Treasury Finance and Development Banking

Credit and credit risk permeates every corner of the financial world. Previously credit tended to be acknowledged only when dealing with counterparty credit risk, high-yield debt or credit-linked derivatives, now it affects all things, including such fundamental concepts as assessing the present value of a future cash flow. The purpose of this book is to analyze credit from the beginning the point at which any borrowing entity (sovereign, corporate, etc.) decides to raise capital through its treasury operation. To describe the debt management activity, the book presents examples from the development banking world which not only presents a clearer banking structure but in addition sits at the intersection of many topical issues (multi-lateral agencies, quasi-governmental entities, Emerging Markets, shrinking pool of AAA borrowers, etc.). This book covers: Curve construction (instruments, collateralization, discounting, bootstrapping) Credit and fair valuing of loans (modeling, development institutions) Emerging markets and liquidity (liquidity, credit, capital control, development) Bond pricing (credit, illiquid bonds, recovery pricing) Treasury (funding as an asset swap structure, benchmarks for borrowing/investing) Risk and asset liability management (leverage, hedging, funding risk)

Credit and credit risk permeates every corner of the financialworld. Previously credit tended to be acknowledged only whendealing with counterparty credit risk, high-yield debt orcredit-linked derivatives, now it affects all things, includingsuch fundamental concepts as assessing the present value of afuture cash flow. The purpose of this book is to analyze creditfrom the beginning--the point at which any borrowing entity(sovereign, corporate, etc.) decides to raise capital through itstreasury operation. To describe the debt management activity, thebook presents examples from the development banking world which notonly presents a clearer banking structure but in addition sits atthe intersection of many topical issues (multi-lateral agenciesquasi-governmental entities, Emerging Markets, shrinking pool ofAAA borrowers, etc.).This book covers:* Curve construction (instruments, collateralizationdiscounting, bootstrapping)* Credit and fair valuing of loans (modeling, developmentinstitutions)* Emerging markets and liquidity (liquidity, credit, capitalcontrol, development)* Bond pricing (credit, illiquid bonds, recovery pricing)* Treasury (funding as an asset swap structure, benchmarks forborrowing/investing)* Risk and asset liability management (leverage, hedging, fundingrisk)

List of Figures xiiiList of Tables xviiAcknowledgments xixIntroduction xxiI.1 Treasury, Funding, and the Reasons behind This Book xxiI.2 Funding Issues as Credit and Pricing Issues xxiiiI.3 Treasury Finance and Development Banking xxvI.4 The Structure of the Book xxviCHAPTER 1 An Introductory View to Banking, Development Banking, and Treasury 11.1 A Representation of the Capital Flow in a Financial Institution 21.2 Lending 31.3 Borrowing 71.4 Investing and ALM 101.5 The Basic Structure of a Traditional Financial Institution 121.6 Development Banking 17CHAPTER 2 Curve Construction 212.1 What Do We Mean by Curve Construction? 222.2 The Instruments Available for Curve Construction 242.3 Using Multiple Instruments to Build a Curve 372.4 Collateralized Curve Construction 422.5 Numerical Example: Bootstrapping an Interest Rate Curve 55CHAPTER 3 Credit and the Fair Valuing of Loans 673.1 Credit as an Asset Class 673.2 A Brief Overview of Credit Modeling 753.3 Fair Value of Loans and the Special Case of Development Institutions 883.4 Numerical Example: Calculating the Fair Value of a Loan 95CHAPTER 4 Emerging Markets and Liquidity 1014.1 The Definition of Emerging Markets 1014.2 The Main Issues with Emerging Markets 1034.3 Emerging Markets and Development Banking 1164.4 Case Studies of Development Projects 122CHAPTER 5 Bond Pricing 1275.1 What Is a Bond? 1275.2 A Few Fundamental Concepts of the Bond World 1295.3 Expressing Credit Explicitly When Pricing a Bond 1385.4 Illiquid Bonds 1505.5 Numerical Example: Estimating the Coupon of an Emerging Market Debt Instrument 164CHAPTER 6 Treasury Revisited 1716.1 Funding as an Asset Swap Structure 1716.2 Funding Level Targets 1796.3 The Fundamental Differences between Investment Banking and Development Banking 1876.4 Benchmarks for Borrowing and Investing 189CHAPTER 7 Risk and Asset Liability Management 2077.1 The Issue of Leverage 2087.2 Hedging 2107.3 Managing Risk Related to Financial Observables 2247.4 Funding Risk 242CHAPTER 8 Conclusion 2618.1 Credit Is Everywhere 2618.2 The Fundamental Steps to Borrowing, Lending, and Investing: A Summary 263APPENDIX A Implying Zero Rates from FX Forward Quotes 269APPENDIX B CDS Spreads and Default Probabilities 271APPENDIX C Modeling the Credit-Driven Prepayment Option of a Loan 273APPENDIX D The Relation between Macaulay and Modified Durations 275APPENDIX E The Impact of Discounting on an Asset Swap Spread 277APPENDIX F Replication Leading to Risk-Neutral Probabilities 279References 283About the Web Site 289Index 293