Another option for 'Funding Mega Dollar Projects' is to use Bank Guarantees (BG's), or similar Bank Instruments.
This is an excellent option for 3rd world countries. The government has a prime 'Bank' issue the Bank Guarantee to the Developer who was awarded the 'Project'. This can be for any type of project:
B.O.T. - Build, Operate, and Transfer
B.O.O. - Build, Operate, and Own
Environmental Project
Construction Project
Hospital or Medical Facility
ManufacEagle Tradersg Facility
Development Project
Quasi Government Project
Government Project
Nature and Natural Preservation Projects - Save the Rain Forest, Plant Tree Farms, etc.
Other
In principal this is how it works
The client may composite the value of the 'Contract' into a series of transactions utilizing Bank Guarantees (BG's) or similar Bank Instruments, whereby they (the client) do large project amounts ranging in increments of 20 to 100 million US Dollars utilizing corresponding Bank Instrument amounts.
However, the cash value (actual conversion amount) of each BG or Bank Instrument must be paid in full at time of every transaction for each of these larger projects. This is done in phases (stages over a period of time) during a predetermined schedule or life of the project.
The basic criteria would be a project or a series of projects rolled into one entity with a contract value of 200 million US dollars and above.
Example
Since projects are generally time phased for payments, the first payment on a 200 million US Dollar project could be 20m. The client would have issued a Bank Instrument such as a BG for 20m. The 'Bank Instrument', such as a BG, is then converted to real working dollars based on the market value of the instrument at the time.
Sunday, August 29, 2010
Corporate Promissory Notes (Continue....2)
Helpful hints:
CPN's are usually issued by a corporation as collateral or for the sole purpose of raising capital (liquid assets in the form of cash).
CPN's held by individuals are highly questioned by banks throughout the world. It is generally easier to raise a 'Credit Line' than convert this type of instrument into CASH!
Fluctuating World Market Conditions set the pace and determine the trading value, if any.
Usually most every instrument can be converted, however, some are just Not desirable
Trading Instruments on the current World Market.
Substantiated "Documentation' is needed for this type of transaction.
The Following Corporate Promissory Notes are very difficult to do at the present, and only a 'Credit Line' could be raised:
Any CPN issued from any Corporation in Indonesian unless backed by a Major World Bank.
Any CPN issued from any Corporation in Thailand unless backed by a Major World Bank.
Any CPN issued from any Corporation in Philippines unless backed by a Major World Bank.
Any CPN issued from any Corporation in Malaysia unless backed by a Major World Bank.
Any CPN issued from Corporation in Russia unless backed by a Major World Bank.
Any CPN held by an Individual in lieu of a company, trust, corporation, endowment, or
nonprofit entity.
The Following CPN's Are NOT Currently Tradable:
CPN's issued from Vietnam
CPN's issued from Cambodia
CPN's issued from Laos
CPN's issued from Burma
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applied to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
CPN's are usually issued by a corporation as collateral or for the sole purpose of raising capital (liquid assets in the form of cash).
CPN's held by individuals are highly questioned by banks throughout the world. It is generally easier to raise a 'Credit Line' than convert this type of instrument into CASH!
Fluctuating World Market Conditions set the pace and determine the trading value, if any.
Usually most every instrument can be converted, however, some are just Not desirable
Trading Instruments on the current World Market.
Substantiated "Documentation' is needed for this type of transaction.
The Following Corporate Promissory Notes are very difficult to do at the present, and only a 'Credit Line' could be raised:
Any CPN issued from any Corporation in Indonesian unless backed by a Major World Bank.
Any CPN issued from any Corporation in Thailand unless backed by a Major World Bank.
Any CPN issued from any Corporation in Philippines unless backed by a Major World Bank.
Any CPN issued from any Corporation in Malaysia unless backed by a Major World Bank.
Any CPN issued from Corporation in Russia unless backed by a Major World Bank.
Any CPN held by an Individual in lieu of a company, trust, corporation, endowment, or
nonprofit entity.
The Following CPN's Are NOT Currently Tradable:
CPN's issued from Vietnam
CPN's issued from Cambodia
CPN's issued from Laos
CPN's issued from Burma
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applied to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
Corporate Promissory Notes (Continue....1)
Corporate Promissory Notes (CPN's) - Issued by Major Corporations, usually public listed and underwritten by a Bank or Underwriter. This can be any foreign bank, or a Central Bank from country of origin.
Convert to Cash like handling a BG or raise a Credit Line.
Value conversion depends on many factors, some fixed, some floating such as…
Type of Promissory Note (time, maturity date, ownership, value, etc.)
Issuing Corporate Rating (preferably a Dunn and Bradstreet or similar Credit Rating)
Underwriting or Guarantor Bank and their Rating (Central Bank of a Government, Local in
Country Bank, Foreign Worldwide Bank, etc.)
Agent, Underwriter, Security House, or Bank Holding Promissory Note
What type of ‘Currency’, US Dollars is always preferred, but most others are acceptable
Market Conditions
Bank Policy or Underwriter Policy
Politics
Ownership, and Type of Restrictions, if any
Currency Fluctuation, if not already in US dollars
Client Anticipation of Return
Place Transaction Occurs
What is done with ‘Cash’ after conversion - this is becoming a paramount issue with banks or security houses converting the instrument, the preferred and acceptable method is to deposit a portion of the redeemed funds with the honoring bank or security house, usually as follows...
(1) For a 'Bank' not less than 50% for a period of not less than six (6) months.
(2) For a 'Security Trading House' not less than 30% either reinvested in other
types of asset portfolio management (stocks, bonds, mutual funds, etc.)
or in their money market fund.
Convert to Cash like handling a BG or raise a Credit Line.
