1. Objectives
At the end of the session you will be able to
•Explain general banking operation
•Demonstrate general understanding on IB products
• Foreign Exchange
• Securities
• Commodities
• Derivatives
1

2. Why do Banks exist?
• To Provide Financial products and Services
2

3. W are clients
ho
Banks
Deutsche Bank
Citibank
ABN Amro
Corporate
Deutsche Asset Management
Fund Managers
Multinational
Small / Mid size firms
Individuals
High Street Banking (Chase Bank) US Only
High Net Worth Individuals (Millionaires / Billionaires)
3

4. Banking as a Whole
 One of the world’s leading
 Major provider of financial services
investment banks
including corporate finance, cash Commercial
management, & credit Banking Investment  Services provided: Advice on
 Comprises of five national business
Bank corporate strategy and structure,
raising and placing capital, making
segments: Middle Market Banking,
markets in financial instruments and
Mid-Corporate Banking, Commercial
offering sophisticated risk
Real Estate, Asset Based Lending
management services
and Commercial Leasing
Retail Treasury and
Financial
Clients Securities
Services Services
 Includes Auto Finance,
 Global leader in transaction
Consumer Banking, Home
Finance, Insurance and Small
Asset processing and information
Business Banking
and Card services to wholesale clients
wealth Services  Three Businesses: Institutional
 Provides mutual fund, insurance Management Trust Services, Investor
& home finance and workplace
banking products to consumers Services(WSS) and Treasury
and small businesses Services
 Delivers credit card and other related
 Provides investment & wealth management
payment products to cardholders and
services to institutional investors, high net
merchant outlets
worth individuals & retail customers
 Aims to be the preferred payment card in
 Provides personalized advice and solutions to
existing customers wallets and to increase
wealthy individuals
access to new customers
4

5. International Banking Locations
North America
Latin America EMEA Asia Pacific
5

6. Banking and Banking operations
Bank is a commercial institution licensed as a receiver of deposits. Banks are mainly concerned
with making and receiving payments as well as supplying short-term loans to individuals.
Exists to help you make the most of your money
Assist you with your monetary requirements and promote savings
How do they do it ??
By offering different products and Services Banking Services
Deposits Loans Services Capital Market
E.g. E.g.
Savings DP
Current Short Term Long Term Retail Institutional Custodian
Fixed E.g. E.g. E.g. E.g. Merchant
Banking
Overdraft Auto Loan DDs Bank
Guarantee Debenture
Home Loan Lockers Trustees
Trade
Bill Pay Finance
Fund based activities, greater market risk
Fee based activities, lesser market risk
6

7. Role of Banks
Intermediary role between lenders and borrowers
• Lenders – Deposits funds with Banks
• Liability products (Liability for Banks)
• Borrowers – Borrows funds from Banks
• Asset Products (Assets for Banks)
7

8. Different types of Banks
Types of Banks
Central Bank (RBI)
Non Banking Term Financial
Commercial Banks Finance Companies Institutions
(NBFCs)
Public Private Foreign Co- Regional
Sector Sector operative Rural State Finance
E.g. E.g. E.g. Corporations Indian Financial
Banks Banks Institutions
(SFCs)
SBI HDFC Bank Citibank
PNB UTI Bank ABN Amro E.g.
BOB ICICI Bank HSBC IFCI
NABARD
SIDBI
State/Central Private Primary Credit
Societies
8

9. Broad Categories
•Retail Banking
•Whole Sale Banking
9

10. Activities of a Bank
•Accepting deposits from Public
•Lending money to public
•Remittances/Collection Business
•Keeping valuables in safe custody
•Government business
•Acting as trustee
•Treasury services
•Capital Market activity
10

11. Capital Markets Overview
Markets – A place where exchange of goods and services happen
Capital Market
•Place where capital (fund) requirements of the issuers are
met; i.e. Issuers (Corporate, Government, etc) raise funds
•Trades in these markets are for debt, equity securities or
other instruments
•Organized, as they are governed by regulatory bodies
[Securities & Exchange Board of India, RBI]
11

