Currency overlay

Jayati WALIA

In this article, Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) explains currency overlay which is a mechanism to effectively manage currency risk in asset portfolios.

Overview

Currency risk, also known as exchange-rate risk, forex exchange or FX risk, is a kind of market risk that is caused by the fluctuations in currency exchange rates.

Both individual and institutional investors are diversifying their portfolios through assets in international financial markets, but by doing so they also introduce currency risk in their portfolios.

Consider an investor in the US who decides to invest in the French equity market (say in the CAC 40 index). The investor is now exposed to currency risk due to the movements in EURUSD exchange rate. You can download the Excel file below which illustrates the impact of the EURUSD exchange rate on the overall performance of the investor’s portfolio.

Download the Excel file to illustrate the impact of currency risk on portfolio

This exercise demonstrates the importance of currency risk in managing an equity portfolio with assets dominated in foreign currencies. We can observe that over a one-month time-period (July 19 – August 19, 2022), the annual volatility of the American investor’s portfolio with FX risk included is 12.96%. On the other hand, if he hedges the FX risk (using a currency overlay strategy), the annual volatility of his portfolio is reduced to 10.45%. Thus, the net gain (or loss) on the portfolio is significantly reliant on the EURUSD exchange-rate.

Figure 1 below represents the hedged an unhedged returns on the CAC 40 index. The difference between the two returns illustrates the currency risk for an unhedged position of an investor in the US on a foreign equity market (the French equity market represented by the CAC 40 index.

Figure 1 Hedged and unhedged returns for a position on the CAC 40 index.
Hedged an unhedged return Source : computation by the author.

Currency overlay is a strategy that is implemented to manage currency exposures by hedging against foreign exchange risk. Currency overlay is typically used by institutional investors like big corporates, asset managers, pension funds, mutual funds, etc. For such investors exchange-rate risk is indeed a concern. Note that institutional investors often outsource the implementation of currency overlays to specialist financial firms (called “overlay managers”) with strong expertise in foreign exchange risk. The asset allocation and the foreign exchange risk management are then separated and done by two different persons (and entities), e.g., the asset manager and the overlay manager. This organization explains the origin of the world “overlay” as the foreign exchange risk management is a distinct layer in the management of the fund.

Overlay managers make use of derivatives like currency forwards, currency swaps, futures and options. The main idea is to offset the currency exposure embedded in the portfolio assets and providing hedged returns from the international securities. The implementation can include hedging all or a proportion of the currency exposure. Currency overlay strategies can be passive or active depending on portfolio-specific objectives, risk-appetite of investors and currency movement viewpoint.

Types of currency overlay strategies

Active currency overlay

Active currency overlay focuses on not just hedging the currency exposure, but also profiting additionally from exchange-rate movements. Investors keeps a part of their portfolio unhedged and take up speculative positions based on their viewpoint regarding the currency trends.

Passive currency overlay

A passive overlay focuses only on hedging the currency exposure to mitigate exchange-rate risk. Passive overlay is implemented through derivative contracts like currency forwards which are used to lock-in a specific exchange-rate for a fixed time-period, thus providing stability to asset values and protection against exchange-rate fluctuations.

Passive overlay is a simple strategy to implement and generally uses standardized contracts, however, it also eliminates the scope of generating any additional profits for the portfolio through exchange-rate fluctuations.

Implementing currency overlays

Base currency and benchmark

Base currency is generally the currency in which the portfolio is dominated or the investor’s domestic currency. A meaningful benchmark selection is also essential to analyze the performance and assess risk of the overlay. World market indices such as those published by MSCI, FTSE, S&P, etc. can be appropriate choices.

Hedge ratio

Establishing a strategic hedge ratio is a fundamental step in implementing a currency overlay strategy. It is the ratio of targeted exposure to be currency hedged by the overlay against the overall portfolio position. Different hedge ratios can have different impact on the portfolio returns and determining the optimal hedge ratio can depend on various factors such as investor risk-appetite and objectives, portfolio assets, benchmark selection, time horizon for hedging etc.

Cost of overlay

The focus of overlays is to hedge the fluctuations in foreign exchange rates by generating cashflows to offset the foreign exchange rate movements through derivatives like currency forwards, currency swaps, futures and options. The use of these derivatives products generates additional costs that impacts the overall performance of the portfolio strategy. These costs must be compared to the benefits of portfolio volatility reduction coming from the overlay implementation.

This cost is also an essential factor in the selection of the hedge ratio.

Note that passive overlays are generally cheaper than active overlays in terms of implementation costs.

Useful resources

Academic articles

Black, F. (1989) Optimising Currency Risk and Reward in International Equity Portfolios. Financial Analysts Journal, 45, 16-22.

Business material

Pensions and Lifetime Savings Association Currency overlay: why and how? video.

Related posts on the SimTrade blog

   ▶ Walia J. Credit risk

   ▶ Walia J. Fixed income products

   ▶ Walia J. Plain Vanilla Options

   ▶ Gupta A. Currency swaps

About the author

The article was written in September 2022 by Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

Posted in Contributors, Financial techniques | Tagged , , , , | Leave a comment

Reverse Convertibles

Reverse Convertibles

Shengyu ZHENG

In this article, Shengyu ZHENG (ESSEC Business School, Grande Ecole – Master in Management, 2020-2023) explains reverse convertibles, which are a structured product with a fixed-rate coupon and downside risk.

Introduction

The financial market has been ever evolving, witnessing the birth and flourish of novel financial instruments to cater to the diverse needs of market participants. On top of plain vanilla derivative products, there are exotic ones (e.g., barrier options, the simplest and most traded exotic derivative product). Even more complex, there are structured products, which are essentially the combination of vanilla or exotic equity instruments and fixed income instruments.