Value conversion depends on many factors, some fixed, some floating such as…
Type of Promissory Note (time, maturity date, ownership, value, etc.)
Issuing Corporate Rating (preferably a Dunn and Bradstreet or similar Credit Rating)
Underwriting or Guarantor Bank and their Rating (Central Bank of a Government, Local in
Country Bank, Foreign Worldwide Bank, etc.)
Agent, Underwriter, Security House, or Bank Holding Promissory Note
What type of ‘Currency’, US Dollars is always preferred, but most others are acceptable
Market Conditions
Bank Policy or Underwriter Policy
Politics
Ownership, and Type of Restrictions, if any
Currency Fluctuation, if not already in US dollars
Client Anticipation of Return
Place Transaction Occurs
What is done with ‘Cash’ after conversion - this is becoming a paramount issue with banks or security houses converting the instrument, the preferred and acceptable method is to deposit a portion of the redeemed funds with the honoring bank or security house, usually as follows...
(1) For a 'Bank' not less than 50% for a period of not less than six (6) months.
(2) For a 'Security Trading House' not less than 30% either reinvested in other
types of asset portfolio management (stocks, bonds, mutual funds, etc.)
or in their money market fund.
Corporate Medium Term Notes (MTNs)
"Corporate MTNs", are simple one mechanism available to selling off Corporate Debt. These 'Corporate MTNs' are sold and traded on the Open Market, just like any other stock, security, or bank instrument.
It is often very advantageous for a company to sell off their "Debt."
Some advantages are:
(1) Getting Rid of the Debt
(2) Raising Capital
(3) Better Market Exposure
(4) Freeing Up Assets to Pursue Other Things
IN A FINANCIAL WORLD GONE CRAZY, DEBT IS AN 'ASSET'
Dr. Money's Team is ready to assist You:
(1) Creating the avenue to Sell "New Bonds"
(2) Arranging to Sell "Existing Bonds"
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
It is often very advantageous for a company to sell off their "Debt."
Some advantages are:
(1) Getting Rid of the Debt
(2) Raising Capital
(3) Better Market Exposure
(4) Freeing Up Assets to Pursue Other Things
IN A FINANCIAL WORLD GONE CRAZY, DEBT IS AN 'ASSET'
Dr. Money's Team is ready to assist You:
(1) Creating the avenue to Sell "New Bonds"
(2) Arranging to Sell "Existing Bonds"
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
Corporate Bonds
"Corporate Bonds", are simple one mechanism available to selling off Corporate Debt. These 'Bonds' are sold and traded on the Open Market, just like any other stock, security, or bank instrument.
It is often very advantageous for a company to sell off their "Debt."
Some advantages are:
(1) Getting Rid of the Debt
(2) Raising Capital
(3) Better Market Exposure
(4) Freeing Up Assets to Pursue Other Things
The Eagle Traders is ready to assist You:
(1) Creating the avenue to Sell "New Bonds"
(2) Arranging to Sell "Existing Bonds"
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
It is often very advantageous for a company to sell off their "Debt."
Some advantages are:
(1) Getting Rid of the Debt
(2) Raising Capital
(3) Better Market Exposure
(4) Freeing Up Assets to Pursue Other Things
The Eagle Traders is ready to assist You:
(1) Creating the avenue to Sell "New Bonds"
(2) Arranging to Sell "Existing Bonds"
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
Bank Guarantees (BG’s)
Bank Guarantees (BG’s) - Raise a Credit Line or Cash them in for real dollars.
Value conversion depends on many factors, some fixed, some floating such as…
Ownership of BG - Corporate or Private - Corporate is Highly Preferred
The Type of BG
Issuing Bank Rating as well as location (branch) of Bank Issuing the BG
Physical Location of the Original BG - Safety Deposit Box, Corporate Office Safe, Home, etc.
If an Agent, Security House, or Third Party Bank is Holding BG’s
BG must be in US Dollars only
Market Conditions
Bank Policy
Client anticipation of return
Place transaction occurS
What is done with ‘Cash’ after conversion - this is becoming a paramount issue with banks
converting the instrument, the preferred and acceptable method is to deposit a portion
of the redeemed funds with the honoring bank, usually not less than 50% for a period
of not less than six (6) months.
Some Helpful Hints Before Starting....
BG's are usually issued by a corporation as collateral.
BG's held by individuals are highly questioned by banks throughout the world.
It is generally easier to raise a 'Credit Line' than convert the instrument to CASH!
Fluctuating World Market Conditions set the pace and determine the trading value, if any.
Usually most every instrument can be converted, however, some are just Not desirable
Trading Instruments on the current World Market.
Substantiated "Documentation' is needed for this type of transaction.
The Following Bank Guarantees are very difficult to do at the present, and only a 'Credit Line' could be raised:
1. Any BG issued from any Indonesian Bank
2. Any BG issued from any Thailand Bank
3. Any BG issued from any Philippine Bank
4. Any BG issued from any Malaysian Bank
Any BG held by an Individual in lieu of a company, trust, corporation, or nonprofit entity
The Following BG's Are NOT Currently Tradable:
1. BG's issued from Russia
2. BG's issued from Vietnam
3. BG's issued from Cambodia
4. BG's issued from Laos
5. BG's issued from Burma
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
Value conversion depends on many factors, some fixed, some floating such as…
Ownership of BG - Corporate or Private - Corporate is Highly Preferred
The Type of BG
Issuing Bank Rating as well as location (branch) of Bank Issuing the BG
Physical Location of the Original BG - Safety Deposit Box, Corporate Office Safe, Home, etc.
