US Treasuries- an Overview

An year and a half later, I finally get to publish another post. Below is just a brief overview of US Treasury securities- product, its settlement system and reasons for trading.

Treasury Securities- What are they?

For a beginner, they’re just another type of bonds. In my current world, I don’t deal with the pricing or yield measurement of these beautiful instruments. But reading about them along with material on settlements will do no harm. Since I deal with settlement of all securities that are eligible to settle in Fedwire (yes, not just the US treasury securities), I will explain about the Fedwire, the securities that settle therein and dig further till the shovel can dig.

So, what is the Fedwire all about?

Fedwire is a real-time gross settlement system (RTGS) of the Central Bank money (no brownie for you for guessing it’s the Federal Reserve!) used by Fed Reserve banks in USA to settle securities and final payments in U.S. dollars electronically between its member institutions.

Owned and operated by the 12 Federal Reserve Banks, the Fedwire is a networked system for payment processing between the member banks themselves, or other Fedwire member participants. Members can consist of depository financial institutions in the United States, as well as U.S. branches of certain foreign banks or government groups, provided that they maintain an account with a Federal Reserve Bank.

Now let’s make that simpler still if you wish! Let’s focus on important points to take away from the above that should give you a clearer picture:

1.       Fedwire is a system used to settle securities and also for inter-member payments.

2.       What settles in Fed? - US Treasury bills, notes and bonds (though I am not so sure how many bonds you’d come across!), federal agency securities and Foreign government bonds.

3.       Who can trade in fedwire? – You gotta be a member dude! Now here I need a little elaboration.

Members can consist of depository financial institutions in the United States, as well as U.S. branches of certain foreign banks or government groups, provided that they maintain an account with a Federal Reserve Bank. (FRB- I have a penchant for acronyms!)

Me: Hey, the FRB is the central bank of USA.

You:  Right mate! So by default, a US bank becomes a member and can settle in Fedwire.

Me: What if I am Reserve Bank of India?

You: Well, you will have to open an account with the Federal Reserve directly.

Me: And what If  I am Deutsche Bank Frankfurt?

You: You can open an account with any of the federal reserve bank members (BONY, JP Chase, Northern Trust, State Street etc.). Enough questions! Shoo off!

There’s another key learning above for ya fellas. You may deal, as I mentioned, less with pricing or trading of these beauties and more with their settlement if you ain't a big gun.  So you will often come across Settlement details or SSI like below:

ABA 021000018  Bank of NYC/RAMM                    ABA 0210 Federal Reserve Bank/RBI

ABA 021000021  CHASNYC/CUST/PXXXX              ABA 0210  Northern Trust/TRUST/17-XXXXX

It is important that you understand these minute details pertinent to settlement before you go on to master the securities themselves.

The ABA that you see in every SSI is nothing but the American Bankers Association Number. It is a unique number every bank has.

Me: So one bank can have only one ABA?

You:  Does the word unique mean anything to you? Yes, ONLY one ABA for a bank. So 021000018 is always representative of Bank of NYC. In an Indian context, think of the nine digit MICR number that you see on your cheques.

Me: So why do some banks have accounts with Bank of NYC and Jp Chase instead of directly having an account with Fedwire.

You: Duh! All Central Banks of the world will have direct Fed relations (though you may have an exception. Generally, people prefer to participate through existing members like BONY/CHASE/NTRS. Enough for today!

Now for the real game- We will look at all securities that settle in Fedwire one by one- Security structure,  key features you ought to know and also gyaan on reasons they are traded for, apart from pure profits of course.

US Treasury Securities are direct obligations of the U.S. Govt issued by the Dept. of Treasury, and hence, considered free of credit risk. Now, assuming you have a fair background of fixed income terminology, Treasury securities are either discount or coupon securities.

Me: Discount notes? Fed gives a discount when they sell the notes?

You: Don’t get cheeky! But yes, Fed sells them at a discount to par; say @ $98. The Fed doesn’t pay any interest on these secs.

Me: What? Why buy them? What if its value falls?

You: That’s blasphemous! You are challenging the might of US financial authority! Well, but Fed redeems the securities at par. So technically, you buy at 98 and sell at 100.

Me: Whoa! Not bad! A neat 2% profit!

