The Money Market

The money market is a market in which the cash requirements of market participants who are long cash are met along with the requirements of those that are short cash. This is identical to any financial market; the distinguishing factor of the money market is that it provides for only short-term cash requirements. The market will always, without fail, be required because the needs of long cash and short cash market participants are never completely synchronized. The participants in the market are many and varied, and large numbers of them are both borrowers and lenders at the same time. They include:
■ the sovereign authority, including the central government (“Treasury”), as well as government agencies and the central bank or reserve bank;
■ financial institutions such as the large integrated investment banks, commercial banks, mortgage institutions, insurance companies, and finance companies;
■ corporations of all types;
■ individual private investors, such as high net-worth individuals and small savers;
■ intermediaries such as money brokers, banking institutions, etc.;
■ infrastructure of the marketplace, such as derivatives exchanges.
A money market exists in virtually every country in the world, and all such markets exhibit the characteristics we describe in this book to some extent. For instance, they provide a means by which the conflicting needs of borrowers and lenders can achieve equilibrium, they act as a conduit for financing of all maturities between one day and one year, and they can be accessed by individuals, corporations, and governments alike.
In addition to national domestic markets, there is the international cross-border market illustrated by the trade in Eurocurrencies. Of course, there are distinctions between individual country markets, and financial market culture will differ. For instance, the prevailing financial culture in the United States and United Kingdom is based on a secondary market in tradable financial assets, so we have a developed and liquid bond and equity market in these economies. While such an arrangement also exists in virtually all other countries, the culture in certain economies such as Japan and (to a lesser extent) Germany is based more on banking relationships, with banks providing a large proportion of corporate finance. The differences across countries are not touched upon in this book; rather, it is the similarities in the type of instruments used that is highlighted.

The Big Ben Strategy

Big Ben is a currency-specific trading strategy designed to capture the first directional intraday move that often occurs within the first few hours after the Frankfurt/London market openings, which begin at approximately 1 a.m. ET.
The strategy works best with the British pound/U.S. dollar (GBP/USD) rate.
Because this currency rate trades lightly outside of London trading hours, the surge in trading every morning in the U.K. gives it a “real” market opening, which the strategy looks to exploit. Figure 1 shows pound/dollar trading is virtually nonexistent during Asian trading hours. When London opens, however, the pound/dollar accounts for nearly one-quarter of all forex trading. Currency rates with more continuous, 24-hour trading will have less of a distinct open/close as they pass through the different money centers.
For example, the dollar/yen rate (USD/JPY), which dominates forex activity during Asian trading hours (78 percent of volume), still accounts for 17 percent of trading during European hours.
Before explaining the specific logic behind the methodology, let’s take a look at what needs to occur for a trade to set up.
The rules
The following rules are for short trades, but the strategy can be reversed to trade on the long side.
Setup:
1. The pair makes a new range low at least 25 pips (a pip is the forex equivalent of a tick, or minimum price fluctuation) below the opening price after the early Frankfurt/London trading in the GBP/USD rate begins around 1 a.m. ET.
2. The pair then reverses and trades 25 pips or more above the opening price.
3. The pair then reverses once again to trade back below the intraday low established in step 1.
4. Sell a breakout (at least seven pips)
below the London low.
5. Once filled, place an initial protective stop no more than 40 pips above the entry price.
6. After the market moves lower by the distance between the entry price and the stop, cover half the position and trail a stop on the remainder.
These simple rules position you to profit from common behavior that can occur in the pound/dollar when the London/European market opens.

ALM

The activity of commercial and investment banks in the money market centers around what is termed asset and liability management of the main banking book. This book (also known as the liquidity book) is comprised of the net position of the bank’s deposits and loans as well as other short-term, high-quality debt instruments (e.g., certificates of deposit, Treasury bills, etc.). The major players in the money markets must manage their exposure to the risk of adverse movements in interest rates as part of their daily operations in these markets. Accordingly, an understanding of asset and liability management, as a branch of banking risk management, is essential for a full understanding of the money markets as a whole.
In this chapter we present an introduction to asset and liability management.
Asset and liability management (ALM) is the term covering tools and techniques used by a bank to minimize exposure to market risk and liquidity risk while achieving its profit objectives, through holding the optimum combination of assets and liabilities. In the context of a banking book, in theory pure ALM would attempt to match precisely the timing and value of cash inflows of assets with the cash outflows of liabilities.
Given the nature of a bank’s activities, however, this would be difficult, if not impossible, to structure. Moreover, it would be expensive in terms of capital and opportunities foregone. For this reason a number of other approaches are followed to manage the risks of the banking book in a way that maximizes potential revenue. ALM also covers banking procedures dealing with balance sheet structure, funding policy, regulatory and capital issues, and profit target; we do not discuss these facets of ALM here. The aspect of ALM we are interested in is that dealing with policy on liquidity and interest-rate risk, and how these are hedged. In essence the ALM policy of a commercial bank will be to keep this risk at an acceptable level, given the institution’s appetite for risk and expectations of future interest rate levels. Liquidity and interest-rate risk are interdependent issues, although the risks they represent are distinct.