If an Agent, Security House, or Third Party Bank is Holding BG’s
BG must be in US Dollars only
Market Conditions
Bank Policy
Client anticipation of return
Place transaction occurS
What is done with ‘Cash’ after conversion - this is becoming a paramount issue with banks
converting the instrument, the preferred and acceptable method is to deposit a portion
of the redeemed funds with the honoring bank, usually not less than 50% for a period
of not less than six (6) months.
Some Helpful Hints Before Starting....
BG's are usually issued by a corporation as collateral.
BG's held by individuals are highly questioned by banks throughout the world.
It is generally easier to raise a 'Credit Line' than convert the instrument to CASH!
Fluctuating World Market Conditions set the pace and determine the trading value, if any.
Usually most every instrument can be converted, however, some are just Not desirable
Trading Instruments on the current World Market.
Substantiated "Documentation' is needed for this type of transaction.
The Following Bank Guarantees are very difficult to do at the present, and only a 'Credit Line' could be raised:
1. Any BG issued from any Indonesian Bank
2. Any BG issued from any Thailand Bank
3. Any BG issued from any Philippine Bank
4. Any BG issued from any Malaysian Bank
Any BG held by an Individual in lieu of a company, trust, corporation, or nonprofit entity
The Following BG's Are NOT Currently Tradable:
1. BG's issued from Russia
2. BG's issued from Vietnam
3. BG's issued from Cambodia
4. BG's issued from Laos
5. BG's issued from Burma
Important Notice:
It is widely considered a trading rule that any securities are deemed NOT Tradable if they originate from a non recognized international public trading exchange. This applies to Any type of Security Note (stock, bond, mutual fund, trust, MTN, debentures, etc.).
Capital Markets
Short-term investments and borrowing are driven by the available rates in the market for these products and services. Likewise, long-term rates in the debt and equity markets will determine the cost of capital for an organization. This section provides sites which offer information to the treasurer on various rates for different segments of the market.
The Federal Reserve Bank of New York provides one of the better sites for daily rates on commercial paper (CP) and foreign exchange (FX). Daily rates are available for dealer-placed and direct-placed commercial paper plus 36 foreign currencies. These are the noon buying rates "as certified by the New York Federal Reserve Bank for customs purposes." All of the rates shown are expressed in terms of foreign currency values (e.g., 118.33 yen/dollar) except for U.K. Sterling rates which are shown in terms of U.S. dollars per pound. In addition, you can access the New York Federal Reserve's 10:00 A.M. midpoint (between buying and selling rates) foreign exchange rates daily for major currencies expressed in foreign currency units:
1. Pound Sterling (expressed in US$ equivalents)
2. Canadian Dollar
3. French Franc
4. German Mark
5. Swiss Franc
6. Japanese Yen
7. Dutch Guilder
8. Belgian Franc
9. Italian Lira
10. Swedish Krone
11. Norwegian Krone
12. Danish Krone
The Federal Reserve Bank of New York provides one of the better sites for daily rates on commercial paper (CP) and foreign exchange (FX). Daily rates are available for dealer-placed and direct-placed commercial paper plus 36 foreign currencies. These are the noon buying rates "as certified by the New York Federal Reserve Bank for customs purposes." All of the rates shown are expressed in terms of foreign currency values (e.g., 118.33 yen/dollar) except for U.K. Sterling rates which are shown in terms of U.S. dollars per pound. In addition, you can access the New York Federal Reserve's 10:00 A.M. midpoint (between buying and selling rates) foreign exchange rates daily for major currencies expressed in foreign currency units:
1. Pound Sterling (expressed in US$ equivalents)
2. Canadian Dollar
3. French Franc
4. German Mark
5. Swiss Franc
6. Japanese Yen
7. Dutch Guilder
8. Belgian Franc
9. Italian Lira
10. Swedish Krone
11. Norwegian Krone
12. Danish Krone
Section 1109.32
A BANK MAY INVEST IN ANY OF THE FOLLOWING:
(1) BONDS, BILLS, NOTES, OR OTHER DEBT SECURITIES OF THE UNITED STATES OR FOR WHICH THE FULL FAITH AND CREDIT OF THE UNITED STATES IS PLEDGED FOR PAYMENT OF PRINCIPAL AND INTEREST;
(2) BONDS, NOTES, OR OTHER DEBT SECURITIES ISSUED BY THIS STATE, OR ANY STATE OF THE UNITED STATES, THAT ARE THE DIRECT OBLIGATION OF THE ISSUER AND FOR WHICH THE FULL FAITH AND CREDIT OF THE ISSUER IS PLEDGED TO PROVIDE PAYMENT OF THE PRINCIPAL AND INTEREST;
(3) BONDS, NOTES, OR OTHER DEBT SECURITIES OF ANY COUNTY, MUNICIPAL CORPORATION, TOWNSHIP, SCHOOL DISTRICT, IMPROVEMENT DISTRICT, SEWER DISTRICT, OR OTHER SUBDIVISION OF THIS STATE OR ANY OTHER STATE OF THE UNITED STATES, THAT ARE THE DIRECT OBLIGATION OF THE COUNTY OR THE SUBDIVISION ISSUING THEM AND FOR WHICH THE FULL FAITH AND CREDIT OF THE ISSUING COUNTY OR SUBDIVISION IS PLEDGED TO PROVIDE PAYMENT OF PRINCIPAL AND INTEREST;
(4) BONDS OR OTHER DEBT OBLIGATIONS ISSUED OR GUARANTEED BY AGENCIES OR INSTRUMENTALITIES OF THE UNITED STATES, REGARDLESS OF THE GUARANTEE OF PAYMENT OF PRINCIPAL AND INTEREST BY THE UNITED STATES;
(5) SUBJECT TO CONDITIONS AND RESTRICTIONS THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS MAY PRESCRIBE, BONDS, DEBENTURES, AND OTHER DEBT SECURITIES ISSUED BY ANY COUNTRY OR MULTINATIONAL ORGANIZATION THAT ARE THE DIRECT OBLIGATION OF THE ISSUING