12. Financial Markets
12

13. Capital Markets intermediaries
Regulator
Underwriters
Merchant Banker / Investment Bank – JPM
Brokers
Exchanges
Custodians
Banks
Depositories
Depositary Participants
R & T Agents
Market Participants
13

14. Capital Markets – Regulators
SEBI – Securities Board of India
SEC – Securities & Exchange commission (USA)
FSA – Financial Services Authority (UK)
14

15. Capital Markets intermediaries
Underwriter
•Who underwrites the issue in case of under-subscription; takes the
stock in its books
Merchant Banker / Investment Bank
•An underwriter or agent for corporations and municipalities issuing
securities
•Maintain broker/dealer operations mostly, maintain markets for
previously issued securities
•Offer advisory services to investors
•Large role in facilitating mergers and acquisitions, private equity
placements and corporate restructuring
•Do not accept deposits from and provide loans to individuals
(Investment Banks, especially)
15

16. Capital Markets intermediaries
Brokers
•An individual or firm that charges a fee or commission for
executing buy and sell orders submitted by an investor.
•The role of a firm when it acts as an agent for a customer and
charges the customer a commission for its services.
Exchanges
•A market in which securities, commodities, options, or futures
are traded.
•Although you will mostly trade stocks through a broker
•NSE, BSE, NYSE, NASDAQ, LSE
16

17. Capital Markets intermediaries
Custodian
An agent, bank, trust company, or other organization which holds and
safeguards an individual's, mutual fund's, or investment company's assets
for them.
Bank
An organization, usually a corporation, chartered by a state or federal
government, which does most or all of the following: receives demand
deposits and time deposits, honors instruments drawn on them, and pays
interest on them; discounts notes, makes loans, and invests in securities;
collects checks, drafts, and notes; certifies depositor's checks; and issues
drafts and cashier's checks.
17

18. Capital Markets intermediaries
Depositories
An institution which facilitates the clearing of securities between the
stock exchange & depository participants; holds assets in electronic form
on behalf of ultimate beneficiaries
Depository Participant
Any institution like a bank that maintains the dematerialized
accounts of beneficiaries, provides services of settling securities
traded on the exchange; Agent of Depository
Registrar and Transfer Agents
maintain the records of members (shareholders) for the issuer company
18

19. Capital Markets intermediaries
Market Participants
Various persons / entities that indulge in buying & selling Examples:
•Qualified Institutional Buyers
•Foreign Institutional Investors, Foreign Venture Capital
•Domestic Institutional Investors - Banks, Financial
Institutions, Insurance Companies, Mutual Funds, Venture
Capital
•Non - Institutional - High Net worth Clients (E.g. NRI, HUF, Government &
Private Corporate bodies)
•Retail Individual Investors
19

20. Primary and Secondary Capital Markets
Primary Market
Sell (float) new stocks and bonds to the public for the first
time. In the primary market the security is purchased directly
from the issuer
Secondary Market
Secondary market is where investors trade among
themselves. An investor purchases a security from
another investor rather than the issuer. Auction
market forms a part of this market.
20

21. Banking Treasury Products
Foreign Exchange
• What is an FX trade
• How does it work
• Why are banks in the in the FX Market
21

22. Products: Foreign Exchange
Definition: Buying (or selling) of a currency and paying for it with another at an agreed price
(exchange rate) for settlement on an agreed date
Complete the grid of descriptions using the following words
1. Payment Instructions
2. Receiving / receipt Instructions
3. Currencies
4. 2 Counterparties
5. Broker
6. Value date
7. Booked the right way round
8. Amount
9. Exchange rate
10. Trade Date
22

23. Products: Foreign Exchange
Component Explanation
Currencies Has to be two of these for the exchange to be possible
Amount A numerical figure that shows the value of the trade
Exchange rate The price of one currency expressed in another
The day the trade will settle. i.e. the funds will be debit / credit
Value date
from / to your account
Booked Right Way Round Shows which currency we are paying and receiving.
Broker Helps to arrange a trade on behalf of others
2 Counterparties The entities involved in the trade
Trade Date The day the deal was agreed
Receipt Instructions Where we are receiving our currency to?
Payment Instructions Where are we paying the currency to?
23

