Hey, good afternoon or good morning, everyone.

We are just gonna wait another minute to see if more people are in the process of joining, but we're gonna kick this off in one minute from now. Thank you very much.

Okay, let's get started.

So, good morning, good afternoon, good evening everyone, and welcome to this Felix Live refresher session, on money markets.

Thank you so much for joining.

Now, I might be mistaken, but I think it's actually the first time that Financial Edge delivers a markets topic in this format here today.

So I'm very excited to be here.

But anyway, please allow me to introduce myself very briefly.

My name is Thomas Krause. I'm the head of financial products here at Financial Edge.

I started my career in fixed income trading, interest rates and effects in cash and in derivatives. And I also had the opportunity to be involved with a cross, ask or cross asset mandate that gave me a good amount of insights into the equity and credit markets as well.

So, what's on the agenda today? As I said, this is a refresher session on money markets. First of all, that means it's gonna be relatively fast paced because we have a lot of agenda items, to go through.

For example, we're gonna refresh your knowledge on what money markets exactly are, who are the participants and why are they getting involved in this market.

We're gonna have a look at some of the cash instruments that are traded here, as well as their mechanics.

We're gonna have a quick discussion on those interest rate benchmark rates.

That includes IBORS.

Yes, some of them are still around, but that also will include the newer near risk-free rates like SOFR, TONAR, ESTR, and the likes. And then towards the end of the session, just to wrap up, we're gonna have a very, very brief look at how those rates or near risk rates or IFRS as they are abbreviated typically are linked to the actual central bank rates.

And we're also gonna have an extremely short word oh, brief introduction into the monetary policy transmission mechanism.

But before we get started, couple of reminders for you.

First of all, the materials are available either via the resources link in Zoom, or you also find them on the Felix Life website.

I believe they have also been shared in the chat, the link.

Second point, you can ask questions in this webinar.

The important thing that you have to remember though, is please ask all questions via the q and a function.

I won't monitor the chat, so please say it once more time, all questions that you would like to have answered during our via the q and a functions.

And then third point here, once the session has finished, you will be directed to a feedback form.

And please, your feedback is very, very important.

So take a minute or two to fill out these feedback forms.

Bit of a pro tip if you like.

This is also a great way of asking follow-up questions. So in case, you have follow-up questions or couldn't for any reason, answer or ask your question during the session, the feedback form is a great way of doing the, and also, if you are looking for other markets topics to be covered in this way, the feedback form is also a great way of letting us know.

But without further ado, let's get started.

And as I said, we're gonna start with a introduction or a refresher on what are we talking about exactly when we talk about money markets.

So, well, let's put money markets on the map.

Now, in general, money markets are a specific part of the financial market. And as you know, the financial market is really the place that facilitates the flow of capital from those who have a capital surplus. They would like to invest to those who need capital, for example, to grow their businesses. And when we're looking at financial markets, and basically we often distinguish these two main categories. There are the capital markets on the one hand, and then there are money markets on the other hand.

Now, capital markets, this is the part of the market where we're trading these longer term financial instruments like stocks, like bonds.

That means that in capital markets, you find both debt and equity instruments, right? On the other hand, we have money markets, and there's, things are quite different because in money markets you will only find debt instruments. And more specifically, you will only find debt instruments here with a time to maturity between time to maturity, between one day and one year.

And one other thing that all money market instruments have in common, or at least most of them, or the vast majority of them, is that usually on money market instruments, the interest, i.e. the amount of money that you are receiving in return for your investment is typically paid at the end of the investment period, at the end of the instrument's life, at the maturity date of the instrument.

So if you were, for example, to invest a hundred million dollars today in a 6 months, US money market instrument, then that means that in six months time, you'll receive your invested money back and you will receive all the interest that will, you know, basically apply for the next six months investment period.

And that in turn means that, or you know, or let's say this is pretty straightforward, right? You get one interest rate payment as just one single cashflow, no interim coupon payments, no messy reinvestment risk, et cetera, et cetera. And what this means at the end of the day is that in case of money market instruments, it's actually really, really simple to calculate the interest that you will receive for investment or the return that you will receive for an investment. Because all you have to do is to multiply the notional.

So in our example here, a hundred million dollars with the interest, let's use 5% here as a example, and then you have to multiply with something called the day count fraction, which is the real meaning of DCF.

And that is nothing else but the number of days over the basis, which is basically the number of days a year, right? Now why is this important or why is this necessary to introduce a state count fraction here? Well, in institutional investment or in the institutional investment space, interest rates are always, always, always quoted on a per annum basis.