(1) BONDS, BILLS, NOTES, OR OTHER DEBT SECURITIES OF THE UNITED STATES OR FOR WHICH THE FULL FAITH AND CREDIT OF THE UNITED STATES IS PLEDGED FOR PAYMENT OF PRINCIPAL AND INTEREST;
(2) BONDS, NOTES, OR OTHER DEBT SECURITIES ISSUED BY THIS STATE, OR ANY STATE OF THE UNITED STATES, THAT ARE THE DIRECT OBLIGATION OF THE ISSUER AND FOR WHICH THE FULL FAITH AND CREDIT OF THE ISSUER IS PLEDGED TO PROVIDE PAYMENT OF THE PRINCIPAL AND INTEREST;
(3) BONDS, NOTES, OR OTHER DEBT SECURITIES OF ANY COUNTY, MUNICIPAL CORPORATION, TOWNSHIP, SCHOOL DISTRICT, IMPROVEMENT DISTRICT, SEWER DISTRICT, OR OTHER SUBDIVISION OF THIS STATE OR ANY OTHER STATE OF THE UNITED STATES, THAT ARE THE DIRECT OBLIGATION OF THE COUNTY OR THE SUBDIVISION ISSUING THEM AND FOR WHICH THE FULL FAITH AND CREDIT OF THE ISSUING COUNTY OR SUBDIVISION IS PLEDGED TO PROVIDE PAYMENT OF PRINCIPAL AND INTEREST;
(4) BONDS OR OTHER DEBT OBLIGATIONS ISSUED OR GUARANTEED BY AGENCIES OR INSTRUMENTALITIES OF THE UNITED STATES, REGARDLESS OF THE GUARANTEE OF PAYMENT OF PRINCIPAL AND INTEREST BY THE UNITED STATES;
(5) SUBJECT TO CONDITIONS AND RESTRICTIONS THE SUPERINTENDENT OF FINANCIAL INSTITUTIONS MAY PRESCRIBE, BONDS, DEBENTURES, AND OTHER DEBT SECURITIES ISSUED BY ANY COUNTRY OR MULTINATIONAL ORGANIZATION THAT ARE THE DIRECT OBLIGATION OF THE ISSUING
A brief history of bond valuation
The value of any bond is the present value of its expected cash flows. This sounds simple: Determine the cash flows and then discount those cash flows at an appropriate rate. In practice, it’s not so simple for two reasons. First, holding aside the possibility of default, it is not easy to determine the cash flows for bonds with embedded options. Because the exercise of options embedded in a bond depends on the future course of interest rates, the cash flow is a priori uncertain. The issuer of a callable bond can alter the cash flows to the investor by calling the bond, while the investor in a putable bond can alter the cash flows by putting the bond. The future course of interest rates determines when and if the party granted the option is likely to alter the cash flows.
A second complication is determining the rate at which to discount the expected cash flows. The usual starting point is the yield available on Treasury securities. Appropriate spreads must be added to those Treasury yields to reflect additional risks to which the investor is exposed. Determining the appropriate spread is not simple, and is beyond the scope of this article. The ad hoc process for valuing an option-free bond (i.e., a bond with no options) once was to discount all cash flows at a rate equal to the yield offered on a new full-coupon bond of the same maturity. Suppose, for example, that one needs to value a 10-year option-free bond. If the yield to] maturity of an on-the-run 10-year bond of given credit quality is 8%, then the value of the bond under consideration would be taken to be the present value of its cash flows, all discounted at 8%.
According to this approach, the rate used to discount the cash flows of a 10-year current-coupon bond would be the same rate as that used to discount the cash flow of a 10-year zero-coupon bond. Conversely, discounting the cash flows of bonds with different maturities would require different discount rates. This approach makes little sense because it does not consider the cash flow characteristics of the bonds. Consider, for example, a portfolio of bonds of similar quality but different maturities. Imagine two equal cash flows occurring, say, five years hence, one coming from a 30-year bond and the other coming from a 10-year bond. Why should these two cash flows have different discount rates and hence different present values?
Given the drawback of the ad hoc approach to bond valuation, greater recognition has been given to the fact that any bond should be thought of as a package of cash flows, with each cash flow viewed as a zero-coupon instrument maEagle Tradersg on the date it will be received. Thus, rather than using a single discount rate, one should use multiple discount rates, discounting each cash flow at its own rate.
One difficulty with implementing this approach is that there may not exist zero-coupon securities from which to derive every discount rate of interest. Even in the absence of zero-coupon securities, however, arbitrage arguments can be used to generate the theoretical zero-coupon rate that an issuer would have to pay were it to issue zeros of every maturity. Using these theoretical zero-coupon rates, more popularly referred to as theoretical spot rates, the theoretical value of a bond can be determined. When dealer firms began stripping of full-coupon Treasury securities in August 1982, the actual prices of Treasury securities began moving toward their theoretical values.
Another challenge remains, however—determining the theoretical value of a bond with an embedded option. In the early 1980s, practitioners came to recognize that an option-bearing bond should be viewed as a package of cash flows (i.e., a package of zero-coupon instruments) plus a package of options on those cash flows. For example, a callable bond can be viewed as a package of cash flows plus a package of call options on those cash flows. As such, the position of an investor in a callable bond can be viewed as:
Long a Callable Bond = Long an Option-Free Bond + Short a Call Option on the Bond.
In terms of the value of a callable bond, this means:
Value of Callable Bond = Value of an Option-Free Bond - Value of a Call Option on the Bond.
But this also means that
Value of an Option-Free Bond = Value of Callable Bond + Value of a Call Option on the Bond.
