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Deutsche BankCorporate and Investment Bank
InationHedging it & Trading it
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This advertisement has been approved and/or communicated by Deutsche Bank AG London. The services described in this advertisement are provided by Deutsche Bank AG or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation.Deutsche Bank AG is authorised under German Banking Law (competent authority: BaFin Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business. Securities and investment banking activities in the United Statesare performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. Copyright Deutsche Bank 2011.
Deutsche BankCorporate & Investment Bank
Winning for our clients:Ination Derivatives House of the Year.
At Deutsche Bank, we are dedicated to setting the
stage so that our clients can perform at their best.
We appreciate winning awards that recognize thequality of service that we deliver.
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Introduction Why ination, why now?
1.0 Deutsche Banks capabilities and credentials in this market1.1 How Deutsche Banks ination oering diers from
competitors
2.0 Market Overview the rise and rise of ination volatility2.1 Components of Ination indices
3.0 Ination Linked Bonds3.1 Ination Linked Bonds3.2 Real Yield and Breakeven Ination and Ination Protection 3.3 Indexation and Breakeven Ination3.4 Risk Measures, EM Sovereign Linkers, Seasonality,
and US TIPS3.5 UK Index Linked Gilts, EUR Sovereign Linkers, and other
Important Markets3.6 ILB coupon frequency and settlement characteristics
4.0 Ination Swaps4.1 ILS Swaps and Markets4.2 UK Swaps, Corporate Linkers, and US Swaps 4.3 ILS Indexation4.4 ILS Pension Fund demand
5.0 Assessing Relative Value
5.1 Linker Asset Swaps and the Leverage Eect5.2 5 sources of Asset Swap Dierence5.3 What is the Fair Price for Ination Protection?5.4 Fair Credit Spread of Ination Linked Bonds5.5 Hedge with Bonds or Swaps5.6 Summary
6.0 Ination Options6.1 Ination Options6.2 Who are the major players in the options market? 6.3 Option Products6.4 What are the trading opportunities?6.5 Option Strategies6.6 Creating Optimal Hedges
7.0 Deation tail risk7.1 Deation Tail Risk: DB 5 Year Note
8.0 Case Study Zero-Coupon Option Trade
9.0 Further Reading9.1 Ination Hedging for Institutional Investors
10.0 Contacts10.1 Deutsche Bank Global Ination Team
Contents
Contents
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InationHedging it & Trading it Deutsche Bank
There has never been a bettertime to talk about ination
Ination looks set to be volatile
for the next 5 to 10 years Any client with a bond portfolio
is exposed to ination risk Clients with revenues or
liabilities indexed to ination
are especially vulnerable.
Deutsche Bank is very stronglypositioned to advise clients onwhat to do
We were recently voted theBest Ination Derivatives housein the industry by Risk magazine
We have a large global inationderivatives trading andstructuring team
We have extensive experienceof helping clients nd inationsolutions
The Deutsche Bank inationteam has developed this briengdocument to:
Set out the challengesand opportunities faced byclients
Explain the products andstrategies we have developed.
The Deutsche Bank GlobalInation team can help
IntroductionWhy ination, why now? Ination Derivatives
House of the Year
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InationHedging it & Trading it Deutsche Bank
1Deutsche Banks credentials andcapabilities in the Ination marketHow Deutsche Banks ination oerings dier fromcompetitors
ContentsContents
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We oer a full range ofination servicesOur primary capabilities aredemonstrated by our leading positionin the league tables; weve also playedan important role in maintaining orderin the secondary markets, distributingand recycling bonds and swaps acrossthe world. DB is the global leader inination-linked bond syndication.
Date DealNo.
LeadsDB UBS RBS Barc HSBC GS JPM Nomura BNPP SG Calyon MPS
24 Sep 09 UKTI50 4 1 1 1 1
29 Sep 09 ACGBi25 3 1 1 1
21 Oct 09 BTPei41 4 1 1 1 1
27 Jan 10 UKTI40 4 1 1 1 1
21 Apr 10 BTPei21 5 1 1 1 1 1
11 May 10 UKRAIL47 2 1 1
26 May 10 UKTI50 4 1 1 1 1
27 Jul 10 UKTI40 4 1 1 1 1
14 Sep 10 ACGBi30 3 1 1 1
01 Feb 11 NZGBi25 1 1
Total number 7 6 5 3 3 3 2 1 1 1 1 1
Issuing long dated ination in largesizes can be dicult to manage; debtmanagers turn to the strongest bankswho have the best track record forrisk management and distribution Deutsche Bank leads in this space
Lead syndication mandates awarded to market counterparties*between September 2009 and February 2011 Source: Bloomberg, Deutsche Bank
Deutsche Banks credentials and capabilitiesin the Ination Market
1.0Deutsche Banks credentials andcapabilities in the Ination Market
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We are outperforming the competitionaround the worldDeutsche Bank is:
No 1 in ICAP market share for EUR Ination/Asset Swaps (2009, 2010)
No 3 in ICAP market share forUKRPI Ination/Asset Swaps(2009, 2010)
No 1 in BGC market share for all USproducts (Ination, Asset Swaps,Options) 2010
Fig.1:Global Linker Syndications as LeadManagerSource: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
Fig. 2:Total Syndication Size for GlobalLinkers (mm)Source: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