However, as we said, if we invest money for a 6 months period, we shouldn't receive interest for a 12 months period.

And the purpose of the day count fraction is really to break down the payment or to adjust this payment down to the relevant period.

So in our case, for 6 months investment period, the day count fraction should be roughly 0.5.

However, it's important to be aware that markets have developed a range of conventions that are used in different markets that will allow us, or that are, you know, that are used to calculate these stake count fractions, right? And the two that are most often used in money markets are actual 360 and actual 365.

Let's have a look at actual three 61st.

Basically what we're doing here is we're using as number of days, the actual number of days.

So we're really calculating the number of days between the issuance date of the instrument, i.e. when the investment is made, and the maturity date of the instrument.

i.e. when we receive our money back, that's the actual number of days.

And then we divide those actual number of days by 360.

And that basically means we're assuming that every year has 360 days.

Now, that of course, isn't the reality, and you might wanna debate as to why there are different decon conventions, et cetera, know that really matters.

They are there and they are used.

And the actual 360, for example, is the most common, used decom convention in US dollar money markets in European or Euro money markets as well.

As I said, actual 365 is also used very, very similar.

We use the actual number of days and then we divide by 365, maybe a little bit closer to reality.

But of course, in case of elite year as 2024 is one won't be reflecting the reality necessarily.

So these are simplifications.

Actual 365 is used for example, in pound sterling money markets and also in domestic Yen, money markets.

Just to give you some examples.

Now, of course, these are fairly technical things, but it's really important that you take those stake home conversions into consideration when you are, for example, comparing investment alternatives.

And a reminder for, or how important this actually can be is right on this, right on the bottom of this slide here, where we are basically looking at two different investment alternatives. And both cases you can invest a hundred million dollars at 5% for a one month period starting today from the 12th of January to the 12th of February, 2024, which is 31 days, by the way.

Now, although the notional amount and the interest that you will get paid, as well as the investment period is exactly the same across both investment alternatives, the amount of interest you will receive isn't because the difference in those two alternatives is that one investment alternative pays interest on an actual 360 basis, the other on an actual 365 basis.

And of course, you will immediately figure out which one is to be preferred here. That will be the actual 360 one, simply because the absolute amount of interest that you receive on your a hundred million dollars investment is, higher than in case of the actual 365 one.

Okay? So, let's have a look at who is involved in money markets next.

And maybe you have already heard someone referring to money markets as the plumbing of the financial system.

It's a pretty often and widely used analogy, and I'm honestly a big fan of it because it's so intuitive.

So let's think about plumbing for a second, right? We all know that behind these walls, there is a lot of stuff that's happening. There's tubes, pipes, connectors, all sorts of things, and they fulfill a very, very important role, right? Under the normal circumstances though, as long as everything is working fine, most of us won't really worry too much about the plumbing, right? As long as everything works, it's fine.

However, when something starts to go wrong, I would suggest plumbing becomes a high priority issue for all of us, right? Because when something starts to go wrong, things can go messy or get messy very, very quickly.

And I don't wanna go into too much detail here for obvious reasons, but I would suggest that many investors actually view money markets in a fairly similar way.

They know it's there, they know it plays a very, very important role in the financial system, but as long as everything is working fine, we don't really, spend too much time worrying about it.

At least most investors don't.

Unless of course we're up to this point though, when something starts to go wrong.

If that's the case, then of course this is, well, not of course, but this is something what almost all that investors can think about. They get really, really focused. And the last time this happened was in March, 2023 when we saw this, if difficulties or issues in money markets because of the bank failures that happened at that time.

So obviously the lesson to take away from this is that, you know, obviously money markets are well-functioning money markets play a very, very important role for the overall financial system, for the overall financial markets.

The question is, why is that the case? And I believe that, you know, the answer becomes clear when you are looking at the main direct market participants in the money markets, and you think a bit about their motives, i.e.

what are they using the money markets for? Now, there's different categories, if you wish.

So, you know, these entities that you can see here on the slide getting involved in, in money markets for different reasons.

But you know, we can sort of distinguish two main categories here above the dotted line.

Everything is really about cash management, right? Short-term investments, short-term borrowings, i.e., efficient liquidity management. Because we all know, the story, right? We, there's always a mismatch between points in time where money is received and points in time where money has to be paid.

And even if you plan things very deliberate or very deliberately, then there might still be some unforeseen circumstances that you know, you have to adjust for on, on short notice.