Amongst the structured products, reverse convertible products are one of the most popular choices for investors. Reverse convertible products are non-principal protected products linked to the performance of an underlying asset, usually an individual stock or an index, or a basket of them. Clients can enter into a position of a reverse convertible with the over-the-counter (OTC) trading desks in major investment banks.

In exchange for an above-market coupon payment, the holder of the product gives up the potential upside exposure to the underlying asset. The exposure to the downside risks still remains. Reserve convertibles are therefore appreciated by the investors who are anticipating a stagnation or a slightly upward market trend.

Construction of a reverse convertible

This product could be decomposed in two parts:

  • On the one hand, the buyer of the structure receives coupons on the principal invested and this could be considered as a “coupon bond”;
  • On the other hand, the investor is still exposed to the downside risks of the underlying asset and foregoes the upside gains, and this could be achieved by a short position of a put option (either a vanilla put option or a down-and-in barrier put option).

Positions of the parties of the transaction

A reverse convertible involves two parties in the transaction: a market maker (investment bank) and an investor (client). Table 1 below describes the positions of the two parties at different time of the life cycle of the product.

Table 1. Positions of the parties of a reverse convertible transaction

t Market Maker (Investment Bank) Investor (Client)
Beginning
  • Enters into a long position of a put (either a vanilla put or a down-and-in barrier put)
  • Receives the nominal amount for the “coupon” part
  • Invests in the amount (nominal amount plus the premium of the put) in risk-free instruments
  • Enters into a short position of a put (either a vanilla put or a down-and-in barrier put)
  • Pays the nominal amount for the “coupon” part
Interim
  • Pays pre-specified interim coupons in respective interim coupon payment dates (if any)
  • Receives interest payment from risk-free investments
  • Receives the pre-specified interim coupons in respective interim coupon payment dates (if any)
End
  • Receives the payoff (if any) of the put option component
  • Pays the pre-specified final coupon in the final coupon payment date
  • Pays the payoff (if any) of the put option component
  • Receives the pre-specified final coupon in the final coupon payment date

Based on the type of the put option incorporated in the product (either plain vanilla put option or down-and-in barrier put option), reserve convertibles could be categorized as plain or barrier reverse convertibles. Given the difference in terms of the composition of the structured product, the payoff and pricing mechanisms diverge as well.

Here is an example of a plain reverse convertible with following product characteristics and market information.

Product characteristics:

  • Investment amount: USD 1,000,000.00
  • Underlying asset: S&P 500 index (Bloomberg Code: SPX Index)
  • Investment period: from August 12, 2022 to November 12, 2022 (3 months)
  • Coupon rate: 2.50% (quarterly)
  • Strike level : 100.00% of the initial level

Market data:

  • Current risk-free rate: 2.00% (annualized)
  • Volatility of the S&P 500 index: 13.00% (annualized)

Payoff of a plain reverse convertible

As is presented above, a reverse convertible is essentially a combination of a short position of a put option and a long position of a coupon bond. In case of the plain reverse convertible product with the aforementioned characteristics, we have the blow payoff structure:

  • in case of a rise of the S&P 500 index during the investment period, the return for the reverse convertible remains at 2.50% (the coupon rate);
  • in case of a drop of the S&P 500 index during the investment period, the return would be equal to 2.50% minus the percentage drop of the underlying asset and it could be negative if the percentage drop is greater than 2.5%.

Figure 1. The payoff of a plain reverse convertible on the S&P 500 index
Payoff of a plain reverse convertible
Source: Computation by author.

Pricing of a plain reverse convertible

Since a reverse convertible is essentially a structured product composed of a put option and a coupon bond, the pricing of this product could also be decomposed into these two parts. In terms of the pricing a vanilla option, the Black–Scholes–Merton model could do the trick (see Black-Scholes-Merton option pricing model) and in terms of pricing a barrier option, two methods, analytical formula method and Monte-Carlo simulation method, could be of help (see Pricing barrier options with analytical formulas; Pricing barrier options with simulations and sensitivity analysis with Greeks).

With the given parameters, we can calculate, as follows, the margin for the bank with respect to this product. The calculated margin could be considered as the theoretical price of this product.

Table 2. Margin for the bank for the plain reverse convertible
Margin for the bank for the plain reverse convertible
Source: Computation by author.

Download the Excel file to analyze reverse convertibles

You can find below an Excel file to analyze reverse convertibles.
Download Excel file to analyze reverse convertibles

Why should I be interested in this post

As one of the most traded structured products, reverse convertibles have been an important instrument used to secure return amid mildly negative market prospect. It is, therefore, helpful to understand the product elements, such as the construction and the payoff of the product and the targeted clients. This could act as a steppingstone to financial product engineering and risk management.

Resources

Academic references

Broadie, M., Glasserman P., Kou S. (1997) A Continuity Correction for Discrete Barrier Option. Mathematical Finance, 7:325-349.

De Bellefroid, M. (2017) Chapter 13 (Barrier) Reverse Convertibles. The Derivatives Academy. Accessible at https://bookdown.org/maxime_debellefroid/MyBook/barrier-reverse-convertibles.html

Haug, E. (1997) The Complete Guide to Option Pricing. London/New York: McGraw-Hill.

Hull, J. (2006) Options, Futures, and Other Derivatives. Upper Saddle River, N.J: Pearson/Prentice Hall.

Merton, R. (1973). Theory of Rational Option Pricing. The Bell Journal of Economics and Management Science, 4:141-183.

Paixao, T. (2012) A Guide to Structured Products – Reverse Convertible on S&P500

Reiner, E. S. (1991) Breaking down the barriers. Risk Magazine, 4(8), 28–35.

Rich, D.R. (1994) The Mathematical Foundations of Barrier Option-Pricing Theory. Advances in Futures and Options Research: A Research Annual, 7, 267-311.

