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Treasury Finance and Development Banking: A Guide to Credit, Debt, and Risk, + Website


"This is an important and timely book that demonstrates the motivation and mathematics underlying the role of Treasury in banking. From first principles, the theory of development banking, emerging market finance, and funding is derived based on the underlying interest rate products available."
—Jamie Walton, Global Head of Rates, FX and Emerging Markets Quants, Morgan Stanley

"An outstanding description of what banking is all about. From the point of view of a treasury in a development bank, Biagio performs a deep analysis of the essential activities of banking, so useful in a moment when, after times of delusion, credit and funding are again recognized to be the heart of finance. Everyone in this field will find this book detailed, useful, and yet enjoyable."
—Massimo Morini, Head of Interest Rate and Credit Models, Banca IMI

Before the credit crisis, credit was primarily considered only when dealing with counterparty credit risk, high-yield debt, or credit-linked derivatives. Credit and credit risk now permeate every corner of the financial world.

Treasury Finance and Development Banking analyzes credit from the beginning—the point at which a borrowing entity decides to raise capital through its treasury operation.

Biagio Mazzi delves into the crucial functions that treasury funding plays in the operations of financial institutions, governments, and corporations. More importantly, he clearly demonstrates the various ways that treasury funding affects how financial activities are assessed, transactions are priced, and financial risks are managed.

As development banking offers one of the clearest and most straightforward examples of a treasury operation, while, at the same time, being situated at the crossroads of a wide range of topical issues (including multilateral agencies, quasi-governmental entities, emerging markets, and the shrinking pool of AAA borrowers), Biago Mazzi uses numerous real-world examples from the development banking world to elucidate:

  • Curve construction, covering instruments, collateralization, discounting, and bootstrapping
  • Credit and loan valuation, with an emphasis on fair value, modeling, and development institutions
  • Emerging markets and liquidity, credit, capital control, and development
  • Bond pricing (featuring coverage of credit, illiquid bonds, and recovery pricing)
  • Treasury funding—with examples of asset swaps, borrowing/investing benchmarks, and more
  • Risk and asset liability management with discussions of leverage, hedging, and funding risk

Treasury Finance and Development Banking will be a welcome addition to the working libraries of banking professionals, financial analysts, fund managers, and traders, especially those who work in the fixed income arena.

Biagio Mazzi, PhD, is a Senior Financial Officer on the Structured Notes Desk in the World Bank Treasury. Prior to the World Bank, Biago Mazzi was a Vice President at Morgan Stanley, where he was responsible for modeling exotic credit derivatives on the Emerging Markets Desk. Before working in fixed income, he was an equity derivatives quant at Barclays Capital and Banca Caboto. He holds a PhD in theoretical physics from the University of Cambridge.

List of Figures xiii

List of Tables xvii

Acknowledgments xix

Introduction xxi

I.1 Treasury, Funding, and the Reasons behind This Book xxi

I.2 Funding Issues as Credit and Pricing Issues xxiii

I.3 Treasury Finance and Development Banking xxv

I.4 The Structure of the Book xxvi

CHAPTER 1 An Introductory View to Banking, Development Banking, and Treasury 1

1.1 A Representation of the Capital Flow in a Financial Institution 2

1.2 Lending 3

1.3 Borrowing 7

1.4 Investing and ALM 10

1.5 The Basic Structure of a Traditional Financial Institution 12

1.6 Development Banking 17

CHAPTER 2 Curve Construction 21

2.1 What Do We Mean by Curve Construction? 22

2.2 The Instruments Available for Curve Construction 24

2.3 Using Multiple Instruments to Build a Curve 37

2.4 Collateralized Curve Construction 42

2.5 Numerical Example: Bootstrapping an Interest Rate Curve 55

CHAPTER 3 Credit and the Fair Valuing of Loans 67

3.1 Credit as an Asset Class 67

3.2 A Brief Overview of Credit Modeling 75

3.3 Fair Value of Loans and the Special Case of Development Institutions 88

3.4 Numerical Example: Calculating the Fair Value of a Loan 95

CHAPTER 4 Emerging Markets and Liquidity 101

4.1 The Definition of Emerging Markets 101

4.2 The Main Issues with Emerging Markets 103

4.3 Emerging Markets and Development Banking 116

4.4 Case Studies of Development Projects 122

CHAPTER 5 Bond Pricing 127

5.1 What Is a Bond? 127

5.2 A Few Fundamental Concepts of the Bond World 129

5.3 Expressing Credit Explicitly When Pricing a Bond 138

5.4 Illiquid Bonds 150

5.5 Numerical Example: Estimating the Coupon of an Emerging Market Debt Instrument 164

CHAPTER 6 Treasury Revisited 171

6.1 Funding as an Asset Swap Structure 171

6.2 Funding Level Targets 179

6.3 The Fundamental Differences between Investment Banking and Development Banking 187

6.4 Benchmarks for Borrowing and Investing 189

CHAPTER 7 Risk and Asset Liability Management 207

7.1 The Issue of Leverage 208

7.2 Hedging 210

7.3 Managing Risk Related to Financial Observables 224

7.4 Funding Risk 242

CHAPTER 8 Conclusion 261

8.1 Credit Is Everywhere 261

8.2 The Fundamental Steps to Borrowing, Lending, and Investing: A Summary 263

APPENDIX A Implying Zero Rates from FX Forward Quotes 269

APPENDIX B CDS Spreads and Default Probabilities 271

APPENDIX C Modeling the Credit-Driven Prepayment Option of a Loan 273

APPENDIX D The Relation between Macaulay and Modified Durations 275

APPENDIX E The Impact of Discounting on an Asset Swap Spread 277

APPENDIX F Replication Leading to Risk-Neutral Probabilities 279

References 283

About the Web Site 289

Index 293