WEEK 1 – PART 1: BIRD’S EYE VIEW ON FINANCIAL MARKETS AND INSTITUTIONS...........................................2
Why do savers and borrowers need intermediaries? (also discussed on page 38).........................................3
Primary and secondary financial markets.......................................................................................................4
Exchanges and over-the-counter markets: 2 different types how trading can be organized.........................6
WEEK 1 – PART 2 : INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY................................7
1. MARKET OVERVIEW...............................................................................................................................................7
2. YIELD CURVE AND FIXED INCOME INSTRUMENTS........................................................................................................10
Annually compounded interest rates.............................................................................................................10
Yield curve......................................................................................................................................................11
Risk-free rates beyond zero-coupon government bond yields......................................................................12
Short-term interest rate futures (a.k.a. money market futures)...................................................................13
Interest-rate swap (IRS) (V_Swap = V_Fixed – V_Floating = 0).....................................................................13
Who needs interest-rate swaps? Used for two main purposes:....................................................................14
WEEK 2: INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY.............................................16
Real and nominal interest rates.....................................................................................................................16
Monetary policy rule – Taylor rule.................................................................................................................16
Unconventional policies.................................................................................................................................17
4. LIBOR AND ITS STYLIZED SETTING PROCESS..............................................................................................................20
How could a better benchmark look like?.....................................................................................................21
GUEST LECTURE ALEX ISAKOV (OTHER DOCUMENT) (CHIEF ECONOMIST AT VTB CAPITAL)...................................................23
INTERVIEW SANDER WILLEMS (QUANT ANALYST AT NATWEST)......................................................................................23
WEEK 3 – PART 3: FX MARKETS: INSTRUMENTS, THEORETICAL PARITIES AND THEIR VIOLATION...................26
TEXTBOOK QUOTATION CONVENTION..........................................................................................................................26
Two types of swaps (one is very important)..................................................................................................27
ARBITRAGE IS EITHER OF THE FOLLOWING:...................................................................................................................29
Interest rate differential: example................................................................................................................30
Uncovered Interest Rate Parity (UIRP)...........................................................................................................30
FX basis..........................................................................................................................................................31
Why is the basis not closing?.........................................................................................................................34
(same reason as why the UST market became illiquid).................................................................................35
WEEK 4 – PART 4: BANKING, REGULATION, MARKET LIQUIDITY....................................................................38
WHY BANKS EXIST (ALSO DISCUSSED ON PAGE 3)..........................................................................................................39
Expected utility...............................................................................................................................................39
Policies which prevent a bank run.................................................................................................................40
FINANCIAL CRISES AND SYSTEMIC RISKS.......................................................................................................................40
Banks are connected through interbank networks: risk of contagion...........................................................41
Credit risk mitigation with CCP......................................................................................................................44
MACROPRUDENTIAL REGULATION – THE GOAL OF MACROPRUDENTIAL POLICY...................................................................44
Risk-weighted assets......................................................................................................................................45
Capital-based ratios:......................................................................................................................................46
Leverage ratio:...............................................................................................................................................46
Liquidity ratios...............................................................................................................................................46
LIQUIDITY CRISES IN THE U.S. TREASURY MARKET AT THE WAKE OF COVID-19.................................................................49
Criteria for a safe-haven asset:......................................................................................................................50
Dealers in the US Treasury market................................................................................................................50
What happens when market-makers are not ready to make the market?...................................................51
Way out? How was the space on the balance sheets of banks created?......................................................51
INTERVIEW WITH JULIEN BLATT FROM UBS (STRESS-TESTING)........................................................................................52
WEEK 5 – PART 5: ASSET MANAGEMENT...................................................................................................... 56
OVERVIEW.............................................................................................................................................................56
Global AUM by region....................................................................................................................................56
1
, Types of products that asset managers offer................................................................................................57
Active versus passive investing of the money................................................................................................57
Asset management arithmetic......................................................................................................................58
Fees matter: chart of management fees:......................................................................................................58
Performance measurement active/passive portfolios...................................................................................60
EXCHANGE-TRADED FUNDS.......................................................................................................................................60
Authorized Participants (APs) arbitrage out ‘mispricing’ of ETF shares on the secondary market...............61
Synthetic replication is getting more popular (passive investing, page 56)..................................................63
MUTUAL FUNDS FEES AND SIZES IN LONG-TERM EQUILIBRIUM.........................................................................................64
Equilibrium net alpha.....................................................................................................................................64
Week 1 – Part 1: Bird’s eye view on financial markets and institutions
2
,Direct way: savers bring money into the financial markets, while the borrowers bring
securities. They meet at the security markets and exchange dollars for securities.