Business references

Six Structured Products. (2022). Reverse Convertibles et barrier reverse Convertibles

Related posts on the SimTrade blog

   ▶ All posts about options

   ▶ Walia J. Black-Scholes-Merton option pricing model

   ▶ Gupta A. The Black Scholes Merton Model

   ▶ Zheng S. Barrier options

   ▶ Zheng S. Pricing barrier options with analytical formulas

   ▶ Zheng S. Pricing barrier options with simulations and sensitivity analysis with Greeks

About the author

The article was written in August 2022 by Shengyu ZHENG (ESSEC Business School, Grande Ecole – Master in Management, 2020-2023).

Posted in Contributors, Financial techniques | Tagged , , , | Leave a comment

Macro Funds

Macro Funds

Akshit Gupta

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) explains marco funds which is a type of hedge fund based on the analysis of macroeconomic or political events.

Introduction

Macro funds, also known as global macro funds, are actively managed alternative investment vehicles (hedge funds) whose strategy profits from the broad market movements caused by macroeconomic (economic, fiscal and monetary) or geopolitical events. These funds typically invest in asset classes including equity, fixed income, currencies, and commodities. They invest in both the spot and derivatives markets. They use a mix of long and short positions in these asset classes to implement their market views to achieve superior returns (higher than a given benchmark).

Some key elements impacting the decisions taken by macro funds include:

  • Economic factors – Macro funds constantly monitor the economic data across different countries including interest rates, inflation rates, GDP growth, unemployment rates and industrial/retail growth rates to make investment decisions.
  • Mispricing – Macro funds try to arbitrage markets based on perceived mispricing.
  • Political situations – The political situations in different countries also play a major role in the investment decisions made by macro funds as unstable political situations can lead to low investor confidence and thus cause a decline in the financial markets.

Benefits of a macro funds

Like other types of hedge funds, macro funds aim at providing their clients (investors) with investments managed in an efficient manner to optimize expected returns and risk. Such funds are especially expected to diversify the clients’ portfolios. So, macro funds are often acknowledged as the alternative funds in the industry.

Other characteristics of macro funds

Other characteristics of macro funds (clients, fee structure, investment constraints) are similar to other types of hedge funds (see the posts Introduction to Hedge Funds and Hedge Funds).

Examples of macro funds strategies

A commonly used asset class in macro fund strategy includes currencies. Their exchange rates are affected by several factors including monetary and fiscal policies, economic factors like GDP growth and inflation and geopolitical situation. Black Wednesday is an example of an infamous event, where we can understand the different factors and use of macro fund strategies.

Black Wednesday

During the 1970s, an European Exchange Rate Mechanism (ERM) was set up to reduce exchange rate variability and stabilize the monetary policies across the continent. Also, a stage was being set to introduce a unified common currency named Euro. The United Kingdom joined ERM in 1990 due to political instability in the country raising fears of higher currency fluctuations.

The pound sterling shadowed the German mark but owing to challenges faced by Britain at that point in time, including lower interest rates, higher inflation rates and an unstable economy, the currency traders weren’t satisfied with the decision.

Seeing the economic situation, George Soros, one of the most famous investors, used the macro fund strategy during 1992 when he took a short position in the pound sterling for $10 billion and made a $1 billion profit from his position.

Useful resources

Academic resources

Pedersen, L. H., 2015. Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined. Princeton University Press, Chapter 11, Global macro Investing.

Business resources

JP. Morgan Asset Management

DeChesare Brian “Global Macro Hedge Funds: Living in an FX Traders’ Paradise?”

Related Posts

   ▶ Gupta A. Asset management firms

   ▶ Gupta A. Hedge Funds

   ▶ Louraoui Y. Introduction to Hedge Funds

   ▶ Gupta A. Portrait of George Soros: A famous investor

About the author

Article written in August 2022 by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

Posted in Contributors, Financial techniques | Tagged , , , | Leave a comment

Initial and maintenance margins in stocks

Initial and maintenance margins in stocks

Akshit Gupta

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) explains the mechanisms of initial and maintenance margin used in stocks.

Introduction

In financial markets, margin requirements are present in leveraged positions in stock trading. They refer to a percentage of assets that an investor must put aside with his or her own cash or assets (collateral) as a means of protection against the risk exposure to its potential default for the other counterpart.

Margin requirements serve as a guarantee that the investor providing the margins will fulfill its trade obligations. Many exchanges across the world provide leverage facilities to investors for trading in different assets. For example, an investor can use leverage facilities for trading in equities, bonds, exchange rates, commodities, etc. It usually takes the form of derivatives contracts like futures and options. Whenever an investor buys or sells stocks using leverage, it is called buying or selling on margin.

Margin requirements can be categorized as initial and maintenance margin requirements.

Initial margin

Initial margin (or IM) refers to the initial deposit required when an investor opens a position in an underlying asset and amounts to a percentage of the nominal contract value. The amount for the initial margin requirement is calculated in accordance with approved margin models that are based on the market’s regulatory rules. The determination of the initial margin requirement is essentially based on the volatility of the asset being covered. The more volatile the asset, the higher the initial margin requirement.

You can download below the file to learn about the different initial margin requirements at Euronext Clearing used in stock trading (PDF document).

Maintenance margin

When an investor holds an underlying asset on margin, she is required to maintain a minimum margin amount of that asset position in her portfolio to keep her position open and this is known as the maintenance margin. Maintenance margin requirements aim to protect against excess losses and ensure the broker has enough capital to cover any losses the investor may incur. In case the investor is unable to fulfill the maintenance margin requirements, she receives a margin call initiated from the broker to deposit a further amount in order to keep her position open. If she fails to provide adequate maintenance margins, the broker has the power to close her position.

