With ongoing policies to allow easier access for foreign institutional investors, China’s interbank fixed income market is increasingly attractive given its tremendous scope for higher yields and portfolio diversification. Commonly traded instruments include rates bond, credit bond and NCD.
The issuer (money demander) obtains the money from investors (money suppliers) through the issuance of bonds, on the maturity date issuers need to pay back the principal and interest that calculated by the fixed interest rate on the coupon, so the two sides is a creditor-debtor relationship. Relative to a newly or additional issued bonds, the bonds have been traded in the secondary market, and bonds divided into two kinds of rates and credit. Rates bond includes treasury bonds, the central bank bills and financial bonds that issued by the policy banks. Due to the low yield and risk, the demand is mainly asset allocation and mortgage financing. The credit bonds have Corporate Bonds, Medium-term Notes, the short-term financing bills and urban construction investment bonds. The institutions in the credit market aim to get interest, including Security companies, fund companies and investment companies, etc.
China’s interbank foreign exchange market has been seeing a growing need for commercial turnover of RMB investments and speculative currency trading from foreign institutional investors. The market has emerged to include FX swap, forward and option.
The contract involves in the two transactions of different exchange rate, different value date and the opposite direction. According to the difference of value date, FX swap divided into the two transactions of spot to forward or forward to forward, now only RMB against U.S.dollar swap. For the swap contract of spot to forward, in the spot side the buyer sells U.S.dollar and buys RMB depend on the spot exchange rate, the seller buys U.S.dollar and sells RMB at the same time; the payer buys U.S.dollar and sells RMB, then the seller buys RMB and sells U.S.dollar in forward side; Therefore, the forward exchange rate of swap contract is critical. Generally speaking, two sides report the swap points in the FX swap market, so the forward exchange rate is equal to the spot exchange rate plus or minus the swap points.
Relative to the spot, one of the features of the forward contract is value date beyond all spot dates. The two parties sign the FX forward contract aim to trade a certain amount of foreign exchange depending on agreed exchange rate in the future. Firstly, FX forward contract generated by trading companies in order to cut down the exchange rate risks for the income or payment of the trade business, because it is able to lock in forward exchange rate and avoid loss. The trading company receives or pays foreign currency in the future, in order to reducing loss for exchange rate fluctuations the company signs FX forward contracts with banks, so that in the future they will able to trade with banks depending on the previously agreed exchange rate. Banks hold foreign exchange positions in the future, in order to flatting and avoid the risk of exchange rate, the interbank market generated automatically.
Foreign exchange option is one kind of option contracts, also known as currency option. Unlike other option contracts including stock option and stock index option etc, foreign exchange option focuses on currencies. Once buyer pays an option fee of certain amount to seller, the buyer obtains a right, which is at the maturity date the buyer has right to buy or sell certain currencies with the seller as per agreed exchange rate and amount, or the buyer also have right not to execute the contract.
A relatively emerging China’s interbank market sector, the derivatives market has gained great momentum and is anticipated to provide new investment and hedging opportunities with the introduction of IRS, FRA and CCS.
Interest rate swap, the buyer and seller swap the interest rates between the fixed against the floating. By the swap contract, the buyer locks the interest rate and avoids risk. Buyer pays the fixed rate and seller pays floating rates, but profit or loss is calculated by comparing fixed rates with floating rates. If the floating rate is higher than the fixed rate, seller loses money by the amount of spreads multiplied by notional principal; On the contrary, the buyer loses money. In IRS market main players includes foreign banks, big Chinese banks, city commercial banks and several leading securities. Underlining rates of IRS include 7days repo, one day Shibor, 3 months Shibor fixing rates and one year deposit interest rate.
Forward Rate Agreement, it is a kind of financial contract that the two sides agree to exchange the notional principal on the basis of the contract interest rate in the future. About the contract, the two sides pay the interest that depend on the spread of the agreed interest rate and the reference rate, so that both buyer and seller are able to avoid the risk by signing the FAR to locking the future interest rates. How to quote in the FAR market, e.g. ‘6×9、5.03%～5.08%’, 6×9 show the duration of contract from the six months to nine months, the period from the trading date to the value date equal to six months, and the nine months is from the trading date to maturity date, so the duration of the contract is just three months; ‘5.03%～5.08%’ is the buyer’s and seller’s price, 5.03% show the bid and 5.08% is offer.
Cross Currency Interest Rate Swap, the two sides exchange a certain amount of two currencies at the start and end of the contract, and pay the interest to each other regularly. Generally, according to the same exchange rate and amount, the two currencies swapped twice in value date and maturity of contract, and pay interest that calculated by the fixed rates of two currencies once three months. Domestic CCS business drops behind, so until now the market is only interest in the single product of U.S.dollar against RMB. The basis days of underlining rates are different, which RMB is 365days and U.S.dollar is 360days. The advantage and disadvantage of CCS exposed easily, when the exchange rate changes toward unfavorable it locks exchange rates to avoid risk, but when the exchange rate changes toward favorable it lost opportunity of making profit.
The most vibrant China’s interbank market sector, China’s money market has been increasingly used by foreign participants as a means for borrowing and lending in the short term. Among the most common money market instruments are IBO, DEPO, REPO and Deposits.
The financial institution or the branches borrows short-term money that include RMB and foreign currencies by the full credit way that the borrower don’t require any collateral, and the business purpose is cut position and transfer money to remain balance. Due to the balance of deposits and foreign exchange frequent changes, so the business is able to meet the demand of transferring funds and cut position. There are two trading modes; both lender and borrower complete the transaction by directly negotiating or by brokers. When the contract signed, and then the lender transfers money to borrower by reserve account in central bank, and the end of the contract until the borrower pay back the principal and interest to reserve account of lender.
The demand party borrows the short-term money by pledging the bond ownership to supplier, and the definition involves money and bonds transferred in an opposite way. Generally speaking, on value date the demand party gets money and pledges the qualified bonds, and pays back money and interest to supplier for repurchase the bonds in maturity date. Once the demand party breaches the contract and unable to repay principal and interest, the supply party is entitled to dispose of the bonds to compensate for the loss, hence the Repo is equivalent to pledge loans and make the bonds as collateral security for loans. Repo is mainly characterized by short-term and low risk, including overnight and seven days short-term products, and two weeks to one year long-term products.
Interbank Deposits, due to the settlement convenience and business cooperation, financial institutions deposit money into commercial banks. The participants open account and deposit money with interest calculated in negotiated rate,and other contract details are determined by consulting between borrower and lender. Interbank deposits are relative to the financial institutions receiving the savings. The business includes RMB and foreign currency, there are the purposes of the business that transfer money from suppliers to demanders and strengthen mutual cooperation. Accounting Standards for Enterprises claims strictly that financial institutions receive or pay the principal and interest from the interbank deposit business, as the Operating Cash flow inputting the Cash Flow sheet.
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