You: 2.041% approximately-it’s 2/98 remember?! Well, not so important. Just remember disc notes are sold at a discount( though they may trade at a premium to par in the secondary market subsequently) and have no coupons. The Coupon secs obviously pay coupons- twice a year!

The Treasury secs can be bonds/ notes or bills. Bills are the short term secs, notes are medium term and bonds the long term secs. Just some extra gyaan for you: The fed no longer issues long term bonds;  they stopped doing that in October 2001 (This I believe is in the best interest of the financial market as a whole!). You will see Bonds still beng traded, these are the ones issued prior to October 2001.

You will also see Treasury Inflation Indexed/Protected Secs or TIPS- the only difference with the TIPS guys is that their principal is adjusted to account for CPI based Inflation; coupons are paid based on this adjusted principal and finally adjusted principal is paid on redemption.

Why trade These Treasury Secs in the first place?

This should be the first question in one’s mind. What makes these securities even attractive to trade? Every security is traded for broadly two purposes: Risk hedging and Return maximization. You need at least one reason; I’ll give you two! You may recall that Treasury secs have the full faith and backing of the U.S. Govt and hence risk free (People’s Bank of China may beg to differ!). This provides the security with ample liquidity in the secondary market. Apart from making profits on pure cash trades, Treasuries are used as a hedge against other volatile securities.

The trading takes place at the three main trading centres- Tokyo (with the thinnest volume), London and NY (You guessed it! NY has the largest volume of all the three!). Remember, settlement, however, will happen during NY hours, as the Fedwire is an RTGS.

It’s not uncommon to see huge volumes in Treasury securities. There are different reasons for different buyers to delve into the world of Treasury Securities. Locally, the treasury securities are exempt from local and federal taxes. Thus, there is an incentive for domestic banks and FIs to buy the Treasuries. In fact, all countries’ banks generally hold a certain amount of their reserves in the form of Central Bank’s paper.

Me: Why would banks park funds in Treasury paper instead of lending in the market? Treasuries don’t sure provide such good return!

You: You are right! Treasuries are not high return investments as they by nature are liquid and safe. First, Banks need to hold some of their assets in the form of Central Bank Paper (It happens in India too buddy! Just check out RBI website or annual report of any Indian bank). But above that, When fed lowers rate, bank may or may not lend. As of early October 2010, despite the Fed lowering the rate, banks are mopping up Treasury Securities and gold instead of lending to the market. Even the market is hesitant to borrow. So you see Treasuries and Gold both going up; a rarity!

Me: Jahanpanah! Tussi Great ho!

You would find a plethora of Central Banks around the world too buying chunks of US Treasuries. Just a brief detour to help you understand the entire business better. You sure would have heard of Forex Reserves and all the hoopla around it. The stupid media- ET or FT, doesn’t matter!- touts countries with better Forex reserves as macho countries and vice versa, without even an understanding of it!

While Forex reserves are not really a big thing and a country like India having lower Forex Reserves than China is not really a problem as projected by the media, it is another argument altogether. What is important for you to know is what these Central Banks do with the accumulated Forex Reserves. Let us take China-US example (it’s also current and relevant to ongoing debates- free advice hai, lena hai toh lo, varna rehne do J )

Chinese Exporter sells to US Importer. Importer pays in USD for the goods, thus earning "precious" Forex for China. (note that the Chinese Central Bank still has had no role in "creation" of these assets. 

The above leads to extra foreign currency, which if not absorbed by the Chinese Central Bank, The exporter will not be able to make payment to his employees in Yuan Renminbi or the CNY (demand supply economics)

Why am I telling you this?

Because this extra forex mopped up by Chinese Central Bank will be deployed to buy Foreign currency assets: US Treasury Securities, Agency Issues etc. Just an FYI, China and Japan happen to be one of the largest holders of US Treasury securities.

Now you know why Central Banks around the world hold Treasury Securities. Now, for those who love this business, just want to add a point you may have already had an intuition about- If any day, dollar losses increase or the financial world perceive the dollar as a weakening currency and consequently think the US govt may, just may not be able to repay its huge public debt that is sitting on the central bank’s books, they (central banks holding the US Paper) will dump Treasuries and move their capital out of the U.S and move to something else; may be gold, may be silver, maybe Euro Bonds (If Greece is no longer a problem child then ).