Mechanism of initial and maintenance margins

Now, we will see how initial and maintenance margins work in the financial markets with the concept of short selling used in equity trading. Since the short sell involves borrowing stock, the investor is required by its broker to post an initial margin at the time the trade is initiated. For instance, this initial margin is set to 50% of the value of the short sale. This money is essentially the collateral on the short sale to protect the lender of the stocks in the future against the default of the borrower (the investor).

Followed by this, a maintenance margin is required at any point of time after the trade is initiated. The maintenance is taken as 30% of the total value of the position. The short seller has to ensure that any time the position falls below this maintenance margin requirement, he will get a margin call and has to increase funds into the margin account.

Example

Here is an example of a typical case of short selling and its margin mechanism:

 Margin call on stocks

You can download below the Excel file for the computation of the Intial and Maintenance Margins for the stocks.

Download the Excel file to compute the initial and maintenance margins on stocks

Useful resources

Euronext Clearing

Maintenance margin

Initial Margin

Financial Industry Regulatory Authority (FINRA)

Related posts

   ▶ Gupta A. Initial and Maintenance margin in futures contracts

   ▶ Gupta A. Analysis of the Big Short movie

   ▶ Gupta A.Analysis of the Margin call movie

   ▶ Gupta A. Analysis of the Trading places movie

About the author

Article written in August 2022 by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

Posted in Financial techniques, SimTrade | Tagged , , , | Leave a comment

Initial and maintenance margins in futures contracts

Initial and maintenance margins in futures contracts

Akshit Gupta

This article written by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) explains the mechanisms of initial and maintenance margin used in futures contracts.

Introduction

In financial markets, margin requirements are present in leveraged positions in derivative products. They refer to a percentage of assets that an investor must pay for with his or her own cash or assets (collateral) as a means of protection against the risk exposure to its potential default for the other counterpart.

Margin requirements serve as a guarantee that the investor providing the margins will fulfil its trade obligations. Many exchanges across the world provide leverage facilities to investors for trading in different derivative assets. For example, an investor can use leverage facilities for trading in futures contracts across different asset classes like equities, bonds, currencies, interest rates, etc.

Margin requirements can be categorized as initial and maintenance margin requirements.

Initial margin

Initial margin (or IM) refers to the initial deposit required when an investor opens a position in a derivative product and amounts to a percentage of the nominal contract value. The amount for initial margin requirement is calculated in accordance with approved margin models that are based on the market’s regulatory rules. The determination of the initial margin requirement is essentially based on the volatility of the underlying asset of the derivative product being covered. The more volatile the underlying asset, the higher the initial margin requirement.

You can download below the file to learn about the different Euronext Clearing margin requirements used in derivatives trading.

Maintenance margin

When an investor holds an underlying asset on margin, she is required to maintain a minimum margin amount of that asset position in her portfolio to keep her position open and this is known as the maintenance margin. Maintenance margin requirements aim to protect against excess losses and ensures the broker has enough capital to cover any losses the investor may incur. Maintenance margin is generally calculated on a daily mark-to-market basis between the period starting from the trading date to the contract expiration date.

In case the investor is unable to fulfil the maintenance margin requirements, she receives a margin call initiated from the broker to deposit further amount in order to keep her position open. If she fails to provide adequate maintenance margins, the broker has the power to close her positions.

Mechanism of initial and maintenance margins

Now, we will see how initial and maintenance margins work in the financial markets using S&P 500 mini futures contract. Since the investor has bought the futures contract, he/she is required by its broker to post an initial margin at the time the trade is initiated. For instance, this initial margin is set to 40% of the nominal value of the contract. This money is essentially the collateral on the purchase to protect the seller of the contract in the future against the default of the buyer (the investor).

Followed by this, a maintenance margin is required at any point of time after the trade is initiated. The maintenance margin call is triggered when the value of the initial margin falls below the 30% threshold (i.e. 70% of the initial margin). The buyer has to ensure that any time the position falls below this maintenance margin requirements, he will get a margin call and has to increase funds into the margin account.

Example with initial margin

Here is an example of a typical case of buying a futures contract and its margin mechanism:

The characteristics of the contract and market data include:

 Margin call on futures

 Margin call on long futures

The final value of the investor’s brokerage account is equal to $253,000. At the end of the contract, the investor can get back its initial margin of $158,000 leaving $95,000 on its account. The gain is equal to $10,000 which is the amount left on the account ($95,000) minus the sum of the margin calls ($85,000).

Here is an example of a typical case of selling a futures contract and its margin mechanism using the same characteristics and market data:

 Margin call on short futures

The final value of the investor’s brokerage account is equal to $178,000. At the end of the contract, the investor can get back its initial margin of $158,000 leaving $20,000 on its account. The loss is equal to $10,000 which is the amount left on the account ($20,000) minus the sum of the margin calls ($30,000).

You can download below the Excel file for the computation of the Intial and Maintenance Margins for the futures contracts.

Download the Excel file to compute the initial margins for futures

Useful resources

Maintenance margin

Initial Margin

Financial Industry Regulatory Authority (FINRA)

Longin F. Margin Call mechanism for a futures contract

Related posts

   ▶ Gupta A.Initial and Maintenance margin in stocks

   ▶ Gupta A. Analysis of the Big Short movie

   ▶ Gupta A.Analysis of the Margin call movie

   ▶ Gupta A. Analysis of the Trading places movie

About the author

Article written in August 2022 by Akshit GUPTA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

Posted in Financial techniques, SimTrade | Tagged , , | Leave a comment

My experience as a credit analyst at Amundi Asset Management

Jayati WALIA

In this article, Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) shares her apprenticeship experience as an assistant credit analyst in Amundi which is a leading European asset management firm.