Fig. 3:USD Ination Market by Volume 2010Source: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
DB
UBS
RBS
Barc
HSBC
GS
JPMC
Nomura
SocGen
BNPP
ML
MS
RBC
Calyon
ANZ
MPS
4
3
2
1
0
5
6
7
8 Number of
Syndications
0
7,000
6,000
5,000
4,000
3,000
2,000
1,000
DB
UBS
RBS
Barc
HSBC
GS
JPMC
Nomura
SocGen
BNPP
ML
MS
RBC
Calyon
ANZ
MPS
Total Syndication
Size
0
12,000
10,000
8,000
6,000
4,000
2,000
1.0Deutsche Banks credentials andcapabilities in the Ination Market
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We are outperforming the competitionin the UK
Fig. 1:UK Linkers Syndications as LeadManagerSource: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
Fig. 2:UK Linkers and Nominals Syndicationsas Lead ManagerSource: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
Fig. 3:UK Linkers Total Syndication Size (mm)Source: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
Fig. 4:UK Linkers and Nominals Syndicationsas Lead ManagerSource: Bloomberg, Deutsche Bank
Deutsche BankCompetitors
DB UBS RBS Barc HSBC GS JPM Nomura
0
3.5
3
2.5
2
1.5
1
0.5
DB UBS RBS Barc HSBC GS JPM Nomura
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
DB UBS RBS Barc HSBC GS JPM Nomura
0
3,000
2,500
2,000
1,500
1,000
500
0
3.5
3
2.5
2
1.5
1
0.5
DB UBS RBS Barc HSBC GS JPM Nomura
1.0Deutsche Banks credentials andcapabilities in the Ination Market
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Integrated trading, structuringand researchUnlike some of our competitors,Deutsche Banks ination trading,structuring and research professionalswork closely together, combiningstrategic and technical expertisewith the macro-economic insights soimportant to this oering.
BloombergForecasts, ination linked bonds,ination swaps and ination linkedoptions. US options will be addedsoon (gure 1)
The market is pricing much moreupside risk than downside risk contrary to what we see in othermarkets
Trade FinderCurrently being upgraded, it will sooninclude additional functionality: e.g.forward matrices ve year forwardon Eurozone or ve year to 25 yearforward. In Frankfurt and Mumbai,real live zero coupon lives and forwardmatrices and cross market indicatorswill soon be added (gure 2)
Fig. 1:Our ination page on Bloomberg DBII
Fig. 2:Ination on Trade Finder newimprovements coming soon
1.1Deutsche Banks credentials andcapabilities in the Ination Market
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How Deutsche Banks ination oering diersfrom competitors
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2Market Overview
Components of Ination indices
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All G7 nations issue ination-linkedbonds
MarketsUS TIPS the US Sovereign linkermarket is the largest globally with atotal market value of over USD700bnbut less liquid than EUR
UK IL Gilts rst issuance 1981; totalmarket value exceeds GBP270bn
EUR sovereign linkers- expandingrapidly; total market value exceedingEUR320bn as of now; France, Italy,Germany & Greece issue ILBs. Italian,German and Greek ILBs are linkedto euro area ination; France issuesbonds linked to EUR ination andbonds linked to FRF ination
Industrial country sovereign linkermarkets Other important marketsinclude Australia, Canada and Sweden.AUD: govt suspended issuance in2003, started again in 2009. Sweden:linkers account for almost 30% of totalgovt bond market, higher share than inany other industrial market
EM sovereign linker markets- mostLatAm ination markets have longhistories; Brazil is the largest market,suppression of investment restrictionsin 2006 spurred international demand.Chile, Colombia & Uruguay also issueILB. Israel is big (USD27bn marketvalue). More recently: South Africa,Poland, Turkey (2007) and South Korea(2007)
Fig. 1:A Fast Growing Asset ClassSource: Deutsche Bank
US ITLUK DEMJPY GrFRF SEKCAD AUD
2.0Market Overview the rise and rise ofmarket volatility
97 98 99 00 09 1001 02 03 04 05 06 07 08
0
1,600 total outstanding, $ bn
1,200
1,400
1,000
800
600
400
200
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The rise and rise of ination
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97 98 99 00 09 1001 02 03 04 05 06 07 08
0
1,600
1,200
1,400
1,000
800
600
400
200
%
Food and beverages
Housing
Apparel
Transportation
Medical Care
Recreation
Other
Education and
Communication
15
42
3
4
17
7
6
6
97 98 99 00 09 1001 02 03 04 05 06 07 08
0
1,600
1,200
1,400
1,000
800
600
400
200
Food and catering
Alcohol and tobacco
Housing and
household expenditure
Personal expenditure
Travel and leisure88
408
82
257
165
%
Food & beverages
Clothing & footwear
Furniture & household goods
Health
Alcohol & tobacco
Housing & household services
Recreation & culture
EducationRestaurants & hotels
Other goods & services
TransportCommunication
16
7
7
4
3
4
15
16
10
19
9
2.1Market Overview the rise and rise ofmarket volatility
Fig. 3:Weights in the EURSource: Deutsche Bank
Fig. 1:Weights in the US CPISource: Deutsche Bank
Fig. 2:Weights in the UK RPISource: Deutsche Bank
Components of Ination Indices
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3Ination Linked Bonds
Ination Linked BondsReal Yield and Breakeven Ination and Ination ProtectionIndexation and Breakeven InationRisk Measures, EM Sovereign Linkers, Seasonality and US TIPSUK Index Linked Gilts, EUR Sovereign and other Important Markets
ILB coupon frequency and settlement characteristics
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Ination Bonds LinkersInation Linked Bonds (also known asination indexed bonds) or Linkers.
