to lend to any single
counterparty. If you lend all of your money to one counterparty (ie. one bank or
corporate) and they were to go out of business, so would you! You must set
counterparty limits to spread your risk.

You might set a blanket limit, or you might have a different limit for banks and
corporates, or you might set a different limit for each different counterparty (for
example, based on their credit rating). Credit ratings are normally common
knowledge, so if someone asks for your credit rating in our sessions you are expected
to give it.

Banks, and corporates whose objective is to invest funds, need counterparty limits. A
corporate whose objective is to borrow funds will probably not need counterparty
limits unless they achieve their primary objective and then start lending significant
amounts of money as part of their secondary objective (discussed below).

In your report, you should set out and explain your counterparty limits. You should
identify and explain any violations. If the violations were unintentional, you should
discuss how you would avoid a repetition in future.

Primary objective

Your primary objective, if you are a corporate, is either going to be to borrow or

invest money.

If your objective is to borrow money, you can do this by borrowing cash or selling
bank bills. In this case, you start with a zero bank balance and your target bank
balance is the amount of money you are supposed to be borrowing.

If your objective is to invest money, you can do this by lending cash or buying bank
bills. In this case, your starting bank balance is the amount of money you have to
invest, and your target bank balance is zero.

In either case, most of your transactions will involve you calling banks (or maybe
other corporates) and acting as price-taker. If another corporate asks you for a quote,
you might be able to enter into a suitable transaction as price-maker. See the
following paragraph for an indication of how to structure your quotes, as a price-
maker, under these circumstances.

Your primary objective, if you are a bank, is either to invest money or simply to act as
a price maker. Either way, your target bank balance is zero. You can borrow or lend
money, as required to move toward your target bank balance, by borrowing or lending
cash, respectively, or selling or buying bank bills, respectively. There are two ways to
do this. You can call other banks and enter into transactions based on their quotes,
with you acting as price-taker. Or you can, hopefully, enter into some appropriate
transactions, which will help you achieve your target, as the price-maker (when
someone calls you for a quote). You may well have to act as price-taker some of the
time, but if that is all you ever do, you won’t be making a profit for your shareholders.

Ideally, at least some of your transactions should be as a price-maker. You should

think about how you are quoting so that your quotes are attractive to people who want
to do what suits you, and unattractive to people who want to do the opposite of what
suits you (in terms of moving toward your target).

For example, let’s say the current market rate for overnight cash is 4.70/80, and you
have a surplus of funds that you need to get rid of to get down to a zero bank balance.
If you keep quoting the market rate, you might not get anyone to borrow your money
– or worse, you might get others lending more money to you and making the situation
worse. You can call other banks, and achieve your objective by acting as price-taker,
but then you have to take the worst side of the quote. If they are quoting the market
rate, you will have to lend at 4.70%. However, the next time someone asks you for a
quote, you might quote 4.68/78, or 4.66/76, or 4.64/74. This makes it attractive for
others to borrow from you, compared to the market rate, because they can borrow at,
say 4.76%. You give up a little profit (compared to lending at 4.80%) but at least you
get the deal you want and it is better than having to lend at 4.70% as the price-taker.

Note that you should adjust the bid and offer rates in the same direction, so that you
not only encourage the transactions you want but you actively discourage transactions
you don’t want.

Market view

You should come to the session with a clear view of how you expect interest rates to
move over the next 6 months. Ideally you will have discussed your view amongst
yourselves before the session. If this is not possible, you will have the opportunity to
discuss it at the start of the session.

In your report, you should explain your market view and why you hold this view, in
such a way that demonstrates that you have an understanding of the determination of
interest rates. This is a CRITICALLY important part of your report.

Trading strategy

You should develop a trading strategy for achieving your primary objective based on
your market view. Ideally you will have discussed this strategy amongst yourselves
before the session. If this is not possible, you will have the opportunity to discuss it at
the start of the session.

Your strategy should enable you to achieve your objective in such a way that you can
take advantage of changes in interest rates if they move as you have predicted. If you
are borrowing and you expect rates to fall, would you rather borrow short-term or
long-term (where the long-term is 6 months)? If you expect rates to increase, would
you rather borrow short-term or long-term? The opposite strategies would apply if
you are investing money.

Your trading strategy, and your speculation strategy (see below) are also critical parts
of your report.

Secondary objective

Your secondary objective, after you achieve your primary objective, is to speculate.
This means borrowing and lending at different ends of the yield curve in order to take
advantage of changes in interest rates if they move as you have predicted. For
example, if you think interest rates will fall, you should be able to work out whether it
would be better to borrow short-term and invest long-term, or vice versa. Your long-
term borrowing and lending locks in the current rates, while your short-term
borrowing and lending will be “rolled over” at least once, or maybe several times,
during the same period.

If you have money to borrow or invest, you should achieve your primary objective
first, and then try speculating. Corporates should wait until they achieve their primary
objective before speculating. If you are a bank starting out square, you are effectively
speculating from the very start of the session. Throughout the session you will be
borrowing and lending, and hopefully doing so at different rates and making a profit
along the way. You should aim to finish close to a zero bank balance, but you should
be striving to position yourself so that you have borrowed short-term and lent long-
term, or vice versa, depending on the speculation strategy you come up with based on
your market view.

Making a profit

The only way you can identify any profit from the session is if you have bought and
sold the same security. Eg. If you buy and then sell 30 day bills at a different yield,
there will be a different price and you will have a profit or loss from that pair of
transactions. By all means identify such situations, but it is more important that you
try to set up your organisation so that you will make a profit if interest rates move as
you expect. Discuss in your report whether you think you have achieved this.

Group pages

Where I have been able to identify the group you are working with, I have set up a
group page on the Learning Hub which will allow you to set up your own Discussion
Board, exchange files and send email. If that has not been set up for you, it will be
after the Dealing Session. You might want to use the group page to discuss your
market view and strategy before the session, and work on your report after the
session.
If there are changes that need to be made to the groups I have set up, please let me
know. If someone needs to be taken out of the group, I need to hear from the person.

A few final tips

Make sure at least one of you has a floppy disk to make it easier to take your results
with you (in case there are problems printing out the results).

Don’t worry about going into negative bank balances. Assume the money will be
found elsewhere in your organisation. You can lend money you don’t have, and go
into a negative balance, as long as you borrow the money back (hopefully at a lower
interest rate) before the end of the session.

Don’t worry about finishing precisely on your target. If you are within $5m, that is
close enough (although obviously the closer the better).

Do the best you can, but don’t worry if your financial result is poor. You don’t get
graded on your result, but on what you say about it in the report. If you lose a billion
dollars, but discuss your result in an intelligent way, demonstrate that you know what
happened and what went wrong, and have some ideas as to how you would do better
if given another opportunity, you can still get an excellent mark.