Indirect way: instead of bringing dollars to security markets, you bring them to banks, asset
managers, pension funds etc., and these guys take your dollars and take them directly to the
security markets or they provide financing in another way, by loans, venture capital
financing etc. (why do we need banks Liquidity transformation and monitoring)
Why do savers and borrowers need intermediaries? (also discussed on page 38)
1. Transaction costs: intermediaries take advantage of economies of scale. They also
reduce search costs (e.g. hire one lawyer for all the cases)
2. Risk sharing: intermediaries facilitate hedging against ‘bad’ states. Thus, they make
markets more complete
a. All people are different and have different preferences. Intermediaries allow
for risk sharing among agents
b. It can happen that there is no one who is readily available to provide you with
a security that hedges you against ‘bad’ states go to investment banker to
ask to write such a security for you. You are better off because you are
hedged against some bad outcomes.
3. Information asymmetries: adverse selection (pre-contractual, used cars example)
and moral hazard (post-contractual). Information inefficiencies may lead to market
breakdown. Financial intermediaries, through pre-contractual research and post-
contractual monitoring, reduce adverse selection and moral hazard risks.
e.g. rating agencies
How are financial intermediaries doing?
Gross value added = Corporate
profits and wages paid to its
employees.
Right before ’08 it was at its peak,
at expense of non-financial
business. Now increasing again.
Financial markets
3
, Fixed income (weeks 1 and 2): massive market that determines the cost of money
(and prices credit risks) (determine real interest rate)
FX – Foreign Exchange (week 3): determines the relative cost of money in different
currency zones
Equity: determines how much shareholders’ equity is worth, not really in this course
Financial institutions
Depository institutions (week 4): commercial banks and other credit institutions
Investment intermediaries (week 5): investment funds, investment banks, private
banks, family offices etc.
Contractual savings institutions: insurance companies and pension funds
Primary and secondary financial markets
1. Primary markets: where debt or equity is being raised for the first time (e.g. funds are
borrowed). Investment banks charge fees for organizing the issuance of securities.
The desks that in charge are usually called ECM (equity capital markets, new equity
securities - IPOs) and DCM (debt capital markets, new debt securities, mainly bonds).
It doesn’t need to be a public market, can be private market as well. Markets for loans and
private equity in financing are also primary markets with this regard.
2. Secondary markets: where the value of existing (previously issued) debt and equity
securities is determined by virtue of trading. This is a huge ecosystem: investors, brokers and
dealers, exchanges, trading platforms, clearing houses, rating agencies etc.
Revenues generated by primary and secondary market services
Investment banking activities (M&A, ECM, DCM, corporate lending) tends to trail secondary
market services in revenue generation among global CIBs recently.
(= Investment bank)
Primary
$2.657
Secondary
$7.176
FICC = Fixed Income Commodities and Currencies.
FICC generating much higher profits than Equities. Has been the case for quite a while.
Secondary market much bigger than the primary market.
Global issuance of bonds and stocks
4
Why do savers and borrowers need intermediaries? (also discussed on page 38).........................................3
Primary and secondary financial markets.......................................................................................................4
Exchanges and over-the-counter markets: 2 different types how trading can be organized.........................6
WEEK 1 – PART 2 : INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY................................7
1. MARKET OVERVIEW...............................................................................................................................................7
2. YIELD CURVE AND FIXED INCOME INSTRUMENTS........................................................................................................10
Annually compounded interest rates.............................................................................................................10
Yield curve......................................................................................................................................................11
Risk-free rates beyond zero-coupon government bond yields......................................................................12
Short-term interest rate futures (a.k.a. money market futures)...................................................................13
Interest-rate swap (IRS) (V_Swap = V_Fixed – V_Floating = 0).....................................................................13
Who needs interest-rate swaps? Used for two main purposes:....................................................................14
WEEK 2: INTEREST RATES, FIXED INCOME MARKETS, AND MONETARY POLICY.............................................16
Real and nominal interest rates.....................................................................................................................16
Monetary policy rule – Taylor rule.................................................................................................................16
Unconventional policies.................................................................................................................................17
4. LIBOR AND ITS STYLIZED SETTING PROCESS..............................................................................................................20
How could a better benchmark look like?.....................................................................................................21
GUEST LECTURE ALEX ISAKOV (OTHER DOCUMENT) (CHIEF ECONOMIST AT VTB CAPITAL)...................................................23
INTERVIEW SANDER WILLEMS (QUANT ANALYST AT NATWEST)......................................................................................23
WEEK 3 – PART 3: FX MARKETS: INSTRUMENTS, THEORETICAL PARITIES AND THEIR VIOLATION...................26
TEXTBOOK QUOTATION CONVENTION..........................................................................................................................26
Two types of swaps (one is very important)..................................................................................................27
ARBITRAGE IS EITHER OF THE FOLLOWING:...................................................................................................................29
Interest rate differential: example................................................................................................................30
Uncovered Interest Rate Parity (UIRP)...........................................................................................................30
FX basis..........................................................................................................................................................31
Why is the basis not closing?.........................................................................................................................34
(same reason as why the UST market became illiquid).................................................................................35
WEEK 4 – PART 4: BANKING, REGULATION, MARKET LIQUIDITY....................................................................38
WHY BANKS EXIST (ALSO DISCUSSED ON PAGE 3)..........................................................................................................39