These are Treasury bonds designedto cancel the capital eroding eectsof ination. Called TIPS (TreasuryInation Protection Securities) in theUS, their interest rate remains xed butthe principal is adjusted to matchchanges in a price index.
For example:A vanilla xed rate bond pays a xedcoupon and redeems at 100
Interest Paid = Fixed Rate *Constant
Notional (e.g. 5% * 100 = 5) Redemption = Constant Notional
(e.g. 100)
A Canadian style Linker pays a realcoupon and redeems at 100 in realterms
Index Ratio = CPI Index onPayment Date / CPI Index onIssue Date
Interest Paid = Fixed Rate * InatedNotional
= Fixed Rate * Notional * IndexRatio (e.g. 2% * 100 * 1.5 = 3)
Redemption = 100 * Index Ratio
(e.g. 100 * 1.5 = 150)
Some ILBs (like US TIPS or OATei/i)have a deation oor, meaning aprincipal repayment of minimum par isguaranteed by the issuer
Fig. 1:Vanilla Fixed Rate Bond versus InationLinked BondSource: Deutsche Bank
RealNominal
3.1Ination Linked Bonds
1 2 3 4 5 6 7 9 10
6%
5%
4%
3%
2%
1%
0%
Year
7%
8%
9%
10% Coupon Principal
80%
60%
40%
20%
0
100%
120%
140%
160%
Expand
Infation Linked Bonds
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Real Yield and Breakeven InationComponents of nominal interest rate:
Real yield Expected Ination Risk Premium Liquidity Premium
Issuing nominals means investors needcompensation for ination uncertainty.
Linkers save issuers the risk premiumby providing certainty about real cashows in the future i.e. their increasein purchasing power is locked in.(gure 1)
Fig. 1:Components of Nominal YieldSource: Deutsche Bank
Ination ProtectionWith positive ination, the ILBs cashows will increase over time to securethe investors purchasing power.
Compared to a nominal bond earlycoupon payments will tend to be lower,and the nal repayment will tend to behigher.
The examples below assume an annualcoupon and ination at 2%. (gures 2and 3)
Fig. 2:Nominal cash owsSource: Deutsche Bank
Coupon Linker (2%) Notional Conventional (rhs)Coupon Conventional Bond (4%) Notional Linker (rhs)
Fig. 3:Real cash ows (purchasing powerof the CFs)Source: Deutsche Bank
Coupon Linker (2%) Notional Conventional (rhs)Coupon Conventional Bond (4%) Notional Linker (rhs)
1 2 3 4 5 6 7 9 10
6%
5%
4%
3%
2%
1%
0%
7%
8%
9%
Nominal Yield
Breakeven RateIndex Linked Bond
Real YieldInflation
ExpectationsRisk
PremiumLiquidityPremium
1 2 3 4 5 6 7 8 9 notl10
60
40
20
0
80
100
120
140
6
4
2
0
8
10
12
14
1 2 3 4 5 6 7 8 9 notl10
60
40
20
0
80
100
120
6
4
2
0
8
10
12
3.2Ination Linked Bonds
Real Yield and Breakeven Infation and
Infation Protection
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IndexationTo oer ination protection you needto: (i) choose a price index, (ii) deneprecise linking rules.
Price index: typically a non-seasonallyadjusted, ocial consumer price index
Indexation: the Canadian model isnow the benchmark, adopted amongothers by TIPS, EUR ILBs and newUKTi (gure 1) Problem: CPI only monthly and
published with a delay The price factor used to ination
adjust cash ows, the DailyInation Reference (DIR), is a linearinterpolation ofthe two monthly values of the ocialprice index three months earlier andtwo months earlier, e.g.:
The DIR for 1 June is theocial CPI March (releasedmid-April)
The DIR for 1 July is theocial CPI April (releasedmid-May)
The DIR for 23 June is: CPI(Mar) + 22/30 *[CPI(Apr) CPI(Mar)]
Breakeven InationCanadian style linkers are quoted inreal terms and the real price (P) - realyield (r) relationship is equivalent tothat of a conventional bond (c: coupon):
ILBs value is often expressed in termsof ination rather than in terms of realyields by considering the dierence inyield between nominal and real bonds.
BEI (Breakeven Ination) is the inationrate that equates the expectedreturn of an ILB and a comparablenominal bond; i.e. if actual inationuntil maturity exceeds BEI, linkersoutperform nominals.
In practice, the market looks at simpleyield spreads (gure 2).