About Amundi

Amundi is a French asset management firm with currently over €2 trillion asset under management (AUM). It ranks among the top 15 asset managers in the world (see Table 1 below). Amundi is a public company quoted on Euronext with the highest market capitalization in Europe among asset management firms (€10.92 billion as of May 20, 2022). Amundi was founded in 2010 following a merger between Crédit Agricole Asset management and Société Générale Asset management.

Table 1. Rank of asset management firms by asset under management (AUM).
Top asset management firms rankings Source: www.advratings.com

Amundi has over 100 million clients (retail, institutional and corporate) and it offers a range of savings and investment solutions, services, advice, and technology in active and passive management, in both traditional and real assets.

Amundi logo Source: Amundi

My apprenticeship

My team at Amundi, Fixed Income Solutions, works in coordination with all the teams of the firm’s global bond management platform. The team’s work revolves majorly around product development on Amundi’s Fixed Income offerings including technological work, generating new investment ideas, and bringing them to clients both institutional and distributors. My position in the team is Assistant Credit Analyst.

Missions

My work primarily involves setting up tools and procedures linked to various investment solutions and portfolios handled by team. The tools are developed through algorithms in programming languages (mainly Python) and their functionalities range from analysis of market signals for investment, pricing of securities, risk monitoring and reporting. I worked on fixed-income portfolio construction and optimization algorithms implementing modern portfolio theory.

My daily responsibilities include report production related to daily fund activity such as monitoring fund balance and calculation of regulatory financial ratios to check for alignment against specific risk constraints. Additionally, I also participate in market research for new investment ideas through analysis of various fixed-income securities and derivatives.

Required skills and knowledge

The work and missions involved in my role require technical knowledge especially programming skills in Python, quantitative modelling and an understanding of financial markets, products and concepts of valuation, various types of risks and financial data analysis. Other behavioral skills such as project management, autonomy and interpersonal communication are also essential.

Three key financial concepts

The following are three key concepts that are used regularly in my work at Amundi:

Credit ratings

Credit ratings are extensively used in fixed income. They reflect the creditworthiness of a borrower entity such as a company or a government, which has issued financial debt instruments like loans and bonds.

Credit risk assessment for companies and governments is generally performed by rating agencies (such as S&P, Moody’s and Fitch) which analyze the internal and external, qualitative and quantitative attributes that drive the economic future of the entity.
Bonds can be grouped into the following categories based on their credit rating:

  • Investment grade bonds: These bonds are rated Baa3 (by Moody’s) or BBB- (by S&P and Fitch) or higher and have a low rate of default.
  • Speculative grade bonds: These bonds are rated Ba1 (by Moody’s) or BB+ (by S&P and Fitch) or lower and have a higher rate of default. They are thus riskier than investment grade bonds and issued at a higher yield. Speculative grade bonds are also referred to “high yield” and “junk bonds”.

Often, some bonds are designated “NR” (“not rated”) or “WR” (“withdrawn rating”) if no rating is available for them due to various reasons, such as lack of credible information.

Credit spreads

Credit spread essentially refers to the difference between the yields of a debt instrument (such as corporate bonds) and a benchmark (government or sovereign bond) with similar maturities but contrasting credit ratings. It is measured in basis points and is indictive of the premium of a risky investment over a risk-free one.

Credit spreads can tighten or widen over time depending on economic and market conditions. For instance, times of financial stress cause an increase in credit risk which leads to spread widening. Similarly, when markets rally, and credit risk is low, spreads tighten. Thus, credit spreads are an indicator of current macro-economic and market conditions.

Credit spreads are used by market participants for investment analysis and bond valuations.

Duration and convexity

Bond prices and interest rates share an inverse relationship, i.e., if interest rates go up, bond prices move down and similarly if interest rates go down, bond prices move up. Duration measures this price sensitivity of bonds with respect to interest rates and helps analyze interest-rate risk for bonds. Bonds with higher duration are more sensitive to interest rate changes and hence more volatile. Duration for a zero-coupon bond is equal to its time to maturity.

While duration is linear measure of bond price-interest rates relationship, in real life, the curve of bond prices against interest rates is convex i.e., the duration of the bonds also changes with change in interest-rates. Convexity measures this duration sensitivity of bonds with respect to interest rates.

Useful resources

Amundi

Related posts on the SimTrade blog

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About the author

The article was written in August 2022 by Jayati WALIA (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022).

Posted in Contributors, Professional experience | Tagged , , , , , , , | Leave a comment

The impact of the Russian invasion of Ukraine on Shell

The impact of the Russian invasion of Ukraine on Shell

 Talia HAMMOUD

In this article, Talia HAMMOUD (The George Washington University, BBA, 2019-2023) discusses the impact of the Russian invasion on Shell, a large multinational oil company.

What is Shell?

Shell PLC is a British publicly traded multinational oil and gas company headquartered at in London, United Kingdom. It is one of the largest energy and petrochemical companies in the world, supplying all over the world.

What happened?

The relationship between Ukraine and Russia was tense since Ukraine gained its independence from the USSR in 1991. Since then, Russia annexed Crimea claiming it belonged to them as well as massing soldiers on the Ukraine-Russia border in 2021. On the 24th of February 2022, Russia invaded Ukraine, starting a full-blown war in Eastern Europe. In an effort to condemn Russia, many multinational companies announced they would withdraw or completely halt operations in the country.

Shell announced plans to withdraw from Russian oil just as people close to the matter say a plan is in the works by the Biden administration to ban Russian oil imports into the U.S. Due to this withdrawal, Shell announced that it anticipates account charges from $4 billion to $5 billion in its first quarter of 2022. This move caused American depositary shares of Shell to rise by 2.7% Tuesday, 8th March.

