So, I am sitting here in Julius Baer (JB) wondering quite what I should do. As a new bank, the team are dashing around trying to get things going but their focus is not on my activities but on the areas that they know and have contacts.
I think that, firstly, I ought to list the players. Firstly, we had Henri Jacquier as Managing Director. He had made his name as the Treasury Manager of Kleinwort Benson so he know his stuff when it came to merchant bank business. The manager was David Mann who came to us from Hill Samuel. His world had been corporate financing. As assistant manager we had Peter de Muralt (or von Muralt). Peter was the JB appointment on the team and he was what we would now call a “bright young thing”. He was of Swiss origin and spoke English fluently as well and French, German and Italian (of course). His job, as I saw it, was to keep David Mann within the JB bounds rather than still living in the Hill Samuel world. Shortly after joining, they employed a back office manager – Peter – and Peggy as an assistant for him. The rest of the team comprised two secretaries – Miss Pfaff (JB Zurich appointee) and an English one who was what we would now call a “Sloane Ranger” – very well spoken and OK-ish at her job.
JB had some great contacts and some of these provided us with our first run of business. I learned an awful lot in a very short time because I had never been exposed to the areas we were now to work in. I had never deal with the likes of Fidelity – a huge US based investment manager – or Pemex – a Mexican oil company, for instance. I will leave Fidelity to later but Pemex taught me a lot. Pemex mostly raised funds by issuing bills of exchange. Now a bill of exchange is a nice piece of paper that is worth nothing until it is accepted by a credit worthy banking institution. The company issues what is effectively an open IOU, say for $1,000,000. This bill has an expiry date of say 90 days. So the company expects to get the million dollars on the day of acceptance and will repay it 90 days later. Pemex issues the paper and we (that is Julius Baer International – JBI) write on the back that this bill is accepted for payment by us on the due date and we, then, give Pemex their funds. It now ceases to be a Pemex debt but becomes one for JBI. There is a borrowing cost on this, of course. This borrowing cost is deducted, in full, from the proceeds payed to Pemex. Let us assume that the US$ 90 day interest rate at that time was around 6 1/2%. So the calculation goes like this:
1,000,000 *0.065 *90/360 = $16,250 deducted from the face value leaves $983,750.00 for Pemex.
This is known as buying the paper at a discount. My job was to sell this onto someone else at a better rate; i.e. at a rate lower than 6 1/2%. But, we had a trick up our sleeve. The market for this type of paper in London was always quoted at a “discount to yield”. Humm. Have I lost you? I bet I have.
You see, if you think about what I have said, we have charged interest on the full $1,000,000 even though we only paid out $983,750. In the minutiae of banking transactions, this helps us make a bigger return. To explain, let us start out with the invested amount and see where we get.
We have invested $983,750.00 to get a $1,000,000 return. Thus, we should really be talking about the actual investment yield which is $16,250/90*360/983,750.00. Now this comes out at 6.607%. So, we are actually getting 6.6% on our investment. What we need to do now is to sell the bill on the market at the “discount to yield” rate (DTY). Assuming that Pemex can see the current market rates, they will know that 6.5% is off from the market because we would always have agreed a margin on market prices with them before starting any transactions. As they are Mexican and, at that time, Mexico suffered from having a poor financial reputation, we would probably agree something like a 0.5% margin over market rates.
Note for 2015: This is where LIBOR rates come in. LIBOR US$ rates were set, at that time, by taking a spread of rates for any one period from a range of sources and taking the average (normally after removing any outliers and also, probably, the highest and the lowest) and calculating an average. So, today’s 3 Month LIBOR (assuming the 0.5% margin) would have been 6%; this being the average offered rate for US$ over three months.
My job would be to fund this bill by selling it on the market at a “discount to yield price of a little over the current LIBOR, taking into account the status of Mexico. let us say that the market will accept this paper at 6.25%. Using the standard DTY calculation, the amount that we will receive will be $984,615.38 showing us a small profit of $865.38. If we hadn’t used our little trick, we would have made $605.54 so it was worth doing. Remember that we would be doing this for $10,000,000 tranches. Sometimes we would find that some counter parties would only trade at a straight discount so we had to forego the little extra but it was worth trying.
The one advantage of holding a bill of exchange was that, if the market moved such that you could sell it on at a cheaper rate then, being a bearer bill (i.e. issued to the bearer of the paper rather than any specific institution) you could sell it on. You had to take care of the paper, of course, because we would pay whoever turned up with it on the due date!
Enough mind bending stuff. More later