24. Different Trades
• Spot trade: Value date = trade date + 2
• Cash trade: value date = trade date
• Tom trade: Value date = trade date +1
• Forward trade: Value date = trade date +
3(or more)
24

25. Products: Foreign Exchange
Example
BMW now need to pay in USD but only have a EURO account
Gear Box Supplier
USA The Solution: Do a Foreign Exchange Trade
Supplies Contact Citibank:
gear
boxes at Want to Buy $5,000,000.
agreed Will pay for it in EURO’s.
price.
BMW JPMorgan will ask what date they want the currency (Value Date)
need to
pay in JPMorgan will advise the Exchange rate. (How much will $5mio cost in EURO)
USD Rate is 1.27 (Euro 1 = $1.27)
Pay USD 5,000,000 to BMW (for Gear Box Supplier)
BMW Citibank
Munich
Pay EURO 3,937,008.
BMW need to import
gearboxes that have
been made in the US.
Cost $5,000,000
25

26. Speculation
Example
Sell GBP 1 M
Microsoft Citibank
USA USA
Rec $1.9 M
sell 1.7M buy Microsoft speculates that GBP price will increase from $1.7 to 1.9
USD
GBP1M in 3 months time
Contact JPMorgan:
Want to Buy GBP 1,000,000.
JPMC Will pay for it in
JPMorgan will ask what date they want the currency (Value Date)
JPMorgan will advise the Exchange rate. (How much will GBP5mio cost in USD)
Rate is 1.7 (GBP 1 = $1.7)
26

27. Currencies
What currencies do you know?
Have a name:
Eg United States Dollar, Japanese Yen
Have a 3 figure code
Eg, USD and JPY
27

28. Price of a currency
• Factors that affect the price of a currency
-Economic e.g. Interest rate, inflation rate
- Political
• Strong currency
• Weak currency
28

29. WHY FX
• For personal requirement
• For business requirement
• For speculation
29

30. Products: Commodities
Commodities
What are Commodities?
Commodities Categories
Example of a trade
30

31. Products: Commodities
W are Commodities?
hat
Review cards and put them into 4 categories
Put a name to the 4 categories
31

32. Products: Commodities
Banks trade in Commodities just as they do in currencies.
Commodities are split Into 4 groups:
• Energy – e.g. Gas, Oil
• Base Metals – e.g. Copper, Aluminium
• Precious Metals – e.g. Gold, Silver
• Soft Commodities – e.g. Coffee, Sugar, paper
32

33. Products: Commodities
W Precious metals do banks trade in?
hat
XAU Gold
XAG Silver
XPT Platinum
XPD Palladium
(In place of currency codes the chemical elements of the metal are used to identify the metal)
33

34. Products: Commodities
Example:
Watch maker requires gold to manufacture watches
Finds a company selling gold
Agrees how much Gold
Agree on the price
Agree on Delivery
Pay $300,000
SWISS Tony’s
Gold watch JPMorgan
Company Deliver Gold
Want to buy 1,000 oz
Price is $300 per oz
Total Price is $300,000
34

35. Products: Commodities
Settlement
• Use depositories
• Allocated
• Un allocated
35

36. Products: Bonds
Bond Trades
What is a Bond?
How does it work?
What role does JPMorgan play?
36

37. Our Products: Bonds
What is a Bond?
A certificate of debt (usually interest-bearing) that is issued by a
government or corporation in order to raise money
The issuer is required to pay a fixed sum annually until maturity
and then a fixed sum to repay the principal
Effectively it is a loan. The company who receives the money,
issues a Bond with terms and conditions stating when they will pay
back interest and principle amount to the lender of the money
(Investor)
37

38. Products: Bonds
Key Terms of a Bond
• Face Value
Nominal Amount
What the Bond is worth when redeemed at maturity
• Coupon
Amount of interest paid to Bond Holder during the life:
(e.g. 5% = 5% of Face Value of investment)
Date for coupon payments. Usually 6 monthly (does depend on terms of issuance)
• Maturity amount is paid back to the investor.
Date the principle
• Issuer the Bond. (Received the money)
Who Issued
Activity: Lets Look at a practical example.
38