An early procedure to determine the fairness of a callable bond’s market price was to isolate the implied value of its underlying option-free bond by adding an estimate of the embedded call option’s value to the bond's market price. The former value could be estimated by applying option pricing theory as applied to interest rate options.
This insight led to the first generation of valuation models that sought to value a callable bond by estimating the value of the call option. However, estimation of the call option embedded in callable bonds is not that simple. For example, suppose a 20-year bond is not callable for five years after which time it becomes callable at any time on 30-days notice.
A second complication is determining the rate at which to discount the expected cash flows. The usual starting point is the yield available on Treasury securities. Appropriate spreads must be added to those Treasury yields to reflect additional risks to which the investor is exposed. Determining the appropriate spread is not simple, and is beyond the scope of this article. The ad hoc process for valuing an option-free bond (i.e., a bond with no options) once was to discount all cash flows at a rate equal to the yield offered on a new full-coupon bond of the same maturity. Suppose, for example, that one needs to value a 10-year option-free bond. If the yield to] maturity of an on-the-run 10-year bond of given credit quality is 8%, then the value of the bond under consideration would be taken to be the present value of its cash flows, all discounted at 8%.
According to this approach, the rate used to discount the cash flows of a 10-year current-coupon bond would be the same rate as that used to discount the cash flow of a 10-year zero-coupon bond. Conversely, discounting the cash flows of bonds with different maturities would require different discount rates. This approach makes little sense because it does not consider the cash flow characteristics of the bonds. Consider, for example, a portfolio of bonds of similar quality but different maturities. Imagine two equal cash flows occurring, say, five years hence, one coming from a 30-year bond and the other coming from a 10-year bond. Why should these two cash flows have different discount rates and hence different present values?
Given the drawback of the ad hoc approach to bond valuation, greater recognition has been given to the fact that any bond should be thought of as a package of cash flows, with each cash flow viewed as a zero-coupon instrument maEagle Tradersg on the date it will be received. Thus, rather than using a single discount rate, one should use multiple discount rates, discounting each cash flow at its own rate.
One difficulty with implementing this approach is that there may not exist zero-coupon securities from which to derive every discount rate of interest. Even in the absence of zero-coupon securities, however, arbitrage arguments can be used to generate the theoretical zero-coupon rate that an issuer would have to pay were it to issue zeros of every maturity. Using these theoretical zero-coupon rates, more popularly referred to as theoretical spot rates, the theoretical value of a bond can be determined. When dealer firms began stripping of full-coupon Treasury securities in August 1982, the actual prices of Treasury securities began moving toward their theoretical values.
Another challenge remains, however—determining the theoretical value of a bond with an embedded option. In the early 1980s, practitioners came to recognize that an option-bearing bond should be viewed as a package of cash flows (i.e., a package of zero-coupon instruments) plus a package of options on those cash flows. For example, a callable bond can be viewed as a package of cash flows plus a package of call options on those cash flows. As such, the position of an investor in a callable bond can be viewed as:
Long a Callable Bond = Long an Option-Free Bond + Short a Call Option on the Bond.
In terms of the value of a callable bond, this means:
Value of Callable Bond = Value of an Option-Free Bond - Value of a Call Option on the Bond.
But this also means that
Value of an Option-Free Bond = Value of Callable Bond + Value of a Call Option on the Bond.
An early procedure to determine the fairness of a callable bond’s market price was to isolate the implied value of its underlying option-free bond by adding an estimate of the embedded call option’s value to the bond's market price. The former value could be estimated by applying option pricing theory as applied to interest rate options.
This insight led to the first generation of valuation models that sought to value a callable bond by estimating the value of the call option. However, estimation of the call option embedded in callable bonds is not that simple. For example, suppose a 20-year bond is not callable for five years after which time it becomes callable at any time on 30-days notice.
Model for valuing bonds and embedded options
Background
One can value a bond by discounting each of its cash flows at its own zero-coupon ("spot") rate. This procedure if equivalent to discounting the cash flows at a sequence of one-period forward rates. When a bond has one of more embedded options, however, its cash flow is uncertain. If a callable bond is called by the issuer, for example, its cash flow will be truncated.
To value such a bond, one must consider the volatility of interest rates, as their volatility will affect the possibility of the call option being exercised. One can do so by constructing a binomial interest rate tree that models the random evolution of future interest rates. The volatility-dependent one-period forward rates produced by this tree can be used to discount the cash flows of any bond in order to arrive at a bond value.
Given the values of bonds with and without an embedded option, one can obtain the value of the embedded option itself. The procedure can be used to value multiple or interrelated embedded options, as well as stand-alone risk control instruments such as swaps, swaptions, caps and floors.
Introduction
In the good old days, bond valuation was relatively simple. Not only did interest rates exhibit little day-to-day volatility, but in the long run they inevitably drifted up, rather than down. Thus the ubiquitous call option on long-term corporate bonds hardly ever required the attention of the financial manager. Those days are gone. Today, investors face volatile interest rates, a historically steep yield curve, and complex bond structures with one or more embedded options. The framework used to value bonds in a relatively stable interest rate environment is inappropriate for valuing bonds today. This article sets forth a general model that can be used to value any bond in any interest rate environment.
One can value a bond by discounting each of its cash flows at its own zero-coupon ("spot") rate. This procedure if equivalent to discounting the cash flows at a sequence of one-period forward rates. When a bond has one of more embedded options, however, its cash flow is uncertain. If a callable bond is called by the issuer, for example, its cash flow will be truncated.
To value such a bond, one must consider the volatility of interest rates, as their volatility will affect the possibility of the call option being exercised. One can do so by constructing a binomial interest rate tree that models the random evolution of future interest rates. The volatility-dependent one-period forward rates produced by this tree can be used to discount the cash flows of any bond in order to arrive at a bond value.