Let's take the example of a bank because we're, most of us are fairly familiar with those kind of institutions and for obvious reasons, banks have to ensure that they can meet their payment obligations every single day of the year.

And in order to be able to do that and to have a little bit of a safety cushion against unforeseen circumstances, banks usually hold a certain amount of liquidity as a cash reserve.

And they don't necessarily just do that voluntarily.

Regulators also make sure that they do that for very obvious reasons.

Again, so this is then of course you can, you can think about how much liquidity should banks hold, and there's a safety argument that says, the more liquidity you hold, the safer it is that you will be able to fulfill your payment obligations, right? No doubts there. On the other hand, holding too much cash reserves or liquidity isn't really attractive from a return point of view because cash reserves usually don't pay, high amounts of returns.

So we have to find the right balance here. It's all about the mix, right? We wanna have as little as possible, but as much as necessary liquidity reserves.

And so we're very careful here. We're budgeting for this.

We have cashflow forecasts, et cetera, et cetera, and we're planning things very carefully.

But again, as I said before, of course, things don't always work out as planned.

Sometimes we have to make sort of last minute adjustments.

And so let's assume here, just to get a better understanding of this, a very, very simplified example.

We're working in a bank's treasury and we're starting, the day and our cash reserve shows an opening balance, our opening balance of $1 billion, right? So we currently are holding a $1 billion cash reserve.

And let's also assumed for simplicity that this is the amount of liquidity that we're generally aiming to hold on an end of day basis, right? This is sort of like the standard balance that we would like to have.

So then we're looking into our cashflow forecast, and for that particular day, the expected inflow or expected inflow into our account is, $0.8 billion.

So $800 million are expected to come in from various, through various payments.

We have expected outflow where we have to make payments, and that should be 0.5 billion.

So we have an expected end of day balance of billion 1.3 dollars, right? So that basically suggests we have more than our, or more than the balance that we're generally aiming for here.

So we could think of investing these 300 million, we could wait and see how things look closer to the end of the day.

You know, there's no right or wrong answer here.

I believe so.

Now we're going through our day, now we're making our payments.

So we are paying our payment obligations, we see some money coming in, and just before we wanna close up for the day, we get notified that one significant payment that was expected to be received that day, a loan redemption payment of $500 million is not coming through because of technical difficulties.

It's not a loss case, it's not that, you know, the client has default or anything like that.

It's just the fact that the money that was expected to arrive today is not arriving today, but it will arrive tomorrow.

Now, what does it mean? The actual end of day balance at that point is not 1.3 billion, but it's now 0.8 billion, simply because 500 million that were scheduled to be received have not been received.

And so now of course, we still have 800 million cash reserve, but assuming we want to hold at least always a billion on those, cash reserves, we would now have to go out and borrow $200 million, relatively short notice for how long? Well, usually, I guess in this case, you would go for overnight, right? Because tomorrow this loan payment is now expected to come, so we really only need these 200 million from today to the next business day.

And so we would get out, go out and borrow this money, and so they can see as to why it is so important that the funding money markets are well functioning and well oiled so that these transactions don't become, a problem.

Even on short notice. That's the case for banks.

Corporates face fairly similar issues in their cash management, groups and also governments, right? Because tax receipts are not equally distributed across or, you know, across a year.

And so aren't government expenses and government bonds that are the main financing tool for governments, deficits at least.

They are issued and sort of, you know, announced preset calendars.

And so in between, governments need to think about cash management and their short-term, boring, short-term investing happening as well.

And then the last, group here in this above the dotted line section are neutral and pension funds, for example.

So investors, institutional investors, and they won't necessarily be hugely involved in the short-term, borrowing front but they might be using money markets for short-term investments. Now, that's pretty obvious if you run a money market fund, that this is your main space for investments.

But even if you run, for example, an equity mandate or a, a long-term bond fund, you might have cash reserves because you want to be able to meet sort of redemption requests, et cetera, on short notice.

And those cash reserves, you will then also invest overnight, maybe in those money market products low risk then, then also low returns.

But then this investment is not primarily made for return, purposes.

So this is the cash management part, and then we have central banks here.

And of course, you would not assume that central banks are to a great deal involved in their own cash management here on the money markets, but they mostly use money markets to conduct monetary policy.

And we're gonna talk a little bit more about that later.

So those are the main direct market participants.

I would suggest, however, that what happens in money markets and money market rates are super relevant for a much larger group of people and organizations than we have here on the slide, because money market rates are very, very frequently used as reference rates that determine payments on loans, mortgages, interest rate, derivatives, et cetera, et cetera.