39. Products: Bonds
Conceptual Example
Pay $1,000,000
Receives Bond
Bond Issuer
e.g. A Corporation or Makes regular payments (Coupons)
Investor
Government
Bond maturity pay back $1m
39

40. Products: Bonds
Conceptual Example
Pays $1,000,000
Big Company Ltd Investor(s)
Issues Bond(s) to Investors
2. Raising capital: 3. Raising capital: 4.Raising capital:
1. In this example, Big It borrows money An Investor buys the
Big Company Ltd Company A looks to by issuing a BOND. bond. (can be a bank,
want to buy Small borrow money corporation, Individual
Company Inc. etc etc)
In order to do so it
needs to raise
capital.
The purchase price
is $1,000,000 5. End Result
Big Company Ltd can now finance its purchase of Small
Company Inc and will pay the Investors back. How much
depends on the bond (loan) terms.
Small Company Inc
40

41. Products: Bonds
Conceptual Example
Paid $1,000,000
Coupon payments
made
every 6 months for
Big Company Ltd Investor(s)
term of bond
10 Year Bond = 20
payments
Pay back principle amount (e.g. $1,000,000) at maturity
Coupons of 5% are paid semi annually
by Big Company to Investors.
Investors hold
the Bond until Maturity
41

42. Products: Bonds
Role of banks in bonds
Example
EURO 5 M EURO 5 M
BMW JPMorgan Bond
BMW JPMorgan Bonds Market
Bonds
Issue Bonds into
the market
Want to start BMW Contact
design and produce JPMorgan and
a new model car appoint them as
Lead Manager on
Bond Issue
Estimate they need Receive
Receive Receive
EURO 5 million to Bonds Bonds
Bonds
do this
JPMorgan Pay BMW
EURO 5 Million and Pay cash Pay cash Pay cash
receive Bonds
They chose to raise
Investors Investors Investors
this capital by
issuing a Bond Bond Buyer Bond Buyer Bond Buyer
42

43. Products: Equities
Equity Trades
What is an Equity trade?
How does it work?
What role does JPMorgan play?
43

44. Products: Equities
Big Company is now
looking to expand its The company decides it It uses a bank to advise how to do this
operation again and will raise the cash by
needs to raise cash in selling shares
order to do this. Will Issue IPO.
Big Company Ltd Bank
44

45. Products: Equities
Bank will:
• Assist with company valuation Advertise the IPO
• Can under-write shares
Potential investors contact
• Advise on timing bank and register their
interest
• Advise on how much of company to sell
Bank Investors
Big Company Ltd
45

46. Products: Equities
Secondary Market
Investor Investor
Investor
Stock Investor
Exchange
Current Share holders (Including
Stock Brokers)
Investor
Investor
Investor Investor
46

47. Products: Equities
Secondary Market
Investor Investor
Investor
Investor
Stock
Exchange
Big Company Ltd
(Including
Stock Brokers)
Investor
Investor
Investor Investor
47

48. Products: Equities
How do banks participate in the Equities market?
Client A, wants to They contact JPMorgan
buy shares in Big with the details of their JPMorgan trader
Company Ltd requirements contacts Stock Exchange.
Wants to Buy 500 shares
Client A JPMorgan
(JPMSL)
JPMorgan and Stock
Broker agree price and Stock Exchange
terms through the Stock
Exchange
Current Stock Broker
Shareholder Through Stock Exchange
A price will be JPMorgan will source a
agreed seller of the Shares.
€20 per share
48

49. Products: Equities Activity
What are we looking to confirm?
Share name Big Company Ltd
Number of shares 500
Price of share EURO €20
Buying or Selling Buying Shares
Currency paying EURO
Trade date 13th October 2005
Value date 15th October 2005 (T +2)
Payment details Where to pay shares and cash to
(from both parties)
49

50. Products: Settling through clearing house
Payments: How do they get made?
The trade will then settle across the
BNP Kassenverein Central Depository.
JPMorgan Frankfurt Delivery versus Payment (DVP)
JPMorgan and
Client send
instructions to Before Payment
their Agents.
Share A/C EURO Cash a/c
Details of the Central Depository
trade and when
to settle e.g. Kassenverein
JPMorgan a/c 500 €10,000
Current
Shareholder a/c 500 €10,000
Trades can
settle over a
central
depository After Payment
The Shares are now transferred to
JPMorgan’s a/c within Kassenverein
They will hold shares on behalf of
their client
Current Citibank
Shareholder Frankfurt
Original Big Company Share Holder,
now has €10,000
50