Given the values of bonds with and without an embedded option, one can obtain the value of the embedded option itself. The procedure can be used to value multiple or interrelated embedded options, as well as stand-alone risk control instruments such as swaps, swaptions, caps and floors.
Introduction
In the good old days, bond valuation was relatively simple. Not only did interest rates exhibit little day-to-day volatility, but in the long run they inevitably drifted up, rather than down. Thus the ubiquitous call option on long-term corporate bonds hardly ever required the attention of the financial manager. Those days are gone. Today, investors face volatile interest rates, a historically steep yield curve, and complex bond structures with one or more embedded options. The framework used to value bonds in a relatively stable interest rate environment is inappropriate for valuing bonds today. This article sets forth a general model that can be used to value any bond in any interest rate environment.
The mechanics of bank SLCS and guarantees
The driving force behind the financial instruments under discussion in this paper is the U.S. government through its monetary agency, the Federal Reserve Board. The U.S. dollar is the basis of the world's liquidity system since all other currencies base their exchange rate on it. Quite simply this means that the U.S. is the world's central banker. As the world's central banker, the U.S. has an enormous responsibility to maintain stability in the world's monetary system. As well, the U.S. as the most powerful nation has accepted the role as the champion and promoter of democracy in all of its endeavors. While the U.S. has many tools to do this, one in particular is relevant for the purposes of this discussion.
The Federal Reserve Board (Fed) uses two financial instruments to control and utilize the amount of U.S. dollars in circulation internationally: Standby Letters of Credit (SLC) and Bank Guarantees (BG).
The Fed's domestic tools to control credit creation are interest rate policy, open market operations, reserve ratio policy and moral persuasion. In the domestic context, these tools are not always as effective as the Fed would like them to be. Part of the reason for the less than perfect effectiveness is due to the substantial stock of U.S. dollars in foreign jurisdictions. Several of the Fed's domestic tools cannot be used by it in other countries. For examples, the Fed cannot change foreign reserve ratios.
Furthermore, a significant amount of credit creation occurs in U.S. dollars in foreign countries, particularly in the Eurodollar market.
The Federal Reserve Board (Fed) uses two financial instruments to control and utilize the amount of U.S. dollars in circulation internationally: Standby Letters of Credit (SLC) and Bank Guarantees (BG).
The Fed's domestic tools to control credit creation are interest rate policy, open market operations, reserve ratio policy and moral persuasion. In the domestic context, these tools are not always as effective as the Fed would like them to be. Part of the reason for the less than perfect effectiveness is due to the substantial stock of U.S. dollars in foreign jurisdictions. Several of the Fed's domestic tools cannot be used by it in other countries. For examples, the Fed cannot change foreign reserve ratios.
Furthermore, a significant amount of credit creation occurs in U.S. dollars in foreign countries, particularly in the Eurodollar market.
ICC endorsement of the UNCITRAL Convention on Independent Guarantees and Stand-by Letters of Credit
On the unanimous consent of its Commission on Banking Technique and Practice, the International Chamber of Commerce endorses the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit.
Since its earliest years, ICC has provided important international leadership in the field of international banking operations, particularly as a forum for developing rules of practice. Since 1933, the Uniform Customs and Practice for Documentary Credits (UCP), in its various revisions, has become a universally recognized standard, stating and establishing custom and practice for letters of credit.
In this process, the United Nations Commission on International Trade Law (UNCITRAL), by its endorsement of the subsequent UCP versions, provided an important bridge to those countries who were at the time unable to participate directly in the work of ICC. Other ICC rules, such as Incoterms, have also been endorsed by UNCITRAL, which has contributed to their international acceptance.
ICC rules cannot be fully effective in all countries without their being recognized under local law. In this respect, the recent work of UNCITRAL on the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit provides an important impetus to attain this objective. The Convention sets forth the basic principles of law for independent undertakings in a manner which fully assures their independent nature, which guarantees widest possible party autonomy and which establishes a uniform international legal standard for limits to the exception for fraudulent or abusive drawings.
ICC appreciates that the Convention was drafted in full recognition of the role of the various ICC rules in this field, that the UNCITRAL Working Group was directly and indirectly influenced by, and in turn influenced, the revision of the UCP, ICC's Uniform Rules for Demand Guarantees (URDG) and its recently adopted rules on International Standby Practices (ISP 98). ICC also notes that the UN Convention expressly defers to international banking practice as represented by ICC rules.
Since its earliest years, ICC has provided important international leadership in the field of international banking operations, particularly as a forum for developing rules of practice. Since 1933, the Uniform Customs and Practice for Documentary Credits (UCP), in its various revisions, has become a universally recognized standard, stating and establishing custom and practice for letters of credit.
In this process, the United Nations Commission on International Trade Law (UNCITRAL), by its endorsement of the subsequent UCP versions, provided an important bridge to those countries who were at the time unable to participate directly in the work of ICC. Other ICC rules, such as Incoterms, have also been endorsed by UNCITRAL, which has contributed to their international acceptance.
ICC rules cannot be fully effective in all countries without their being recognized under local law. In this respect, the recent work of UNCITRAL on the United Nations Convention on Independent Guarantees and Stand-by Letters of Credit provides an important impetus to attain this objective. The Convention sets forth the basic principles of law for independent undertakings in a manner which fully assures their independent nature, which guarantees widest possible party autonomy and which establishes a uniform international legal standard for limits to the exception for fraudulent or abusive drawings.
ICC appreciates that the Convention was drafted in full recognition of the role of the various ICC rules in this field, that the UNCITRAL Working Group was directly and indirectly influenced by, and in turn influenced, the revision of the UCP, ICC's Uniform Rules for Demand Guarantees (URDG) and its recently adopted rules on International Standby Practices (ISP 98). ICC also notes that the UN Convention expressly defers to international banking practice as represented by ICC rules.