We will see more on terminologies surrounding the securities, in particular price quote conventions that scare the hell out of people. Also coming up is How the repo market functions, and how it is used in US Treasuries market. Keep reading Nonsensexrules.blogspot.com

RBI Q3 Press Release-2008-09- Part 1

SIMPLIFYING THE Q-3 PRESS RELEASE OF THE RBI

RBI Q3 Press Release-2008-2009/1164

Despite all initial rejection of any theory on the global crisis impacting India any way, we saw the world's a small place- A disease in one place spreads easily to the other places. In this case, the disease was passed onto the emerging markets by the developed nations. Nonetheless, we know now that no Nation- however big or small is insulated from the turmoils that the world is witnessing. If there is anything that is surprising, it is the magnitude of the impact and the uncertainty over how deep will the sword cut through before it is put back into its sheath!

The RBI has, to begin with, acknowledged that since its Mid year review, the world financial markets have come a long way. It says that while there has been a cyclical moderation in growth, there is scope for further downside as a consequence of the events plaguing the global markets. The repo and Reverse repo were unchanged, but the stock markets had already factored this in and hence did not react much to this news at the time.

• An interesting thing that is worth mentioning is the Govt's announcement of setting up a Special Purpose Vehicle[SPV] to bail out the cash strapped Non Banking Finance Corp [NBFCs].

• The SPV would issue govt guaranteed securities to the RBI. Then it would with these funds buy investment grade products and non convertible debentures of NBFCs, thereby providing them with the the much needed liquidity, but at the same time also ensuring these funds are NOT USED FOR EXPANSION. The below diagram i made should help understand the flow of liquidity.

In recessionary times, liquidity of domestic currency is of prime importance and every country's Central Bank ensures the same is taken care of. Our RBI is obviously not an exception.

• To ensure that banks have sufficient funds, RBI has been reducing the CRR over the past quarter. The CRR or Cash Reserve Ratio is the amount of bank's cash parked with the RBI. Reduction of this ratios naturally frees up the funds for lending, creating a liquid base for the rupee.
• The Repo Rate[rate @ which RBI lends money] was brought down from 9% to 5.5% in just one quarter. The Reverse Repo was brought down from 6%to 4%. What this does is induce banks to borrow more from the RBI as rates are lower, lend more consequently improving the liquidity situation.
• RBI is also allowing banks a special refinance facility without any collateral.
• The Statutory Liquidity Ratio [SLR] is reduced by one percentage point

What does the reduction in SLR hold for us? Well, it is the percentage of deposits that banks must invest in govt or govt approved securities. So, reducing SLR frees up more money for credit deployment.

Whew! I am tired, am sure if u have been reading till here, so are you![ unless u follow Latha Venkatesh on CNBC TV18 or are an avid follower [by force or choice] of government and RBI policies.] I touched upon the steps RBI had taken to ease the domestic liquidity situation.

BUT What has RBI done to manage forex liquidity? What about sector specific credit that is now facing the heat with Capital Markets drying up and NBFCs themselves in deep trouble?

On my next post....

Satyam- Part II

A-Satyam- auditors' insights !!

I happened to meet a friend who works at one of the Big Four [i dun wanna term it Big Three so soon].. So here we were at CCD, and sharing a conversation over hot coffee. I personally thought it to be weird for a guy to discuss finance with a woman at a coffee shop!
Nonetheless, we arrived at the point of Satyam, and I got to know what the auditor circle actually thinks of this whole saga. Here's a bit of that auditor gyaan for you [grab a coffee, u may fall asleep]

" PwC as auditors had to verify every FD receipt as per the regulation. "
Something Mr Vadlamani and Co apparently did not seem to find important while handling the onerous task of fudging the already fudged books.
" Now Raju went and got a FD receipt for a paltry Rs.1000 crore. When auditors ask for it, Lo and Behold! " But wait, did miss something, Raju was riding the Tiger worth 7000crore,right?

"Raju and Co went to the bank,told them -'Oh you know what, we lost our receipt, can u issue a duplicate?'-the bank obliges to the request of a prestigious client. Gives them another receipt. "

This my friends was the second Rs1000 cr. Thats how they turned it into Rs7K Cr.