51. Types of Shares
• Ordinary Share – These shares give the investor the right to a dividend, if declared.
Should the company go into liquidation, then holders of this class of share holds the
lowest priority of repayment.
• Deferred Ordinary share- These give shareholders additional voting rights or the right to
higher dividends. Often these shares will not qualify for dividend until a particular date
has been reached or the company profit has reached a pre- determined.
• Golden Shares – These shares are designed to allow the shareholders the right to a
casting vote. In cases of privatization, the government often held golden shares. This
allowed them to have the casting vote if required, as a form of control, during take-over
bids or other serious matters. These shares are normally used in UK.
• Preference Shares – These shares form part of the share capital of the company. They
pay fixed dividend and in the event of liquidation they hold preference
51

52. Differences
• Bonds Vs Equities
52

53. Products: Derivatives
Derivative Trades
What is a Derivative?
How does it work?
What role does JPMorgan play?
53

54. Products: Derivatives
Definition
A security, such as an Option or Futures contract, whose value depends on the
performance of an underlying product.
Derivative in itself is not a product, it does however rely on an underlying
product for its market value.
For this course we will look at 3 derivative examples
• Futures
• Options
• Single Currency Interest Rate Swap
54

55. Products: Derivatives
Futures
What is a Future?
How does it work?
55

56. Products: Derivatives
Futures
Definition
Standardised exchange-traded contract to buy or sell a commodity at
an agreed price for settlement or delivery on an agreed future date
How does it work
56

57. Products: Derivatives
Futures
UK Potato • Has crop of potatoes
UK Potato
Farmer
Farmer • Ready to sell in 6 months
What can happen in the 6 months before the potatoes are ready?
• Potato Supplies worldwide except UK could fail
• In 5 months time there is a scare about effect of potatoes on health
• Supply remains stable with no impact on current prices
57

58. Products: Derivatives
Futures
What can happen in the 6 months before the potatoes are ready?
Risks: Controls:
• Crop could fail • Insurance
• Price movement • Agree buyer now at agreed price
(Future trade)
58

59. Products: Derivatives
Futures
UK Potato Agree to sell
Futures Agree to buy
UK Potato Exchang Supermarket
Farmer
Farmer potatoes potatoes Supermarket
e
Farmer enters into a Futures contract
Future Contract
Using the Futures Exchange
Seller: UK Potato Farmer
Finds a buyer for potatoes
Buyer: Supermarket
Product: Grade A Potatoes
Agrees a price
Price: £5 / sack
Agrees a delivery date Quantity: 5,000 Sacks
Delivery: 5th June 2005
Total Price: £25,000
59

60. Products: Derivatives
Futures
June 5th 2005
• Farmer will deliver potatoes to Supermarket through Exchange
• Supermarket will pay Farmer through Exchange
• Farmer has guaranteed income (providing crop doesn’t fail – insurance would cover this)
This agreement means the Farmer has an obligation to deliver
potatoes on this date and Supermarket has an obligation to pay
farmer the agreed price. All this happens via Exchange
60

61. Products: Derivatives
Options
What is an Option?
How does it work?
61

62. Products: Derivatives
Options
Definition
The buyer has the right, but not the obligation to buy or sell
the underlying product at an agreed price on an agreed date
The buyer pays a premium to the seller have this right.
Let’s look at an FX Option
Page 45-49 in Workbook
62

63. Products: Derivatives
FX Option
Big Company has ordered a
Big Company
Big Company supply of computer
USA What needs to happen
USA components from CRUUK
(Computer R Us UK) To Pay for this order Big
Company will have to do a
Foreign Exchange trade.
Deliver
Have to pay Computer Computer R Us UK will deliver
£1,000,000 Components the computer equipment in 3 They need to buy GBP
in 3 months months time 1,000,000 (to pay CRUUK)
This will cost Big Company Ltd
GBP 1,000,000. in 3 months And pay for it with USD
Computer RRUs UK
Computer Us UK
(CRUUK)
(CRUUK)
Page 45-49 in Workbook
63