Expected utility...............................................................................................................................................39
Policies which prevent a bank run.................................................................................................................40
FINANCIAL CRISES AND SYSTEMIC RISKS.......................................................................................................................40
Banks are connected through interbank networks: risk of contagion...........................................................41
Credit risk mitigation with CCP......................................................................................................................44
MACROPRUDENTIAL REGULATION – THE GOAL OF MACROPRUDENTIAL POLICY...................................................................44
Risk-weighted assets......................................................................................................................................45
Capital-based ratios:......................................................................................................................................46
Leverage ratio:...............................................................................................................................................46
Liquidity ratios...............................................................................................................................................46
LIQUIDITY CRISES IN THE U.S. TREASURY MARKET AT THE WAKE OF COVID-19.................................................................49
Criteria for a safe-haven asset:......................................................................................................................50
Dealers in the US Treasury market................................................................................................................50
What happens when market-makers are not ready to make the market?...................................................51
Way out? How was the space on the balance sheets of banks created?......................................................51
INTERVIEW WITH JULIEN BLATT FROM UBS (STRESS-TESTING)........................................................................................52
WEEK 5 – PART 5: ASSET MANAGEMENT...................................................................................................... 56
OVERVIEW.............................................................................................................................................................56
Global AUM by region....................................................................................................................................56
1
, Types of products that asset managers offer................................................................................................57
Active versus passive investing of the money................................................................................................57
Asset management arithmetic......................................................................................................................58
Fees matter: chart of management fees:......................................................................................................58
Performance measurement active/passive portfolios...................................................................................60
EXCHANGE-TRADED FUNDS.......................................................................................................................................60
Authorized Participants (APs) arbitrage out ‘mispricing’ of ETF shares on the secondary market...............61
Synthetic replication is getting more popular (passive investing, page 56)..................................................63
MUTUAL FUNDS FEES AND SIZES IN LONG-TERM EQUILIBRIUM.........................................................................................64
Equilibrium net alpha.....................................................................................................................................64
Week 1 – Part 1: Bird’s eye view on financial markets and institutions
2
,Direct way: savers bring money into the financial markets, while the borrowers bring
securities. They meet at the security markets and exchange dollars for securities.
Indirect way: instead of bringing dollars to security markets, you bring them to banks, asset
managers, pension funds etc., and these guys take your dollars and take them directly to the
security markets or they provide financing in another way, by loans, venture capital
financing etc. (why do we need banks Liquidity transformation and monitoring)
Why do savers and borrowers need intermediaries? (also discussed on page 38)
1. Transaction costs: intermediaries take advantage of economies of scale. They also
reduce search costs (e.g. hire one lawyer for all the cases)
2. Risk sharing: intermediaries facilitate hedging against ‘bad’ states. Thus, they make
markets more complete
a. All people are different and have different preferences. Intermediaries allow
for risk sharing among agents
b. It can happen that there is no one who is readily available to provide you with
a security that hedges you against ‘bad’ states go to investment banker to
ask to write such a security for you. You are better off because you are
hedged against some bad outcomes.
3. Information asymmetries: adverse selection (pre-contractual, used cars example)
and moral hazard (post-contractual). Information inefficiencies may lead to market
breakdown. Financial intermediaries, through pre-contractual research and post-
contractual monitoring, reduce adverse selection and moral hazard risks.
e.g. rating agencies
How are financial intermediaries doing?
Gross value added = Corporate
profits and wages paid to its
employees.
Right before ’08 it was at its peak,
at expense of non-financial
business. Now increasing again.
Financial markets
3
, Fixed income (weeks 1 and 2): massive market that determines the cost of money
(and prices credit risks) (determine real interest rate)
FX – Foreign Exchange (week 3): determines the relative cost of money in different
currency zones
Equity: determines how much shareholders’ equity is worth, not really in this course
Financial institutions
Depository institutions (week 4): commercial banks and other credit institutions
Investment intermediaries (week 5): investment funds, investment banks, private
banks, family offices etc.
Contractual savings institutions: insurance companies and pension funds
Primary and secondary financial markets
1. Primary markets: where debt or equity is being raised for the first time (e.g. funds are
borrowed). Investment banks charge fees for organizing the issuance of securities.
The desks that in charge are usually called ECM (equity capital markets, new equity
securities - IPOs) and DCM (debt capital markets, new debt securities, mainly bonds).
It doesn’t need to be a public market, can be private market as well. Markets for loans and
private equity in financing are also primary markets with this regard.
2. Secondary markets: where the value of existing (previously issued) debt and equity
securities is determined by virtue of trading. This is a huge ecosystem: investors, brokers and
dealers, exchanges, trading platforms, clearing houses, rating agencies etc.
Revenues generated by primary and secondary market services
Investment banking activities (M&A, ECM, DCM, corporate lending) tends to trail secondary
market services in revenue generation among global CIBs recently.
(= Investment bank)
Primary
$2.657
Secondary
$7.176
FICC = Fixed Income Commodities and Currencies.
FICC generating much higher profits than Equities. Has been the case for quite a while.
Secondary market much bigger than the primary market.
Global issuance of bonds and stocks
4