Fig. 1:IndexationSource: Deutsche Bank
Fig. 2:BEI nominal yield real yieldSource: Deutsche Bank
Real YieldNominal Yield
Jan 04 Jun 04 Nov 04 Apr 05 Sep 05 Feb 06 Jul 06
100
99
98
97
96
101
102
103
BTPe
i08
BTANe
i10
BTPe
i10
OATe
i12
BTPe
i12
OBLe
i13
BTPe
i14
OATe
i15
DBRe
i16
BTPe
i17
OATe
i20
BTPe
i23
GGBe
i25
OATe
i32
BTPe
i35
OATe
i40
Breakeven Inflation
%
4.5
4.0
3.5
3.0
2.5
1.5
2.0
1.0
5.0
5.5
6.0
3.3Ination Linked Bonds
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Indexation and Breakeven Infation
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Risk Measures The concepts of duration and
convexity can be applied to linkersin the same way as for conventionalbonds
But in the case of linkers, durationdescribes the sensitivity of the priceto a change in the real rate
Linkers have a higher duration thansame maturity conventionals
Convexity rises exponentially withduration, for the same maturity ILBshave a higher convexity thannominals
EM Sovereign Linker Markets Most Latin American ination
markets have long histories; Brazil isby far the largest market, suppressionof investment restrictions in 2006spurred international demand
Chile, Colombia & Uruguay alsoissue ILB
Israel has a large linker market(USD27bn market value) More recently South Africa, Poland,
Turkey (2007) and South Korea (2007)
Seasonality Seasonal movements in price indices
mean that ination accrual is notlinear
Quoted real yields of ILB adjust to thechanging ination uplift
real yields & BEI exhibitseasonal patterns
detecting the seasonalpattern in prices is importantfor valuing ILBs
Estimation of seasonal factors is notwithout diculties, especially in theeuro area where there is instability
There is no consensus on theirprecise value
US TIPS The US sovereign linker market is the
largest globally with total marketvalue in excess of USD700bn (gure 1)
TIPS were rst issued in 1997; inrecent years, there have been two
5y, two 20y and four 10y auctions peryear; in February 2010 30y TIPS werereintroduced, replacing the 20y
Maturities range from 1y to 30y
Fig. 1:US TIPS total outstanding market valueSource: US Treasury
3.4Ination Linked Bonds
2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 12010
300
200
100
0
400
500
600
700 US Db n
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Risk Measures, EM Sovereign Linkers,Seasonality and US TIPS
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UK Index Linked Gilts The UK linker market is the oldest in
Europe (rst issuance 1981) Total market value exceeds
GBP270bn and more than 20% ofsovereign debt is linked to ination
Traditionally bonds have an 8Mindexation lag, but since Sep 2005 allnew issues follow the 3M lag model;UKTi have no deation oor
Issuance has been weighted towardsthe long end
Maturities range from 1Y to 50Y,with issues available on all maincurve points (gure 1)
Fig. 1:UK Total Outstanding Market ValueSource: UK DMO
EUR Sovereign Linkers Euro area sovereign ination-linked
bond (ILB) markets are expandingrapidly with the total market valueexceeding EUR320bn today
France, Italy, Germany & Greeceissue ILBs
Italian, German and Greek ILBs arelinked to euro area ination; Franceissues both bonds linked to EURination and bonds linked to FRFination
Maturities range from 1Y to 32Y, withissues available on all main points onthe curve (gures 2 and 3)
Fig. 2:EUR Sovereign Linker IssuanceSource: National Treasury
FR DEIT GREUR (rhs)
Other important markets includeAustralia, Canada and Sweden AUD: govt suspended issuance in
2003, but started again in 2009.Strong liability related demand fromPF and insurance companies
Sweden: linkers account for almost30% of the total government bondmarket, a higher share than in anyother industrial market
Fig. 3:Sovereign Linkers, Outstanding VolumeSource: National Treasury
Germany Fr (FRCPIxt)France ItalyGreece
2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0
110
60
160
210
260
310 US Db n
20102009200820072006200520042003
5
10
15
0
20
25
30
35
50
100
150
0
200
250
300
350Linker Issuance
EURbn
Total Outstanding
EURbn
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031
2033
2035
2037
2039
2041
5
10
15
0
20
25
30
35
4 0 E UR bn
3.5Ination Linked Bonds
UK Index Linked Gilts, EUR Sovereign Linkers,and other Important Markets
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Price index BBG Index lag Deation oor Coupon
US CPI-U CPURNSA 3M YES semi-ann
UK RPI UKRPI 8M/3M NO semi-ann
FRCPI x tob, FR FRCPXTOB 3M YES annual
HICP x tob, EMU CPTFEMU 3M YES annual
IT HICP x tob, EMU CPTFEMU 3M YES semi-ann
JP CPI x fresh food JCPNJGBI 3M NO semi-ann
SE CPI SWCPI 3M YES (new ILB) annual
CA CPI CACPI 3M NO semi-ann
GR HICP x tob, EMU CPTFEMU 3M YES annual
DE HICP x tob, EMU CPTFEMU 3M YES annual
AU CPI quarterly ACIF 6M YES quarterly
3.6Ination Linked Bonds
Most ILBs have coupon frequency and settlement characteristics in line withthe nominal market
ILB coupon frequency and settlementcharacteristics
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4Ination Swaps
ILS Swaps and MarketsUK Swaps, Corporate Linkers and US SwapsILS IndexationILS Pension Fund Demand
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Ination Linked Swaps (ILS) a pureination product as opposed to a realrate product
What is an Ination Swap?The cash-ows Receive Compounded Ination from
Start to Maturity: pay one cash-ow CPIt/CPI0 -1 Pay a known Fixed cash-ow at
Maturity (1 + X%)^t
What is the break-even rate? Receive Compounded Ination from
Start to Maturity: pay one cash-ow CPIt/CPI0 -1 Pay a known Fixed cash-ow at
Maturity (1 + X%)^t
ILS MarketsThe most liquid ILS are typically thoselinked to the same price index as theination-linked government bonds ofthe corresponding market (US CPI-U,EUR HICP ex-tobacco, French CPI extobacco, UK RPI).