64. Products: Derivatives
FX Option
What choices does Big Company Ltd have?
• Buy the £’s via a forward FX trade (arrange today value 3 months)
• Buy the £’s in 3 months – spot trade
(exchange rate unknown until 3 months)
• Do an FX Option
Page 45-49 in Workbook
64

65. Products: Derivatives
FX Option
Big Company Ltd decide to use an FX Option
Why?
• Want to know state of cash flows (now and future)
• FX Option will limit any exchange rate movements
Page 45-49 in Workbook
65

66. Products: Derivatives
FX Option
How does it work?
Big Company
Bought By The FX Option
Big Company Buyer: Big Company
(USA)
(USA) On January 5th 2004 Seller: JPMorgan
FX Option Details
Big Company contact JPMorgan
Call: GBP: 1,000,000
To have this right but not Put: USD: 1,500,000
obligation Big Company Big Company agree to buy an FX
pay JPMorgan a premium Option from JPMorgan. Strike Price 1.5
Expiry Date 5th March 2004
Delivery date 7th March 2004
This Option gives them the right
but NOT the obligation to use this
trade on the delivery date Premium: $5000
JPMorgan
JPMorgan
Page 45-49 in Workbook
66

67. Products: Derivatives
FX Option
Big company now have the right to use [exercise] this trade for settlement on March 7th
What are the key dates?
The FX Option Expiry Date:
Buyer: Big Company
Date that Big Company have to decide whether to exercise the Option
Seller: JPMorgan
Delivery Date:
FX Option Details Date that transfer of funds would occur if Big Company Ltd
exercise this Option
Call: GBP: 1,000,000
Put: USD: 1,500,000
Strike Price 1.5 Other FX Option Components
Expiry Date 5th March 2004
Delivery date 7th March 2004 Call:
Currency that the buyer of the Option would receive
Premium: $5000 Put:
Currency that the buyer of the Option would sell
Strike:
Exchange Rate that would be used if Option is exercised
Page 45-49 in Workbook
67

68. Products: Derivatives
FX Option
How do Big company know whether to exercise the Option?
On 5th March
The FX Option
Buyer: Big Company
Seller: JPMorgan • Look at current FX [Spot] rate
FX Option Details
Call: GBP: 1,000,000 • If they used the spot rate (Not the Option Strike rate)
Put: USD: 1,500,000 how much would it cost to buy the £1,000,000?
Strike Price 1.5
Expiry Date 5th March 2004
• Would it be cheaper to use the Spot rate and let the
Delivery date 7th March 2004
Option expire or…
Premium: $5000
• Use the Option because the spot price in market would
cost more in USD.
Lets look at possible choices Big Company Could make
Page 45-49 in Workbook
68

69. Products: Derivatives
FX Option
To buy £1,000,000 on Spot Market
The FX Option 5th March RATE Would Exercise
Buyer: Big Company COST in USD Option
Seller: JPMorgan
If SPOT Rate 1.3 $1,300,000 NO
FX Option Details
Call: GBP: 1,000,000 If SPOT Rate 1.7 $1,700,000 YES
Put: USD: 1,500,000
Strike Price 1.5
Expiry Date 5th March 2004 To Buy £1,000,000. using the FX Option would cost:?
Delivery date 7 March 2004
th
$1,500,000
Premium: $5000
Remember:
Big Company bought the Option 3 months ago So wouldn’t know what
the rates would be today. Buying the Option limits the cost of the
Computer purchases to a maximum of $1,500,000.
(plus the $5000 premium)
Page 45-49 in Workbook
69

70. Products: Derivatives
FX Option: To buy £1,000,000
‘In’, ‘At’ or ‘Out Of’ the Money?
$1,700,000 In the Money
Cost
in $1,500,000 At the Money
USD
$1,300,000 Out of the Money
1.3 1.5 1.7
Foreign Exchange Spot Rate
Page 45-49 in Workbook
70