Stock market reaction

When it was first revealed that Shell was still buying discounted Russian oil after other oil companies announced their withdrawal on March 4th, Shell’s market shares plummeted by 5.73%. This shows that the market is efficient and was informed of Shell’s decision as many condemned them for still supporting Russia. There was increased market pressure for Shell to cut ties with all Russian oil suppliers. On March 8th, Shell apologized and announce its withdrawal from Russia as well as stopping all oil purchases from there. Thus, the market increased by 1.05% on March 8th.

Evolution of Shell stock market share price
hell stock market share price
Source: CNBC

Why this is important?

Firstly, it shows how volatile the oil market is as short-term demand for energy responds much faster to changes in growth than to price changes, especially due to the current Russian invasion of Ukraine, and how an act of war can impact millions around the world due to price increases of oil. This inherently impacts a big oil company such as Shell. However, I think that the market stocks rose in support of Shell withdrawing from Russian contracts and territories even though it is very costly as shown by the almost $5 billion in accounting costs for the first quarter. I think that this is an efficient market as stocks began to rise right before the announcement of this withdrawal was revealed showing that people were expecting Shell and other big oil companies to withdraw from Russia due to immense public pressure to condemn the Russian invasion of Ukraine.

Market efficiency

The market is quite efficient as the stock chart reflects all relevant information about Shell and its actions. For example, the announcement of Shells withdrawal in Russia is reflected in the market price of the day it was announced.

Key concepts

American depositary shares (ADS)

American depositary shares (ADS) are shares in foreign companies that are held in American depositary banks and can be traded in the U.S and on major exchanges. Shell Plc has an ADS facility managed by JPMorgan Chase Bank. Each American depositary share is equal to two Shell ordinary shares.

Market efficiency

Market efficiency refers to the degree how which many market prices reflect all relevant information available. If a market is efficient, it means all traders are well-informed and all the information available is reflected in the price of shares.

Volatility

Volatility represents the rate at which the price of a stock increases or decreases over a particular period. Higher stock price volatility often means higher risk and helps an investor to estimate the fluctuations that may happen in the future.

Useful resources

CNBC Shell PLC share price

Wall Street Journal Shell, BP to Withdraw From Russian Oil, Gas

Shell (March 8th, 2022) Shell announces intent to withdraw from Russian oil and gas

Related posts on the SimTrade blog

   ▶ All posts about financial news in the SimTrade blog

About the author

The article was written in August 2022 by Talia Hammoud (The George Washington University, BBA, 2019-2023).

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My internship experience at Little Friends for Peace

My internship experience at Little Friends for Peace

 Talia HAMMOUD

In this article, Talia HAMMOUD (The George Washington University, BBA, 2019-2023) shares her experience as an intern at a non-governmental organization Little Friends for Peace.

Little Friends for Peace

Little Friends for Peace (LFFP) is a small-medium-sized non-profit organization, based in Washington, D.C., that welcomes youth and adults to experience, learn and practice peace through various peace education programs. Started by MJ and Jerry Park in 1981, LFFP believes that all people can create homes, classrooms, teams, and workplaces where everyone gives, everyone gains, and everyone wins. Named for the “little” part we can all play in spreading peace, LFFP seeks to eradicate violence by teaching skills for peace. Some ways they can do this are by hosting ‘peace circles’, summer camps for children, and weekly visits to the McKenna Center, an organization that helps incarcerated men get back on their feet. Furthermore, they have international programming to certain parts of the world such as China, the Middle East, and Latin America.

Logo of Little Friends for Peace
Little Friends for Peace
Source: Little Friends for Peace

My Internship Experience

Since my internship experience took place during the unprecedented pandemic, it was not quite the same as other people’s internship experiences. Firstly, we met weekly on zoom as a team for updates, to-dos, and any exciting news about the NGO. Then we had the option to choose what tasks we wanted to be a part of or lead. For example, I chose to lead the Halloween fundraising event as well as lead in-person peace circles for children between the ages of 6-10 every Monday.

Knowledge and skills needed

Some of the skills required for the internship include organization, fundraising skills, and communication via e-mails, meetings, and social media. I had to organize a fundraising event and create an itinerary for the night. I also had to create advertising and marketing materials to spread awareness and attract attention to the event. This proved difficult as it required the use of a lot of social media outlets to stimulate interest.

What I learned

Operating a non-profit organization is very difficult in terms of financing it. Since a lot of the services they provide are pro bono (meaning for free), the non-profit must find other sources of income to keep the program running. Thus, LFFP must make use of donations, host fundraising events, request grants, and other methods of public funding. Despite this, Little Friends for Peace can maintain operating the business successfully.

Financial Concepts

Interdependence: Non-profits are very dependent on governments and donors which requires them to well connect all parts of operations such as planning, programs, evaluations, etc., to ensure that they receive the right amount of funding and to please potential donors.

Another thing to note is that non-profits must have a substantial amount of cash in operating reserves in case of any downturn or opportunities. For example, due to the pandemic, the government had significant delays in handing out grants and donations to NGOs, thus many organizations had to turn to their reserves to keep business operating.

Why should I be interested in this post?

I think it is very important for all students studying business to experience or learn about all different types of businesses, especially non-profit organizations. I feel that the business behind NGOs and the difficulties of running one is not discussed enough. Therefore, I encourage all business students to consider learning more about the behind-the-scenes of a non-profit organization.

Useful resources

Little Friends for Peace

Non-Profit Finance: 12 Golden Rules

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   ▶ All posts about professional experience in the SimTrade blog

About the author

The article was written in August 2022 by Talia Hammoud (The George Washington University, BBA, 2019-2023).

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Muhammad Yunus

Muhammad Yunus

Louise Pizon

In this article, Louise PIZON (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2022) presents the portrait of Muhammad Yunus a well-known economist.

