Money Market Trading Strategies free essay sample

Money market trading strategies Looking at the prediction made, i. e. the money market interest rate will increase for the next six months, the team has come out with a few strategies to be undertaken in order to maximise the bank’s profit. The first instrument will be of the cash products, including overnight cash, 7-day cash and loan, and secondly, the discount security which consists commercial bills. 1. Overnight 7-day Cash The bank can offer to take overnight deposits or make overnight loans to big corporations, making use of the increasing interest rate for the next six months. High interest rate will attract corporations who have some amount of money which is unused to be parked somewhere to at least generate some profit, to invest the deposit in the bank. This will give them some yield of say, 0. 0178% per day (6. 5% per annum). Therefore, a deposit of $5 million will give them a return of ,780. We will write a custom essay sample on Money Market Trading Strategies or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page Likewise, corporations who need an overnight loan will also go to the bank for some funds. The bank’s strategy is to know which price other banks are offering to the client. The two prices quoted by a bank will determine the lending and investing rate of clients. Therefore, if the common quote is 6. 50-65, our bank can narrow down spread, with quote of say 6. 50-62. Though it gives lesser profit, it attracts more clients who are savvy with the market condition. 7-day cash gives the same yield. The only difference is the period of the deposit and loan, which is a fixed period of 7 days. 2. Loan (fully-drawn advance) There are two types of short-term loan; committed loans and uncommitted loans. The bank can concentrate more on the committed loans, as it has commitment fee payable. An increase in interest rate will then increase the profit of the bank issuing loan to corporations. . Commercial Bills (Bills of exchange) The bank can issue commercial bills; or rather bank accepted bills (BAB), where the bank acts as the acceptor of the bill and charges a fee for acceptance. BABs will be more attractive than normal commercial bills, as banks have high credit-worthiness. Therefore, it is a good step to promote on the BAB issuance with the prediction of the increasing interest rates, as PV = FV__ (1 + yt) An increase in y (yield to maturity, or return) will cause the denominator in the fraction to increase, and PV to decrease, as PV is inversely related to the fraction. When PV decreases, more lender (discounter) will be attracted to buy the bill. Recommendation After all the analysis, it is recommended that the bank promote on cash product like overnight cash, 7-day cash and loans, and discount security like commercial bills to maximise its profits. Risk Obstacles Associated From the Strategies When endorsing cash products such as overnight cash, 7-day cash, loans and discount securities, there are risks that a bank may face. Competition One of the risks related would be competition. Competition from other banks will put pressure on a bank to bid lower while forcing higher offer rates, this in turn will minimize the market spread. This mainly involves overnight cash and 7-day cash products. Price Risk There is also price risk. This risk is where the interest rate movement will reduce the value of securities held by a trader or dealer. A bank will be affected by market risk if it sets a competitive price should an unexpected increase in market yield occur, as this will drop the value of a bank’s position. Basis Risk Another risk is the basis risk. This is the risk where the hedge is insufficient to cover the movement of the value in interest rates. Market interest rates might increase instead of decrease and this will reduce a bank’s profit. Information asymmetry Other risks may include information asymmetry. This is a situation where dealers may anticipate and forecast yield movement better because of information data that they can access but which the bank does not have. Bank-Accepted Bills: Acceptor’s Risk The primary liability to exchange the bill at maturity falls upon the acceptor; therefore, the bank has the ultimate responsibility to honour the bill at maturity. It carries the risk that the drawer may not comply with the associated financial agreement to pay the bank the face value of the bill at maturity. Difficulty to Cancel or Alter Once a forward cash contract is entered, its commitment may be difficult to cancel or alter. This limits the bank to retreat from the contract if the terms appear unfavorable in the future. Conclusion The report shows that interest rates have been increasing since January 2005 due to the rise in the economic growth rate in Australia. According to the analysis the market interest rate is expected to increase in the next 6 months due to various factors such as economic growth, inflation and increase in commodity prices. Based on this prediction, various strategies can be used to hedge interest rate risks and maximize profits of the bank. The bank can make its decisions based on the viability of the strategies considering the possible risks and obstacles that the bank may face for taking a particular profit-driven strategy.