For the major markets, ZC ILS areusually quoted for tenors out to 30years, sometimes 50 years.
Fig. 1:Ination Swaps
(1+BEI)N1
Fixed
Floating
Client
CPI(N)
CPI(0)1
4.1Ination Swaps
ILS Swaps
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UK Swaps and Corporate LinkersNon-sovereign ination supply in bonds& swaps has grown rapidly in the UK inparticular 2006 and H107
MarketPriceIndex
Lag CPI Fixing
US CPI-U 3M Interpolated
Euro areaHICP extobacco
3M Straight
FranceCPI ex
tobacco3M Interpolated
UK RPI 2M Straight
US SwapsThe ination swap market hasdeveloped rapidly from 2004, butremains less liquid than its Europeancounterparts
A lack of natural ination swap supplytranslates into structural richness inswap BEI vs bond BEI and wide linkerASW discounts
Fig. 1:Bond Breakevens vs Swap BreakevensSource: Deutsche Bank
USCPI ZC swap ratesTIPS-implied ZC B/E
Fig. 2:Measures of Relative Value: ASWSpread and Z-spreadSource: Deutsche Bank
US Linker Z-spread discountUS Linker ASW discount
4.2Ination Swaps
0 5 10 15 20 3025
2.5
2.3
2.1
1.9
2.7
2.9
3.1 %
TIIApr13
TIIJ
ul13
TIIJa
n14
TIIApr14
TIIJ
ul14
TIIJa
n15
TIIApr15
TIIJ
ul15
TIIJa
n16
TIIJ
ul16
TIIJa
n17
TIIJ
ul17
30
25
20
15
5
10
0
35
TIIJa
n18
TIIJ
ul18
TIIJa
n19
TIIJ
ul19
TIIJa
n20
TIIJ
ul20
TIIJa
n21
TIIJa
n25
TIIJa
n26
TIIJa
n27
TIIJa
n28
TIIApr28
TIIJa
n29
TIIApr29
TIIApr32
TIIFe
b40
TIIFe
b41
ExpandExpand
UK Swaps, Corporate Linkers and US Swaps
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ILS IndexationFor FRCPIxt & US CPI, the indexationlag convention is the same as for thecorresponding ination-linked bondmarkets Strong demand has led to a low
level of real interest rates, lock inlow nancing costs
PFI projects with ination component(usually bonds, but typicallytransformed into ASW)
Credit wrapping allowed corporatesto issue highly rated debt whichis more appealing to institutionalinvestors
But has fallen signicantly during thecredit crisis
Main sources: regulated utilities, PFIs,property leases, railway companies,retailers, supranationals
Alternative supply has led to two-wayswap market and narrow swap-bondB/E spread, but swap richness hasincreased again during the crisis
4.3Ination Swaps
ILS Indexation
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ILS Pension Fund demand In the UK, pension indexation to RPI
(LPI) is more explicit than elsewhereand the pension industry is largerthan in other European countries
Accounting rules (FinancialReporting Standard 17) haveencouraged pension funds to matchtheir indexed liabilities more closely
As a result, demand growth frompension funds and life insurers hasoutstripped supply leading to lowreal yields and expensive BEI at thelong-end of the curve But has fallensignicantly during the credit crisis
Long-term investors own themajority of ILB as a hedge fortheir real liabilities
All public and part of private sectorpension liabilities will be linked to CPI(instead of RPI) from scal year2011/12 future issuance of CPIlinked Gilts looks possible
Fig. 1:Real YieldsSource: Deutsche Bank
USUKFRF
Fig. 2:UK Non-sovereign Ination SupplySource: Deutsche Bank
UK Non-sovereign ination supply
Fig. 3:UK Non-sovereign Ination SupplySource: Deutsche Bank
OtherRailUtility
4.4Ination Swaps
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0
0.5
1.0
1.5
2.0
2.5
2058
Maturity
Real Yields
205020422034202520172009 Q310Q305 Q306 Q307 Q308 Q309
500
1,000
1,500
0
2,000
2,500
3,000
3,500
4,000 GBPm
2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0
6,000
5,000
4,000
3,000
2,000
1,000
0
7,000
8,000
9,000
10,000 Issuance
GBPm
Expand
Expand Expand
ILS Pensions Fund Demand
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5Assessing Relative Value
Linker Asset Swap and the Leverage Eect5 Sources of Asset Swap DierenceWhat is the Fair Price for Ination Protection?Fair Credit Spread of Ination Linked BondsHedge with Bonds or SwapsSummary
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Linker Asset Swap Investor buys an Ination Bond Investor agrees to pay away all the
cash-ows (P+I) from the bond Investor receives in return Libor +
x% until maturity as well as aprincipal payment
The Leverage EectSophisticated investors may notbe able to borrow to buy additionalnominal bonds due to constraints,hence are willing to give up some oftheir excess return
Some investors just like the pick-upover equivalent tenor nominal bondson asset swap (gure 2)
For example
This is how we expect a Linker toincrease in the Eurozone over time
Why is this important?Sovereign default is currently very realpossibility like for like exposuresneed to be carefully assessed for fairvalue some investors have increasedcredit risk for very little reward
Fig. 1:Linker Asset SwapSource: Deutsche Bank
Fig. 2:The Leverage EectSource: Deutsche Bank
InationLibor
5.1Assessing Relative Value
Libor + X
Inflated Notional Inflated Notional
