An Introduction to Banking, 2nd Edition

Chapter 6INTRODUCTION TO MONEY MARKET DEALING AND HEDGING

In this chapter we introduce some basics of trading and hedging as employed by a bank asset–liability management (ALM) or money market desk. The instruments and techniques used form the fundamental building blocks of ALM, so the reader can imagine that a full and comprehensive treatment of this subject would require a book in its own right.¹ Our purpose here is to acquaint the newcomer to the market with the essentials. The market yield curve and the bank's internal curve are paramount in this discipline, which is why we introduced that topic earlier. The next two chapters look at the ALM discipline in more detail.

The ALM and money market desk has a vital function in a bank, funding all the business lines in the bank. In some banks and securities houses it will be placed within the Treasury or money market areas, whereas other firms will organise it as an entirely separate function. Wherever it is organised, the need for clear and constant communication between the ALM desk and the other operating areas of the bank is paramount. But first we look at specific uses of money market products like deposits and repo in the context of the shape of the yield curve.

MONEY MARKET APPROACH

The yield curve and interest‐rate expectations

When the yield curve is positively sloped, the conventional approach is to fund the book at the short end of the curve and lend at the long end. In essence, therefore, if the yield curve resembled ...