So movements in money, market rates concern a lot more than the direct market participants.

This feeds through into large parts of the economy as well.

Okay? But, why don't we now start having a look at those different instruments that are traded in the money market, and we're looking at cash instruments, so derivatives for a different day, right? So, when we're looking at those cash instruments, then we can really distinguish two categories on a high level, right? They're seen unsecured instruments, and then of course there's also secured borrow.

Let's start with those unsecured instruments.

First this is then basically borrow of money by, you know, issuers that's only really backed by the credit quality of the issuers.

So they promise to pay the money back, but there's no collateral involved at all.

And typically what we find then in the different money markets are in this category, deposits, certificate of deposits, treasury bills, and commercial paper.

So they obviously differ quite significantly across a variety of factors.

And first, and one that we wanna look at here, introduce here is who is issuing those sort of instruments? Deposits and certificate of deposits are only issued by banks.

Treasury bills are only issued by governments commercial paper by all sorts of corporations, financial, non-financial, et cetera.

Now, the second point by which these instruments differ is in the method the interest is paid or the return is generated.

Deposits and certificate of deposits or CDs are what we call coupon instruments. And that means you invest a notional amount. Let's say you invest a hundred million dollars today and then add maturity, you get your notional amount back, plus a coupon that is calculated, as we've discussed on the very, very first slide. Notional times interest times stays over basis, right? So it's like interest added on to the notional amount.

Now the second group here, treasury bills and commercial paper are what we call discount instruments. And that means that you buy them at a price at that is trading at a discount to par.

And then this instrument doesn't pay an explicit coupon, but at maturity, you get par back. And we're gonna look at an example of that one, we'll talk a little bit more about T Bills in a moment.

Then the last criteria by which we want to look at these or distinguish these instruments is the negotiability or the tradability.

In other words, do investors have the opportunity or the chance to sell out of this investment before the actual maturity day? And for deposits, regular deposits, the answer is generally not.

They are non-negotiable.

It's a bilateral contract between the investor and the bank.

And, uh, there's no legal claim to get your money back earlier.

The bank might give you your money back if you're an important client, and you can really make the case as to why this is important to you, but you don't have a legal claim, right? Certificate of deposit, T-bills and commercial paper, they are negotiable, at least under the most circumstances.

And what that means is that there's a security that exists that represents this investment, and you can sell this security then in the secondary market to another investor.

So you have at least the possibility to do so.

How liquid these secondary markets are is a different story.

In case of certificate of deposits and commercial paper, we often see that these instruments are mainly used as buy and hold.

So hold to maturity instruments, given that the maturity is not really that long anyway.

It's money market instruments, remember, it's up to one year.

So there's not really a lot of liquidity necessarily in the secondary markets.

For t-bills, this is obviously different, but you know, it's still you have the possibility to transfer these instruments to somebody else.

Okay? So now what we're gonna do, we're gonna have a look at, uh, deposits and CDs and T-bills as well.

And we're starting first with deposits and certificate of deposits.

And the first thing I think that's worth noting here is that most deposits that are traded, especially in the interbank market they are overnight deposits, which means that money is l or borrowed from today to the next business day, right? And kind of makes sense given this cash management example that we talked about earlier when we were looking at back, right, client payment didn't go through, comes tomorrow.

So you need to borrow the shortfall for one day.

Only however easy to imagine that banks might have a sort of more structural liquidity shortfall. So maybe the cashflow forecast shows that you're underneath your balance for the next month.

In that case, you might wanna, think about if you borrow money by taking in one month's deposit, so for the whole one month's term, rather than having to rebo it overnight over the next, 30 days or so, right? And also, clients might have appetite to invest money in deposit format for actually longer than overnight. They might have a surplus that they don't need for two months or one month or three or whatever.

And so they might want to think about issuing or investing this for the whole term rather than overnight, and then tomorrow they have to renegotiate, et cetera, et cetera. Just more convenient in a way and takes uncertainty up, right? So that's then the reason why there are term deposits, right? There's definitely decline demand for that. However, remember what we said earlier, deposits, the classic traditional deposit does not come with negotiability.

So one concern clients might have that might stop them from going into term deposits is they're losing the liquidity, right? There's no way to really get or be sure that you can get out of this instrument.

And so to address these concerns, then certificates of deposits have been developed and the idea is that you take the deposit as a bank and then you issue a certificate that is basically a receipt for having received this deposit.

It states the amount that you have to repay, it states the maturity date at which the money has to be repaid.