Notional
InvestorLinker
CPICPI
0 5 10 15 20 25
Constant Swap Notional
Increasing Credit Exposure
30 35 40Years 45 50
150
100
50
0
200
250
300
350 Notiona l
The increasing credit exposure,and thereby return, on a linkerasset swap generates signicant
outperformance Daragh McDevitt,Global Head of Ination Structuring
Expand
Expand
Linker Asset Swaps and the Leverage Efect
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5 Sources of Asset Swap Dierence
PV01 dierence Linkers have a higher duration
Swap richness The spread between ination-linked
swaps and implied bond break-evensgives rise to dierent asset swaplevels for linkers and nominals
It also usually tells the story of swapsupply and demand
Seasonality See the section on page 3.4
Credit / Liquidity Mis-priced credit cost leading to
value for issuers
Tax Favourable deferrals for issuers
encourage supply
The dierence between a nominalasset swap and a Linker Asset Swapof the same maturity is a function ofthe larger credit exposure, the termstructure of credit and the swaprichness
For example20 bps richness results in an additional28 bps on asset swap a 40% increase
Fig. 1:
Measures of Relative ValueSource: Deutsche Bank
Adjusts forDirty Price
Accounts
for CashowPattern
Accounts forTerm Structure
of Credit
Fair ValueDiscounting
Par par ASW
Net ProceedsASW
Z spread
Richness
5.2Assessing Relative Value
Of these comparative measuresrichness is the true measure
Stephane Salas,Global Head of Ination Trading
5 Sources of Asset Swap Dierence
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What is the Fair Price for InationProtection?
Ination Breakeven is not equal tomarket ination expectations but is afactor of Ination expectations Risk Premium Liquidity Premium
Ination expectations over the verylong run are hard to judge but tend to
be based on current economic policy ECB target rate is under, but close
to 2%
Risk Premium includes Potential change in monetary policy
target (e.g. 4% plus or minus 1%instead of under 2%)
Abandonment of monetary policyin favour of employment orcurrency board
EUR breakup, expansion orsuccession
Asymmetric elasticity of ination:wages are easier to raise than to cut
Liquidity premium includes Relative demand and supply for
ination bonds v nominal bonds Balance sheet costs of holding
ination bonds to recycle ination Opportunity cost of capital for cash
used to hedge ination
5.3Assessing Relative Value
The biggest mistake people makewith ination-linked bonds isthinking that the breakeven inationis the markets expected inationrate. It is not and should not be.The breakeven includes what themarket expects ination to beand the major portion of the riskpremium that you should nd inthe nominal market, and theliquidity premium
Markus Heider,Global Head of Ination Research
What is the Fair Price for Ination Protection?
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Fair Credit Spread of InationLinked BondsIssuing Linkers equates to borrowingmore over time in nominal terms i.e. itcan be thought of as a set of forwardstarting bonds
Forward starting bonds = greatercredit risk
Two components to fair price: The issuers current credit spread for
the maturity of the bond Forward credit spreads for each of
the forward starting borrowings i.e.forward credit spreads
A simple point, but investors may notrecognise and price this correctly
Fig. 1:Linker as a Series of ForwardStarting BondsSource: Deutsche Bank
Initial Principal Amount Fwd Borrowing Year 1Fwd Borrowing Year 2 Fwd Borrowing Year 3Fwd Borrowing Year 4 Fwd Borrowing Year 5Fwd Borrowing Year 6 Fwd Borrowing Year 7Fwd Borrowing Year 8 Fwd Borrowing Year 9
Fig. 2:Creating a synthetic 30-year oldNominal BondSource: Deutsche Bank
5.4Assessing Relative Value
0 1 2 3 4 5 6 7 8Years 9 10
60
40
20
0
80
100
120
140 Borrowed Amount
=
EUR 100mm
EUR 25mm
EUR 25mm
EUR 50mm
20y @ 130bp
10y @ 100bp30y accreting @ 175bp
30y @ 150bp
Expand
Fair Credit Spread of Ination Linked Bonds
Expand
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The Question isHedge with Bonds or SwapsTraditionally, many investors haveprimarily considered ination-linkedbonds to hedge exposure
However, a more modern approach is: Bonds can be cheaper or more
expensive than swaps Buy the cheapest asset Hedge the ination with swaps Opportunistically switch
between assets
This also gives a lot more exibility tohedge the desired cash ows, since atthe long-end there are only relativelyfew bonds outstanding (and liquiditycan be better as well)
Fig. 1:Swap Ination Price Bond Ination PriceSource: Deutsche BankPast performance is not a reliable indicator of future performance
UK ItalyFrance (French CPI) GermanyFrance (Euro CPI)
The Bond UniverseValue within the UK for exampleFigures 3 and 4 on the right depict thevalue that can be created by switchingbetween similar maturity nominal andination linked bonds.