Muhammad Yunus or the “banker to the poor” was born in June 1940 in Bangladeshi in the city of Chittagong. He is a social entrepreneur, banker, economist and civil society leader. In 1976, he founded Grameen Bank, a micro finance organization and a community development bank. Microcredit is a delivery system to provide banking services to the rural poor. He is a pioneer of micro funding and microfinance concepts. In 2006, Muhammad Yunus was awarded Nobel Peace prize for these concepts.

Muhammad Yunus
Portrait Yunus
Source: Wikipédia

After his studies in United States, he came back to Bangladesh and worked for three months for the government’s Planning Commission. He quitted to join Chittagong University as head of the Economics department. He started to be involved in poverty reduction in 1974 when famine has struck Bangladesh.

Grameen bank (“village bank”)

It is in 1976, while visiting a poor village of Jobra next to Chittagong University that Muhammad Yunus has the idea of micro funding. He offered the opportunity to women to take a very small loan to create their business. He explains that at the beginning it was complicated to convince women to take loans because they were afraid of not being able to repay the loan. Also, he faced cultural problem; indeed, male didn’t agree to let women manage money.

Grameen Bank consists in constituting groups of solidarity within the villages of people who know each other. The risk of non-refunding is very low because the shame of mismanaging the loan money, naturally prevented borrowers from being dishonest with the Grameen Bank. At the very beginning groups were formed of five people, with one with the role of president and another one of secretary. Women are so proud to be part of these groups and they are meeting every week to check the status of their finance. Grameen bank allowed them to have an easier and more secure access to their money. It never had a shortage of funds for its loans. It was always local money for the poor women in the area. Members were always told that they had to create, operate and develop their branches with their own money.

Six years after the creation of Grameen Bank, the equality gender of the member rose to a 50/50 ratio. The bank observed that the impact on the family was significantly better in families where women were the borrowers compared to families where the borrowers were men. After this the priority for women borrower was set up and it became a common policy for all microcredit programs worldwide.

Link to VICOBA

Grameen Bank has many similarities with Village Community Bank (VICOBA). VICOBA is a savings and loan fund for members who have joined together and formed a group for economic improvement purposes. The system started in Tanzania twenty years ago and has shown great success for its members in being able to lend to each other, helping each other to solve various problems as well set up joint economic projects.

Both forms of micro funding aim at empowering women and lifting families out of poverty by allowing them to borrow a small amount of money to be able to start a business and generate more money. In both cases, the groups are formed in the same way: members come from the same village and in general it is group of close friends or family members. Within the group, a steering committee of five people is elected annually with the roles of chairperson, secretary, treasurer and two accountants. Both village community banks have weekly meetings to manage the accounts and ensure that people repay on time their loans.

However, there are some differences such as the number of members in the groups: five for Grameen bank versus fifteen to thirty members for VICOBA.

The biggest difference between Grameen and VICOBA is that people part of Grameen bank must open a bank account in Grameen bank whereas VICOBA is completely manage by the members of the group and the money is lock in a box by the treasurer of the group. In VICOBA they also have the possibility to follow business trainings to help them to build their businesses.

Why should I be interested in this post?

Do you want to know how an economist won a Nobel Peace Price? Find out the story of Muhammed Yunus or “the banker to the poor” who created the concept of micro funding to help the poor rural to lift out of the poverty and let them a chance to live in better conditions. Besides being a brilliant economist, he is also a humanitarian and a successful businessman whose purpose in life is creating a World without poverty.

Useful resources

Forbes Muhammed Yunus (Prix Nobel) (in French).

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About the author

The article was written in August 2022 by Louise PIZON (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2022).

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My professional experience as an intern at Caisse des Dépôts

My professional experience as an intern at Caisse des Dépôts

Louise Pizon

In this article, Louise PIZON (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2022) presents her internship experience at Bank of Territories from La Caisse des Dépôts in the Social and Solidarity Economy.

About the company

Caisse des Dépôts et Consignations (CDC), sometimes referred as Caisse des Dépôts, is a French public financial institution created in 1816. Under the direct control of a supervisory commission reporting to Parliament, it carries out general interest activities on behalf of the State and local authorities as well as competitive activities. It employs both civil servants and private-sector personnel under collective agreements.

Launched in 2018, Bank of Territories is a department of CDC. It supports local players in the service of regional development. It offers tailored advisory and financing solutions in loans and investments to meet the needs of local authorities, social housing organizations, local public companies and the legal professions. Bank of Territories also forges strategic partnerships with companies and financial players to carry out projects with a strong territorial impact. It is aimed at all territories, from rural areas to metropolitan areas, with the ambition of fighting against social inequalities and territorial fractures.

It mobilizes 20 billion by year to finance projects for local authorities and social housing actors. It has 35 local offices to ensure greater proximity to its clients. In September 2020, the Bank of Territories and BPI France launched a €40 billion “climate plan” over five years to support French companies in their ecological transition. Priority is given to building renovations and the development of renewable energies, with more than €14 billion budget for each. The rest of the budget should be devoted to innovation (5.6 billion euros), mobility (3.5 billion euros) and industry (1.5 billion euros).

To give an example, in 2013, the Caisse des Dépôts with the help of the State launched the waste recycling and insertion project in Haute Marne. The SCIC (Société Coopérative d’Intérêt Collectif) is called DIB 52 and consists of transforming common industrial waste (CIW), via the creation of platforms allowing the sorting and transformation of CIW into solid recovered fuel (SRF). This project has made it possible to respond to environmental issues thanks to an innovative industrial solution and, in addition, to create jobs.

Logo of La Banque des Territoires
Logo banque des territoires
Source: CDC

What is SSE?

The concept of Social and Solidarity Economy (SSE) designates a set of organizations in the form of cooperatives, mutual insurance, associations or foundations, whose internal functioning and activities are based on a principle of solidarity and social utility.