It states the interest rate that you will have to pay, and therefore it's almost like a tradable security that then an investor, if they needed their money back before the actual time to maturity could sell in the secondary market, assuming they're finding a buyer that's willing to pay a fair price.

And that's where what we want to think about next.

Assuming an investor decides to sell for whatever reason, this certificate of deposit before the actual maturity date, how can we calculate the fair price for this? So let's have a look at an example here.

Let's say that's an investor bought a hundred million, notional, or invested a hundred million dollars in a six month certificate of deposit.

That's 182 days. In this particular case, the interest rate was 5%.

Now, 34 days before the maturity date, they want to sell this, cd, and they are gonna, or they have asked a dealer or market maker for a price.

And the dealer sees the 34 day rate for this issue currently at 5.1%.

So how can we now work out what the fair price under those circumstances will be? Well, the good news is because we're talking about money markets here and there is no compounding feature, et cetera involved, as I said, calculation of interest rates is actually quite straightforward.

And the same applies for calculating the price of a certificate of deposit. Because basically what we're faced with here is an instrument that, or this certificate actually represents one single cashflow in the future at maturity, the holder of the security of the certificate will receive a hundred million plus the interest of 5% over 182, days period.

So if you remember the simple interest rate calculation, a hundred million times, 5% times 182 over 360 because it's US dollars and extra 360 applies.

But of course, they also get the notional amount back.

So a hundred million on top of that.

And so you can express that in this sort of way here that you will get back a hundred million times 1 plus 5% times 182 over 360.

And that's basically the cashflow, the single cashflow of the instrument, which we can also refer to as the future value.

Now, this future value will be realized by whoever holds the certificate 34 days from now.

So what do we have to do? We now have to discount this future value by 34 days using the appropriate discount rate, and the dealer has said, I see the appropriate discount rate for this instrument at 5.1%.

At the moment, IE they are gonna apply 5.1% as a discount rate.

And if you do discount and this is basically what the denominator does, this is basically just the discounting then you get a fair price of 102.036, and a bit million.

Now, some of you might have expected that the day count or the, sorry, the discounting to look slightly different because we're used to normally see one plus interest to the power of time or fraction of time.

However, as you know, we're talking about money market instruments. And in money market instruments, as I said before, there's no compounding simple interest calculations apply.

We use the same simple approach also in discounting, not just in calculating the interest rate.

So that's actually the right way to discount in case of a certificate of deposit here.

Okay, so then let's move on to treasury bills, T Bills and here this is obviously the market which has the highest liquidity in a secondary market.

And I mentioned before the T-Bills are basically discount instruments that are issued by governments.

So remember, you buy them at a discount, you get par back.

Just to put a concrete example into this as well.

If you, for example, would have bought this 26 week, which was 182 days, US treasury bill, when it was issued in July, 2023, you would've had paid a price of 97.3357 something percent.

So for a hundred million notional, you would have paid a 97,335,000 and a bit.

Then if you don't sell this T-Bill prior to the maturity date, this amount would have grown to a hundred million and that amount you would have received at the maturity date 182 days later.

That's how discount instruments work.

Now, as I said, this is like the one is a coupon instrument. The other is a discount instrument.

Generally speaking, I don't think it matters really that much for investors unless maybe there's some sort of like different tax treatment if, you know, the, the wells is increased by receiving coupons or by increasing the price or buy at a discount and get par back.

But it's something that we need to be aware of that there are sort of minor technical differences in these instruments similar to the daycom convention that we discussed earlier.

We just need to be aware of this when we want to make sure that, or when we want to compare investment alternatives, we need to make sure that we're comparing apples with apples, okay? So T-Bills are discount instruments. They are issued at a discount.

However, when you ask for T-BilI prices in the secondary market, what most often happens is that you won't get quoted in price terms, but you get quoted in return terms.

So if, for example, on the twenties of November, 2023, you would've picked up the phone called a market maker, ask for a secondary market or for a price in this specific 182 T Bill date T-Bill that was issued in July, you would've received at some point in during that day, a quote of 517.5 to 5.16.5.

Now, what that means is that if you wanted to sell the T-Bill to the market maker or dealer, they would've given you a price that equates to a return of 5.175% for debt holding the t bell of the remaining, time period.

If you wanted to buy the T-Bill yourself, you would have had paid a price that equates to a return of 516.5.

Now, that's a regular bit of a spread here, if you wish, that we see for all sorts of financial instruments when you're calling a market maker or even if you go to an exchange.

But, it's just here given in return terms rather than in price terms.