Figure 2 below depicts the value inswitching between short and longmaturity linkers.
In terms of trading capability, howdoes this work?We should always be free to switchbetween UK Bonds and UK Linkers
Fig. 2 :PV Gain of UKTi40 over the UKTi27Source: Deutsche BankPast performance is not a reliable indicator of future performance
Switch inSwitch out
Fig. 3:PV Gain of UKTi27 over the UKT27Source: Deutsche BankPast performance is not a reliable indicator of future performance
Switch inSwitch out
Fig. 4:PV Gain of UKTi40 over the UKT40Source: Deutsche BankPast performance is not a reliable indicator of future performance
Switch inSwitch out
5.5Assessing Relative Value
2 0 10 2 0 16 2 0 21 2 0 27 2 0 32 2 0 38 2 0 43 2 0 49 2 0 54 2 0 60
10
0
-10
-20
20
30
40
50
01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11
2
0
4
6
8
10 PV Gain (%)
01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11
2
0
4
6
8
10 PV Gain (%)
01/ 10 03/ 10 05/ 10 07/ 10 09/ 10 11/ 10 01/ 11 03/ 11
2
0
4
6
8 P V Gai n ( %)
Expand
ExpandExpandExpand
Hedge with Bonds or Swaps
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To sum up Given the displacement between
ination and nominal markets, thereare opportunities for arbitrage
Asset swap spreads on linkersrepresent a premium for credit thatis hard to price, and when coupledwith demand/supply imbalances andhigher duration, they oer a pickupto nominals for the same underlyingissuer
Switching between equivalent risk
sovereigns/supra sovereigns canoften, driven by dynamics of thecross currency swaps market,provide additional yield pick-ups
These displacements can beassessed by a variety of metrics
The value of switching is evidentfrom the incremental excess pickupthat is generated by selling thecostlier asset to buy the cheapestasset from time to time
Used as a systematic strategythis can yield substantial returnsover medium term horizons
These represent incredible
opportunities for asset-heavyinvestors, and the markets willlikely normalize with time, henceit is important to act quickly
5.6Assessing Relative Value
There isnt one risk free curve,there are 100, 150, 200 the key iswhen do you pick the fruit, whenis the bond cheap enough?
Daragh McDevitt,Global Head of Ination Structuring
there are incredible opportunitiesfor asset-heavy investorsit isimportant to act quickly
Haroon Sana,Global Head of Rates Sales
Summary
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6Ination Options
Ination OptionsWho are the major players in the options market?Option ProductsWhat are the trading opportunities?Option StrategiesCreating Optimal Hedges
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A relatively new market, inationoptions traded between Europe andthe US have doubled every year sincetrading started in ination swaps in2002/2003. 2010 saw a particulargrowth spurt.
Long term growth looks set tocontinue at this explosive rate, whichis clearly indicative of its importanceto clients and represents a substantialopportunity to DB as intermediary
between buyers and sellers of ination.
Interbank volumes reached 50bn in2010, up from 13bn in 2009, and just1bn in 2005.
Fig. 1:London Options VolumesSource: Tullett Prebon
Fig. 2:NY Options VolumesSource: Tullett Prebon
6.1Ination Options
01/09
03/09
05/09
07/09
09/09
11/09
01/10
03/10
05/10
07/10
09/10
11/10
01/11
03/11
400
200
600
0
800
1,200
1,400
1,600
1,800 Volumes
(millions)
01/09
03/09
05/09
07/09
09/09
11/09
01/10
03/10
05/10
07/10
09/10
11/10
01/11
03/11
1,000
2,000
0
3,000
4,000
5,000
6,000
7,000 Volumes
(millions)
ExpandExpand
Infation Options
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The market is becoming more andmore complex as sophisticated newplayers such as hedge funds, liabilitydriven investors, and non-life insurancepractitioners are added to the mix.
Any client: holding a bond portfolio subject to tail ination high or low who has revenues or liabilities that
are indexed to inationis exposed to ination risk
6.2Ination Options
Hedge Fund Real Estate Investor
Asset Manager
Inflation Options
MarketInsurance Company Pension Fund
Directional/RV TradesHedge LPIRevenues
Hedge LPI
Liabilities
Buy Deflation
Protection
Monetize
Embedded
Floors
Expand
Who are the major players in the Options market?
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Year on Year cap/oor YoY oorlet : Max [ K - YoY
t, 0 ]
With YoYt= I
t/I
t-1- 1
A 5 year 0% YoY oor costs 80cor 18bp p.a.