These enterprises adopt democratic and participatory management methods. The profits made are reinvested. Their financial resources are generally partly public.

Thus, SSE enterprises are concerned with their social or ecological impact. They aim at putting the human being and solidarity at the heart of the economy and respond to the major challenges of society (ageing well, transition to a local, sustainable food system, the circular economy).

My role and personal missions

I was intern in the Social and Solidarity Economy department of Bank of Territories.

I selected innovative start-ups respecting the environment or social utility company and I created their identity card to classify them. Indeed, to be eligible for different type of funding we need to segment them by type of activities. Then some of them will be chose to be financed and we help them for the process of development as an incubator.

The Social and Solidarity Economy department offered them a two-stage support solution for the creation stage and then the development stage. Our mission was to offer them a support as early as possible to be successful during the maturation of the project.

During the creation stage

We help for several tasks :

  • Create spaces for experimentation in each territory: specific advisors “young people” in an employment support contract, “hosting”/sponsoring of the bearers within a SSE enterprise of the sector (financed).
  • Help for the rebound in case of failure: assessments of the skills acquired during the creation.
  • Ensure a flexible and reactive support, adapted to the functioning of these initiatives, based on a mutual relationship between the mentor(s) and the entrepreneur(s)
  • Offer both technical support (legal, financial, administrative) and support on the substance of the projects’ approach (values, collective management, knowledge of the SSE …).
  • Immersions in other SSE companies, training on SSE and its values.
  • To insert the young people as soon as possible in a network as broad and varied as possible (collectives of support to projects). Mutualize the tools and devices of the SSE and the classic economy by the creation of common platforms.

During the development stage

We help them to set up supports for the perpetuation: lines of financing intended for the social innovation of young people (indicators and criteria adapted to the realities of the projects), improve the links between funders to simplify access to funding, make available specific territorial “funds of assistance” for funds for SSE activities of people under 35 years of age.

Raising awareness among local support network’ agents about the characteristics of young SSE projects. Provision of “drawing rights” on all the dimensions that cover support for young people over several years. Offer permanent and informal exchange spaces between holders to simplify the mode of creation of a SCIC. To make a place for young entrepreneurs in the SSE support systems.

Commitment of the Bank of Territories to the development of the SSE and social innovation

The State Secretariat for the SSE and Bank of Territories signed on November 3rd, 2020, an agreement to take an action on the strengthening of the support of SSE companies, the development of their financing and the support to social innovation.

With this objective in mind, Bank of Territories is mobilizing €300 million for the social and solidarity economy (SSE) between 2020 and 2022, as part of a pact to boost the SSE and social innovation.

This pact is based on two main goals:

  • Strengthening the support of SSE companies: Several actions must be carried out to improve the meeting between SSE companies and private financiers, particularly in the booming field of impact investment.
  • Financing SSE companies and social innovation

Thus, in addition to its support actions, Bank of Territories is committed to the State to deploy its investment actions over the next three years by:

  • Massively increasing the use of impact contracts*: These contracts make it possible to finance social innovation based on results and impact measurement. Within this framework, the State will launch calls for expressions of interest to identify projects in which the Bank of Territories will be able to invest in pre-financing.
  • Reinforcing its direct investments in the sectors of solidarity and medico-social services, food transition, local economic development, education and professional training, and digital inclusion.
  • Facilitate access to financing.

In addition, indirect investments (impact funds and sharing funds) will allow the Bank of Territories to multiply its support actions to SSE actors, in a complementary way to its direct investments.

General concepts

Impact contract

The impact contract is a partnership between the public and private sectors designed to encourage the emergence of innovative social and environmental projects. These contracts allow for the scaling up of solutions that have been identified in the field and are effective. The private and/or public investor pre-finances the project and takes the risk of failure in exchange for a pre-determined remuneration in case of success. The State only reimburses according to the results obtained and objectively observed by an independent evaluator.

How it works ?

The impact contract renews the financing of innovative projects carried out by actors in the social and solidarity economy. Under this system, social and environmental projects are financed by private and/or public investors, who are reimbursed by the State if the projects achieve the objectives previously set.

Impact contracts are not intended to replace traditional financing of social or environmental activities. They provide a complementary method of financing to facilitate the development of new activities or an innovative program for existing activities.

In concrete terms, the public authorities will launch calls for projects to meet social or environmental needs that are not, or are poorly, covered by the State: the selected structures will then be financed by a third-party investor. Depending on the results observed, based on indicators determined by the stakeholders, the State will remunerate the project leader, who will then be able to reimburse the investor.

Circular economy

The circular economy refers to an economic model whose objective is to produce goods and services in a sustainable manner, by limiting the consumption and waste of resources (raw materials, water, energy) as well as the production of waste. It is about breaking with the linear economy model (extract, manufacture, consume, throw away) for a “circular” economic model.

Intended to generate potential for the creation of activities and jobs, and to respond to the challenges of resource scarcity, circular economy approaches are based on the dynamics of multi-actor cooperation on a territorial scale.

Transition to a local, sustainable food system

The transition to food system refers to the process by which a society profoundly modifies its way of producing and consuming food. The term is used in the context of energy transition, the ecological transition or the demographic transition.

In the 2010s, the term transition to food system is increasingly used in the public debate to designate the expectations or efforts undertaken by the different actors in the chain (producers, processors, distributors, consumers, public authorities) to better respect the environment, improve the nutritional status of food, develop organic and fresh products, and produce under conditions that are more respectful of animal welfare and with greater equity between the actors in the chain.

Useful resources

Banque des territoires

Ellen MacArthur Foundation L’économie circulaire : du consommateur à l’utilisateur Video (in French).

About the author

The article was written in August 2022 by Louise PIZON (ESSEC Business School, Master in Strategy & Management of International Business (SMIB), 2020-2022).

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