And these return terms are of course, interest rates.

However, there's one very important thing that one needs to be aware of in this context, and that is that there are different methods of how we get from the return quote to the actual price that has to be paid for that T-Bill.

And those two methods are called the discount quote method and the yield quote method and the US T-Bill market, obviously the most important T-Bill market in the world, I would suggest is a bit of an outlier here in the sense that they use the discount quote method.

What this means is if you or to get from the quoted return to the actual price of the T-Bill, you have to subtract a So-called discount, that is this part here from the paramount i.e. from the future value.

That's not special so far, but what's kind of the outlier here is that the discount itself is actually calculated on the future value, not on the present value.

And that's kind of unusual because the normal way we think about interest rates is that interest rates are the return that you get paid or that you receive on the amount of money invested, not on the amount of money that you're gonna receive in total at the end of the investment.

But this is kind of what the discount quote method does.

It pays, or this return is effectively paid on the future value.

And as I said, that's a bit unusual because in any other instrument, it's the other way around.

And the, now the good news is that most other t-bills use the yield quote method, which is sort of as we know it, right? The interest that is quoted will be received on the amount that you are investing on the present value.

And what that means to get from the return quoted to the actual T-Bill price, you can apply the same discount approach that we have already discussed in the context of the certificates of deposit.

Now, once again, this might be sort of like technical details, however, again, something to be aware of when you are comparing investment alternatives, because all else being equal, right? Assume that you have to choose between two T-Bills.

Those are coming at the same return that's quoted.

Both have the same issue, both have the same time to maturity, but one is using the discount method and the other one is using the yield method.

Then of course you would prefer one of them, wouldn't you? You would prefer the discount method simply because there, as I said, the interest that you're gonna get paid, the return that has been quoted to you is paid on the future value.

Whereas in the yield method, this return is only paid in inverted commas on the present value. And in most circumstances, future value is higher than the present value.

So we all prefer getting the return on the future value rather than on the present value.

So under normal circumstances, what this means is that all else being equal, the rate quoted on a discount quote method T-Bill, should be lower than the one on a yield code method.

That's just something, to be aware of, again, to make sure you're comparing apples with apples.

But that should be enough on those unsecured money market instruments.

Let's have a look at secured borrow and lending in money markets, especially as a huge part of money market transactions are actually secured or collateralized, in other words.

So instead of borrow money and just promising to pay it back, the borrower also provides a lender with valuable collateral on top.

And the most prominent example of such secured borrowing, in money markets is repo, which economically speaking is collateralized. Borrowing one party effectively borrows cash from the other, and in exchange they give a bond, for example, as collateral, and of course, they pay interest on the borrowed cash as well.

That's economics.

However, repo is short for repurchase agreement, and that's how most repos are actually set up legally.

There's two steps right at inception.

So when the traders agreed on the same day, usually the cash borrower, so the person that is willing to raise financing here, and that's referred to as repo party sells the collateral, the bond to the cash provider, which is called the reverse repo party.

So it's not, I'm delivering some collateral and I expect it to receive back, no, I'm selling you a bond and you pay me a price for that bond, right? So the collateral is delivered and the agreed upon cash amount is received.

Now the repo party has the amount of cash simultaneously at the same point in time.

The two parties also agree on a reversal of this sales reduction, i.e. the repurchase off the collateral by the cash borrower or the repo party at repo maturity.

And very similar to the deposit case, most repos are actually overnight repos, which means from today to the next business day, we agree the price at which the, you know, collateral will be repurchased tomorrow already today as well.

And usually this agreed upon repurchase price is slightly higher than the price that was received by the repo party to today.

And that difference between, you know, the price today and the repurchase price tomorrow, that reflects the interest rate cost for the borrowed cash amount.

So legally it's really a sale and repurchase in most cases economically, you can think about it as secured lending by the cash provider or in other words, the reverse repo party.

Again, you might have heard someone saying this before, and that is, there's a saying saying everything goes to repo.

And that sort of refers to the fact that repo financing plays a very, very critical role in the financial system.

Now, why is it so important? Why is it so popular? Obviously? Well, first of all, it does allow market participants to access low cost secured financing that can be used to purchase security, so leverage outcomes to my right, or for just servicing purposes. So for example, think of a market maker in government bonds that has just bought a bunch of govvys from clients, and they will probably fund some of these positions, if not all of them in the repo market temporarily.

So they will act as a repo party.

However, market makers do not always act only as repo parties. They might also be on the other side and take the position of a reverse repo party.