History and Development of Bank Instruments (Continue....2)
Marshall plan - lMF - World Bank and Bank of International Settlements
The Bretton Woods Convention produced the Marshall Plan, the Bank for Reconstruction and development known as the World Bank. the International Monetary Fund (IMF) and the Bank of International Settlements (BIS). These four would re-establish and revitalize the economies of the western nations. The World Bank would borrow from rich nations and lend to poorer nations. The IMF working closely with the World Bank, with a pool of funds, controlled by a board of governors. would initiate currency adjustments and maintain the exchange rates among national currencies within defined limits. The Bank of International Settlements would then function as a "central bank" to the world.
The International Monetary Fund was to be a lender to the central bank of countries which were experiencing a deficit in the balance of payments. By lending money to that country's central bank, the IMF provided currency, allowing the underdeveloped country to continue in business. building up is export base until it achieved a positive balance of payments. Then, that nation's central bank could repay the money borrowed from the lMF, with a small amount of interest and continue on its own as an economically viable nation. If the country experienced an economic contraction, the IMF would be standing ready to make another loan to carry it through.
Bank of International Settlements
The Bank of International Settlements (BIS) was created as a new central bank to the central banks of each nation. It was organized along the lines of the U.S. Federal Reserve System and it's principally responsible for the orderly settlement of transactions among the central banks of individual countries. In addition, it sets standards for capital adequacy among the central banks and coordinates the orderly distribution of a sufficient supply of currency in circulation necessary to support international trade and commerce.
The Bank of International Settlements is controlled by the Basel Committee which is comprised of ministers sent from each of the G-10 nations central banks.
The Bretton Woods Convention produced the Marshall Plan, the Bank for Reconstruction and development known as the World Bank. the International Monetary Fund (IMF) and the Bank of International Settlements (BIS). These four would re-establish and revitalize the economies of the western nations. The World Bank would borrow from rich nations and lend to poorer nations. The IMF working closely with the World Bank, with a pool of funds, controlled by a board of governors. would initiate currency adjustments and maintain the exchange rates among national currencies within defined limits. The Bank of International Settlements would then function as a "central bank" to the world.
The International Monetary Fund was to be a lender to the central bank of countries which were experiencing a deficit in the balance of payments. By lending money to that country's central bank, the IMF provided currency, allowing the underdeveloped country to continue in business. building up is export base until it achieved a positive balance of payments. Then, that nation's central bank could repay the money borrowed from the lMF, with a small amount of interest and continue on its own as an economically viable nation. If the country experienced an economic contraction, the IMF would be standing ready to make another loan to carry it through.
Bank of International Settlements
The Bank of International Settlements (BIS) was created as a new central bank to the central banks of each nation. It was organized along the lines of the U.S. Federal Reserve System and it's principally responsible for the orderly settlement of transactions among the central banks of individual countries. In addition, it sets standards for capital adequacy among the central banks and coordinates the orderly distribution of a sufficient supply of currency in circulation necessary to support international trade and commerce.
The Bank of International Settlements is controlled by the Basel Committee which is comprised of ministers sent from each of the G-10 nations central banks.
History and Development of Bank Instruments (Continue....1)
Introduction
Picture the world at war in 1944. All of Europe, except for Switzerland, is pounding its infrastructure, manufacEagle Tradersg base and population into rubble and death. Asia is locked into a monumental straggle which is destroying Japan, China, and the Pacific Rim countries. North Africa, the Baltic's, and the Mediterranean countries are clutched in a life and death struggle in the fight to throw off the yoke of occupation. A world gone mad! Economic destruction, mad, human misery and dislocation exists on a scale never before experienced in human history. What went wrong? How could the world rebuild and recover from such devastation? How could another war be avoided?
Keynes, Harry White and Bretton Woods
This was the world as it existed in July 1944 when a relatively small group of 130 of the western worlds most accomplished economic, social and political minds met in upstate New Hampshire at a small vacation town called Bretton Woods. John Maynard Keynes, the man who had predicted the current catastrophe in his book, The Economic Consequences of the Peace, written in 1920, was about to become the principal architect of the post-World War II reconstruction Keynes presented a rather radical plan to rebuild the worlds economy, and hopefully avoid a third world war. This time the world listened, for Keynes and his supporters were the only ones who had a plan that in any way seemed grand enough in foresight and scope to have a chance at being successful. Yet Keynes had to fight hard to convince those rooted in conventional economic theories and partisan political doctrines to adopt his proposals. In the end, Keynes was able to sell about two-thirds of his proposals through sheer force of will and the support of the United States Secretary of the Treasury, Harry Dexter White.
At the hart of Keynes proposals were two basic principals: first the Allies must rebuild the Axis Countries, not exploit them as had been done after WW 1; second, a new international monetary system must be established, headed by a strong international banking system and a common world currency not tied to a gold standard.
Keynes went on to reason that Europe and Asia were in complete economic devastation with their means of production seriously crippled, their trade economies destroyed and their treasuries in deep dept. If the world economy was to emerge from its current state, it obviously needed to expand. This expansion would be limited if paper currency were still anchored to gold.
The United States, Canada, Switzerland and Australia were the only industrialized western countries to have their economies, banking systems and treasuries intact and fully operational. The enormous issue at the Bretton Woods Convention in 1944 was how to completely rebuild the European and Asian economies on a sufficiently solid basis to foster the establishment of stable, prosperous pro-democratic governments.
