Thursday, December 5, 2013

bond ^ deposit , briefly

Bond and deposit are the 2 basic, basic FI instruments, underlying most interest rate derivatives.

Both pay interest, therefore have accural basis, like act/360 or 30/360

Both have settlement conventions, such as T+2. Note Fed Fund deposit is T+0.

# 1 difference in pricing theories -- Maturity value is know for a bond, but in contrast, for some important deposits (money-market deposits) we only know the value tomorrow not later. Though many real life fixed-deposits have a long tenor comparable to bonds, the deposits used in pricing theories are "floating" short term deposits like overnight deposits.

# 2 difference -- Bond has maturity value exactly $1 and is traded at a discount before maturity, making it an ideal enbodiment of discount factor. A Deposit starts at $1 and grows in value due to interest.

--1) Bonds
eg of bonds -- all treasury debts, corp debts, muni debts.

Has secondary market

The most popular asset for repo.

--2) Deposits is fairly similar to zero bonds.
eg of deposit -- Fed Fund deposit, or deposits under other central banks. Unsecured
eg of deposit -- Eurodollar deposit, in about 20 major currencies. Unsecured

OIS is based on deposits (Fed Fund deposit)

Libor is based on eurodollar deposits, for a subset (5) of the currencies.

Libor IRS and OIS IRS - all based on deposits.

No secondary market.

I feel deposits tend to be short term (1Y or less)

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http://www.linkedin.com/in/tanbin