And that's happening, for example, after they sold government bonds to a client and they don't have these bonds on the inventory, they didn't have these bonds on the inventory.

So then they effectively short this bond and they might source these bonds in the repo market delivering some cash in return so that they're able to deliver these bonds, to the client that has just bought them.

But it's not only market makers obviously involved in the repo market, but you can see as to why a well-functioning repo market is quite essential for liquid market making in in government bonds.

Other examples, for example are sort of any trader that wants to go short a particular bond and sells them in the spot market needs to deliver them and then of course has to source these bonds in the repo market acting as a reverse repo party in order to be able to deliver those bonds.

And then also we have other parties involved as reverse report parties typically, remember we talked about mutual funds and the likes earlier.

They often use money markets to, you know, invest undeployed cash balances where they're just, you know, redemption repayment reserves and they don't wanna take a large amount of credit risk. They also don't wanna take large amount of market risks.

So then acting or entering into the market as a reverse rate prop party for them makes a lot of sense.

That only as obviously the only downside of those repo markets in this context, and it's obviously that because of the almost risk-free character returns will of course be reasonably look, okay probably the best known repo rate in the world is sulfur, which stands for secured overnight financing rate. And it's a broad measure of the costs of boring cash overnight in a collateralized way, and the collateral being US treasuries, right? And the volume that is sort of used here that's underlying this sulfur fixing that you can see every day gives you a little bit of a flavor of how significant the repo market actually is.

Now, during the period that we're showing here on the chart, the volume of overnight reposts in US treasuries underlying the sofa fixing ranged from about $1.3 trillion to more than $1.6 trillion.

And these are daily transactions, right? That's definitely huge.

And we also have to remember that this only includes repos with US treasury.

So agencies are not included, MBS ABS are not included, corporate bonds are not included.

So the actual size of the repo market will be significantly higher than that.

Good. Now let's move on to money market, benchmark rates.

And SOFR is of course one of them, but there are more, right? So let's have a quick look, at them as well.

And the idea of a benchmark rate really is to allow everybody to have some awareness of where interest rates are within the money market.

So they should be publicly accessible at least, and within certain limits, they should be updated regularly.

And they also should of course, deliver to their promise.

And that is to truly reflect the general level of borrow costs within a specific market.

And this is especially critical as those benchmark rates this is had before, are used in a wide range of financial transactions as a reference rate, mortgages, corporate loans, interest rate derivatives. And when you have loans, for example, linked to those money market rates. And what that means is that they are fluctuating, or the interest cost for the borrower are fluctuating in line with those money market benchmark rates.

Now, there are still two types of interest rate benchmarks that one should be aware of, right? There are the term deposit benchmarks, and we know what a term deposit is, right? It's deposits longer than overnight.

So typically 1 month, 2 months, 3 months, 6 months. And what immediately comes to mind is LIBOR, London Interbank offered right now, we all know LIBOR is no more, right? But there are other IBOR rates, IBOR is a very generic terms, just stands for interbank offered rate that are still being used.

Euribor is one example.

And of course, you know, following the LIBOR scandal, there were significant reviews and we changed the fixing process of Euribor rather significantly to make sure that, you know, this is a robust benchmark representative and, and also reliable.

But it's in the long run probably also gonna be replaced by those new risk rates, IFRS like SOFR, TONAR, ESTR is the European short-term funding rate.

It already exists, but it has yet not completely replaced Euribor.

Now, Euribor used to be the absolute dom, or not Euribor, but LIBOR IBOR rates in general used to be the absolute dominating benchmark rate for money markets.

And in 2017, just again as a little bit of history here is a estimated that around $370 trillion worth of financial instruments were linked to IBOR rates.

But we all know that obviously there were significant issues with LIBOR and IBOR concepts.

And so nowadays, probably the more important type of benchmark that you should be aware of are those overnight rates and overnight rates, as I already explained, transactions from today to the next business day.

This means lending periods are generally very short, right? One day only. And that means that you can expect credit risk on these transactions to generally be relatively low, especially when we're looking at interbank lending.

So it's fairly unlikely that a financial institution that is absolutely financially solid today is not gonna be back in business on Monday, right? Cannot completely rule it out, but it feels rather unlikely that this is gonna be the case.

So, that now means or explains why these rates are usually referred to as the near risk-free rates, or are RFRs I'm gonna skip the next slide simply because it's just showing how IBOR are nowadays fixed using Euribor as an example.

So there have been significant improvements.