Question, What did PwC do here? "they did not check for TDS that the banks should have cut on interest earned on every Rs1000 Cr deposit."


Hmmm... with some insight, i bumped into another auditor friend [this guy works for a decent auditing firm, though not exactly of Deloitte or E&Y stature] This time, it was over Beer! And when all job related frustrations were puked out, we returned to some sanity and discussed..of many things...u guessed it...Satyam.
His view : Satyam had cash. So there was no artificial cash as told by my friend from the Big 4.

" They siphoned out money to fund projects in many of their group companies- Maytas included"
Ok but what about the missing cash?
"Satyam jacked up its headcount by almost 13000 employees, imagine where all this money must have been going.. and to show that you had cash, they might have done the needful to forge bank documents too"

The rest, most of us already know- The proposed Maytas deal was, as admitted by Raju, an attempt to plug the hole in the Balance Sheet, as real estate valuations are difficult to arrive at.

When Enron Collapsed, Arthur Anderson became a thing of the past too. The Big Five became Big Four. But soon after, we learnt of the Worldcom scandal. Maybe I am one of the sceptics, but I am keeping my fingers crossed- The Satyam PwC saga may unleash bigger names. Rumour has it that Reliance may be in the news for all the wrong reasons pretty soon.

Like David Fleischer at Goldman Sachs asked post Enron bankruptcy, I ask "What's next?"

A-Satyam....Raju's Vanishing Cash ka Jaadu!

The Satyam Saga : Flash Back and Now!!
If I say I am going to give you the complete Satyam saga, give you a blow- by- blow account of what Ramalinga Raju did, you better don't believe me!

The image here is Raju playing Holi @ Satyam, Perhaps, he was preparing for "Hands Up" for a long time before anyone could catch him "red-handed" !

Satyam stock plunges..Andhra Cm says he's not responsible for Raju's Rise..Satyam's 6.55 acre land being handed over to Indian Navy..

This is not what I am going to expound on- This is something that's already in the news. After all, it is the most "googled" thing today, greater than even Obama!
Just to bring forward a few interesting facts i got :

1. Satyam's website has some interesting write up on compliance : "Compliance isn’t just about reporting, or data management, or training, or having the right technologies; it’s all of these together. The overarching intent of all of these compliance programs is to help enterprises address four key areas: information integrity, process integrity, controlled access to information, and secure information retention" Hehe... Information integrity.. secure information retention..hehe, to think of all the institutional investors close to satyam and the top management who sold shares days before Raju's infamous acceptance of fraud. By the way, that image is from Satyam website : it says : SATYAM'S EXECUTION : Ordinary people doing extraordinary Things! ..ahem..well..
2. Five Years back, at the time of US elections, Ramalinga Raju was thought to be the most feared man, greater than Osama! Today, again, Raju is feared to unveil more dirty news of untruth! For the uninitiated, let me give you a gist : Satyam reported a 28% jump in Q2 profit in 2004."It's not that they're doing anything better than competitors like [Montreal-based CGI Group Inc.]," said Forrester Research analyst John McCarthy. "They're just doing it with a different cost structure." For your information, John McCarthy is a VP at Forrester. perhaps, McCarthy was referring to false cost structure and inflated profits! Check this out http://www.indiadaily.com/editorial/11-01k-04.asp
   
3. Today, the same McCarthy states that any investor would be nervous about how much Satyam's books have been fiddled with! Well, the period when Satyam was praised for its cost structure was also included in its "fraudulent era". Did McCarthy not really examine satyam's books thoroughly before lauding its cost structure? Agreed, cooked books that even the auditor PwC "could not" trace are difficult for an analyst to identify. But these very people claim to be the best in business, so whom do we look upto now? Even before the Raju admittance, here came a Forrester research view : http://www.forrester.com/Research/Document/Excerpt/0,7211,48121,00.html
   
4. To think of it, Satyam is the very company that received the pretigious Frost & Sullivan Excellence in Leadership Award for 2008. People appreciated Satyam's Corporate Social Governance at the time. The defamed company's CSR has gone for a toss.