At the time, the majority of the world's gold supply, hence its wealth, was concentrated in the hands of the United States, Switzerland and Canada. A system had to be established to democratize trade and wealth; and redistribute, or recycle, currency from strong trade surplus countries back into countries with weak or negative trade surpluses. Otherwise, the majority of the world's wealth would remain concentrated in the hands of a few nations while the rest of the world would remain in poverty.
Keynes and White proposed that the United States supported by Canada and Switzerland would become the banker to the world, and the U.S. Dollar would replace the pound sterling as the the medium of international trade. He also suggested that the dollar's value be tied to the good faith and credit of the U.S. Government not to gold or silver, as had traditionally been the support for a nation's currency.
Keynes concept of how to accomplish all of this was radical for its time, but was based upon the centuries old framework of import/export finance. This form of finance was used to support certain sectors of international commerce which did not use gold as collateral, but rather their own good faith and credit, backed by letters of credit, avals, or guarantees.
Keynes reasoned that even if his plans to rebuild the world's economy were adopted at the Bretton Woods Convention, remaining on a Gold standard would seriously restrict the flexibility of governments to increase the money supply. The rate of increase of currency would not be sufficient to insure the continued successful expansion of international commerce over the long term. This condition could lead to a severe economic crisis, which, in turn, could even lead to another world war. However, the economic ministers and politicians present at the convention feared loss of control over their own national economies, as well as, run-away inflation, unless a "hard-currency" standard were adopted.
The Convention accepted Keynes' basic economic plan, but opted for a gold-backed currency as a standard of exchange. The "official" price of gold was set at its pre-WW II level of $ 35.00 per ounce One U.S. Dollar would purchase 1/35 an ounce of gold. The U.S. dollar would become the standard world currency, and the value of all other currencies in the western. non-communist world would be tied to the U.S. dollar as the medium of exchange.
Picture the world at war in 1944. All of Europe, except for Switzerland, is pounding its infrastructure, manufacEagle Tradersg base and population into rubble and death. Asia is locked into a monumental straggle which is destroying Japan, China, and the Pacific Rim countries. North Africa, the Baltic's, and the Mediterranean countries are clutched in a life and death struggle in the fight to throw off the yoke of occupation. A world gone mad! Economic destruction, mad, human misery and dislocation exists on a scale never before experienced in human history. What went wrong? How could the world rebuild and recover from such devastation? How could another war be avoided?
Keynes, Harry White and Bretton Woods
This was the world as it existed in July 1944 when a relatively small group of 130 of the western worlds most accomplished economic, social and political minds met in upstate New Hampshire at a small vacation town called Bretton Woods. John Maynard Keynes, the man who had predicted the current catastrophe in his book, The Economic Consequences of the Peace, written in 1920, was about to become the principal architect of the post-World War II reconstruction Keynes presented a rather radical plan to rebuild the worlds economy, and hopefully avoid a third world war. This time the world listened, for Keynes and his supporters were the only ones who had a plan that in any way seemed grand enough in foresight and scope to have a chance at being successful. Yet Keynes had to fight hard to convince those rooted in conventional economic theories and partisan political doctrines to adopt his proposals. In the end, Keynes was able to sell about two-thirds of his proposals through sheer force of will and the support of the United States Secretary of the Treasury, Harry Dexter White.
At the hart of Keynes proposals were two basic principals: first the Allies must rebuild the Axis Countries, not exploit them as had been done after WW 1; second, a new international monetary system must be established, headed by a strong international banking system and a common world currency not tied to a gold standard.
Keynes went on to reason that Europe and Asia were in complete economic devastation with their means of production seriously crippled, their trade economies destroyed and their treasuries in deep dept. If the world economy was to emerge from its current state, it obviously needed to expand. This expansion would be limited if paper currency were still anchored to gold.
The United States, Canada, Switzerland and Australia were the only industrialized western countries to have their economies, banking systems and treasuries intact and fully operational. The enormous issue at the Bretton Woods Convention in 1944 was how to completely rebuild the European and Asian economies on a sufficiently solid basis to foster the establishment of stable, prosperous pro-democratic governments.
At the time, the majority of the world's gold supply, hence its wealth, was concentrated in the hands of the United States, Switzerland and Canada. A system had to be established to democratize trade and wealth; and redistribute, or recycle, currency from strong trade surplus countries back into countries with weak or negative trade surpluses. Otherwise, the majority of the world's wealth would remain concentrated in the hands of a few nations while the rest of the world would remain in poverty.
Keynes and White proposed that the United States supported by Canada and Switzerland would become the banker to the world, and the U.S. Dollar would replace the pound sterling as the the medium of international trade. He also suggested that the dollar's value be tied to the good faith and credit of the U.S. Government not to gold or silver, as had traditionally been the support for a nation's currency.
Keynes concept of how to accomplish all of this was radical for its time, but was based upon the centuries old framework of import/export finance. This form of finance was used to support certain sectors of international commerce which did not use gold as collateral, but rather their own good faith and credit, backed by letters of credit, avals, or guarantees.
Keynes reasoned that even if his plans to rebuild the world's economy were adopted at the Bretton Woods Convention, remaining on a Gold standard would seriously restrict the flexibility of governments to increase the money supply. The rate of increase of currency would not be sufficient to insure the continued successful expansion of international commerce over the long term. This condition could lead to a severe economic crisis, which, in turn, could even lead to another world war. However, the economic ministers and politicians present at the convention feared loss of control over their own national economies, as well as, run-away inflation, unless a "hard-currency" standard were adopted.
The Convention accepted Keynes' basic economic plan, but opted for a gold-backed currency as a standard of exchange. The "official" price of gold was set at its pre-WW II level of $ 35.00 per ounce One U.S. Dollar would purchase 1/35 an ounce of gold. The U.S. dollar would become the standard world currency, and the value of all other currencies in the western. non-communist world would be tied to the U.S. dollar as the medium of exchange.
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