But you know, the essence just to remind you, is that IBOR rates have historically been survey-based i.e. we ask participants where they believe they would be able to borrow certain amounts of money for certain times or certain periods at this particular day, which of course, this type of question opened the door to manipulation.

So what we're doing in the RFR space, in the space of risk free rates or near risk free rates, is that we are using what's called the transaction based fixing, right? So, that means instead of asking where do you think you can borrow you know, money today we look at where was money actually borrowed.

So we're taking the actual transactions, which means that the participants in this market will report transactions. So if a bank borrowed let's say $500 million at 5.31% today in US dollars, that will get reported to the relevant calculation agent.

And not just that transaction, but all others of, you know, obviously relevant market participants will get reported and we're calculating a weighted or volume weighted average out of all these reported transactions.

And that weighted volume or volume weighted average is then gonna be published tomorrow, or in this case here because it's Friday on Monday.

Then as sofa fixing that applies for Friday.

At least this is a case in the US dollars.

So this is something that all these risk rates have in common.

They are transaction based.

The other thing they have in common is they're all on overnight transactions, only.

At least the direct fixing differences exist as well, not just in the currency and the publication time and calculation agent, but one thing that is important to be aware of here is that, as we said already, SOFR transactions or SOFR, the sulfur fixing is based on repos that contrast with the other ones on the screen here, SONIA ESTR, and TONAR, which are based on unsecured overnight borrow.

So basically, strictly speaking, SOFR is just a little more risk-free than the other rates on this slide.

Good. And with that, we're almost at the end.

Let's just have a quick look, as I said, at how those risk free rates or near risk rates are linked to central bank rates.

Right now, as you can see on the chart, the IFRS tend to be relatively stable for certain periods of time.

But every now and then they gap higher or low, right? And these larger steps, if you were to draw central bank meeting and decision dates onto this timeline, would for the most part at least coincide with the central bank decisions to hike or cut central bank rates.

So obviously there is a strong, even if it's not a hundred percent perfect, but at least it's very, very strong link between the two, elements here, IE central bank rates and risk rates.

Now, very, very high level explanation of as why this is the case.

Central bank rates can generally be understood as rates that central banks charge regular banks for overnight loads.

At least in most cases it's overnight.

And these can be freely determined by the respective central bank. And of course, the central bank will, you know, to conduct them or in within their monetary policy mandate, decide to hike or to cut those interest rates in order to maybe cool down the economy slightly or stimulate it.

And when the central bank, for example, now raises this, Overnight loan rate borrow money from central banks would become more expensive for banks.

And as the cost increase usually will be passed on to banking clients, this should make loans like mortgages, business loans, et cetera, that are linked.

Add to money market rates more expensive as well.

So we obviously have this strong link between central bank rates and overnight rates.

And so this correlation makes a lot of sense because both are overnight, but it can be, I think it's relatively intuitive that the central bank do not only need to change overnight rates if they wanna slow down or you know, the economy or stimulate it, but they also need to affect longer term rates.

But this connection here, this direct link, if you wish, only exists for this overnight rates.

So how can a central bank then affect longer term rates, 3 months rates, 6 months rates, 12 months, 2 years, 5 years? Well, here we need to understand that to some degree, longer term interest rates can be seen as the expected average of all short-term rates over the time to maturity.

So for example, a 1 month's term deposit rate, if we ignore credit risk and term premium and all those things for simplicity for a moment, they can be interpreted as the expected average overnight rate over the next months.

So what the central bank can do by changing the central bank rate, it can directly affect today's or tomorrow's overnight rate.

But by changing expectations regarding future central bank rates, they can actually change or influence longer term rates.

That happens through expectation management, through conversations, through communication is of course, less direct, therefore less precise tool.

But it sort of hopefully gives you an idea of how this management of longer term rates generally works.

Now, of course, that only works up to a certain point at the curve.

If you really wanna talk 30 year rates lower, then maybe think giving the market a message that you're gonna cut rates, in the next couple of quarters is not really necessarily gonna do the trick, because I don't think that anybody really has a lot of expectation of where overnight rates are gonna be over 30 years time. There's other things like inflation expectations, et cetera, but those sort of rates can also be directly being affected. But that's more through unconventional measures like quantitative easing, for example.

So ladies and gentlemen, that's it from me for today.

Thank you so much for your participation.

I hope you found this useful, last opportunity.

Are there any questions, because we still have three minutes left, so use the q and a function.

If you do have any questions, I'm gonna wait.

Looks like we're good. So thank you so much once again.

Have a great rest of your day. Hope to see you again soon.

Bye for now.