Well.. Let me add my disclaimer, I have no personal stake whatsoever in Satyam or any of its associated companies [read Maytas]. Which is why, perhaps, my tone is a bit mellowed down..
More on Satyam and the IT industry..soon to come!!!

Apple's Cook gets Jobs' Job

Jobs is away from Job @ Apple again..This time for a tad bit longer...and worries loom large over whether his hiatus will mark his return to business at all.
His cancerous tumour has been giving him trouble for quite some time now, only now he thinks it has become more complex. Speculation is rife that this time around, he may not return to his top job as CEO. In the interim, COO Tim Cook, the master of Apple's operational minutiae will step into Jobs shoes. What does this mean for pioneer company?
Sure, Jobs was kicked out of his job early in his career [he was just 30, 10 years after he jointly founded Apple]. But the company survived. Jobs with his famous "Stay Hungry, Stay Foolish" attitude battled this phase, and came to the rescue via the NeXt acquisition to the Apple Inc Board and lead the i Mac, i Pod revolution. as many people put it, if Apple's design is taken care of by Jonathan Ive, the vision that drive Apple and propels it ahead is that of Mr. Jobs.

Check out this link that has one if is famous speeches made at Stanford University
http://news-service.stanford.edu/news/2005/june15/jobs-061505.html

Post Mortem report for the economy : by the G-30

The financial turmoil began with the collapse of Bear Stearns, bolstered by the Lehman Fall and the humbling of AIG and Merrill Lynch. What next? The panel of economic doctors are here to tell the world- how these giants died, what was the cause of the disease, and how do you prevent the next gen from being infected!

Yes, the G-30 team, which includes Paul Volcker, former Fed chairman and economic adviser to the president elect Barrack Obama, Euro Central Bank Chief Jean-Claude Trichet, Larry Summers..and so on. Surprising why all the great names speak up only after a crisis, why not hen they were at the helm of things or when their "opinions" could have really averted disasters.

Nonetheless, let me sum up the G-30 report to fix the financial markets in brief for you.

• Banks to have stricter capital requirements
• Banks to be under Central Bank's glare for proprietary trading activities
• Conditions similar to the Glass Steagall Act that was repealed in 1999
• Hedge Funds may have to reports to a regulator, may be subject to stringent capital and liquidity requirements
• OTC Derivative contracts may be subject to proper regulation

All In all, they have woken up to a new reality. Or may i say they are presenting to the world a probable new reality in the wake of dismal financial performance by many industries. This looks good, and would probably hold good, till the next big fall and another post mortem report holds out that all that was valid till date was grossly inaccurate and always demanded change.

Snip Snap- Companies get a Haircut

p headlines
Its snip- snap time...the companies have got themselves Edward scissor hands- they are all aggressively cutting either jobs, man hours, pay or even businesses.

With the recent financial turmoil putting in a lot of insecurity into every average employed household- especially the BSFI[ Banking Financial and Insurance] sector and Tech sectors. We are not asking if there are appraisals happening- we rather ask each other if the other still has a job.

No wonder then that my friend who didn't contemplate further studies after 6 years of work ex decided to take the CAT this year.

Here are some of the shocking news that reflects the business scenario :

• The best and the craziest of all- Air India(AI) is not cutting jobs, but is offering leave without pay for 3-5 years.Oh! isn't that good? so considerate! Not removing the employees form the pay rolls, just not paying them for 3-5 years, asking them to go on a forced leave. Hats off to you Raghu Menon- CMD,AI.
• Tata Yazaki- manufacturer of wire harnesses for auto industry- says no electricity in its company after 06pm- OOps!.. Dark days ahead fo the employees- I am sure the management would fend this off saying- "its an eco friendly decision" [hmm...]
• The tops execs at ThyssenKrupp and Kirloskar no longer would travel by Business class, in fact, Kirloskars went a step further and shun the practice of using luxury cars like the Mercs for travel- The top brass may have to be content with an Indica!! Perhaps the Three wheelers and bicycles would be the next viable option.
• Citi's Vikram Pandit announced that the company would cut 52000 jobs across the globe to get a leaner look- However, speculation is rife that Pandit himself may not be able to hold on to the job for long.

Even as i write, the Sensex is down 88 points, eroding all of Friday's gains. Readying for darker days ahead..