Demand from retail notes >> Supplyfrom premium sellers
Zero Coupon cap/oor ZC oor: Max [ (1+K)^t - I
t/I
0, 0 ]
A 10 year 0% ZC oor costs 55c Supply from linkers and asset swaps
>> Demand from deation hedgers
Limited Price Index (LPI) LPI
t= LPI
t-1* { 1 + max [ min [ YoY
t,
5% ] , 0% ] } Ination observed annually, collared,
compounded and paid at maturity Demand from LDI funds >> Supply
from real estate investors
Fig. 1:5y 0% YoY oor HICPxTSource: Deutsche BankPast performance is not a reliable indicator of future performance
Fig. 2:10y 0% ZC oor HICPxTSource: Deutsche BankPast performance is not a reliable indicator of future performance
Fig. 3:Limited Price Index (LPI)Source: Deutsche Bank
Fig. 4:DB Ination pages: DBII
6.3Ination Options
04/09 10/09 04/10 10/10 04/11
40
20
60
80
0
100
120
140
160
-2%YoY Inflation -1% 0 % 1 % 2 % 3 % 4% 5% 6% 7%
1.0
2.0
0
3.0
4.0
5.0
6. 0 %
0 8/ 06 0 5/ 07 02/ 08 11 /0 8 08 /0 9 0 5/ 10 0 2/ 11
100
50
150
200
0
250
300
350
400 Price (bps)
Expand
Expand
Expand
Options products
Expand
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LPI Collars represents a great ination-hedging alternativeInation risk for Pension funds andother liability-driven investors is big,20 30% of scheme risk.
Breakevens are deemed expensive: if,for example, breakeven is 3.7% andthe scheme expected ination of 2.8%,hedging loses value (gure 1).
Whats the solution?
Cover ination risk by creating anination collar Pay LPI Receive RPI
Expert historical perspectiveMarkus Heider, responsible forEuropean ination research at DBGlobal Markets Research, providesa useful long term perspective: thisgraph shows how the volatility we haveseen in the last three years is nothingcompared to the last 200 years. In thelong run, ination is a very volatileentity, which means risk and therefore,opportunity.
The relative stability weve seen in thelast 20 years can very quickly change
Signicant risk factors currently includegovernments with unsustainabledecits and globalisation; the needto hedge ination risk is becomingincreasingly relevant
Fig. 1:Assumed Constant Year on YearInation ReturnSource: Deutsche Bank
RPI ZC Swap100% LPI Collar
Fig. 2:Consumer price ination, y/y%, 11-yr MASource: EH Net
UKUS
1. US war of Independence2. Napoleonic Wars decit monetised3. 1st Industrial Revolution: productivity- led deation4. US Civil War5. 2nd Industrial Revolution: productivity rebounds; gold nds6. Fiscal monetisation during WWI7. Great Depression8. Fiscal monetisation during WWII9. Fiscal monetisation during Vietnam War; oil shocks10. Volcker clamps down on ination
6.4Ination Options
-2%-3%-4% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8%-30
40
30
20
10
0
-10
-20
Payoff
30y Breakeven3.63%
180017751 75 0 1 82 5 1 85 0 1 87 5 1 90 0 1 92 5 1 95 0 1 97 5 2 00 0
-10
15
10
5
0
-5
2
3
4
5
6
7
8
9
10
1
The catalyst that makes this tradework is ination at above 5% this5% strike is currently lower thanspot ination a change from thelast ve years
Nicolas Tabardel,Global Head of Ination Volatility
and Exotics
Expand
Expand
What are the trading opportunities?
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Market vs Economist ExpectationsUK RPI future ination: the marketin the long term is pricing muchmore downside risk than upsiderisk. In the UK, the risks of inationovershooting are much higher thanthem undershooting. This is contrary towhat we see in other markets.
In Europe and the US, there is morebalance; caps are becoming moremuch more expensive than oors.
Consensus economist predictionsindicate that market implied volatilityis too high; tails are too fat and theskew is too deep. Caps have no naturalsupply in Europe or the US so the tailrisk is always expensive (gure 1).
In Europe, volatility is too high, tails aretoo fat, and the skew is too steep.
What does this mean?Selling volatility now is a good idea
The skew was pricing oors higherthan caps; the skew is now symmetric(gure 2).
Fig. 1:Skew prices oors higher than capsSource: Deutsche Bank
SPF prob distribution for 5y in forecastMarket Implied Probability from EUR YoY caps/oors
1. Deation risk is overpriced2. Consensus economist predictions imply market implied volatility is too high3. Fat Tails
Fig. 2:Ratio of market implied probability vs.Economist ExpectationsSource: Deutsche Bank
6.4Ination Options
0
0.4
0.3
0.2
0.1
4
%
1
2
3
0
40
30
20
10
4
Value in selling wingsdistribution i.e. far out of
the money caps and floor
We expect this trend to continue,
so that by the end of 2011, capsbecome more expensive than oors,better reecting fundamentals
Stephane Salas,Global Head of Ination Trading
Expand
Expand
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Collars (gure 1) Sell Floor Buy Cap
Strangles (gure 2) Sell OTM Floor Sell OTM Cap
Straddles Sell Floor and Cap at same strike
Range Accruals
Pays N/12 * Fixed Rate, Annual N = No. of months 1% < YoY EUR
HICP
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Building Blocks Selling a 0% YoY oor Selling a 1x / 2x cap spread
Premiums 5Y 0% oor generates 160bps 5Y 2% cap costs 260bps 5Y 5% cap costs 100bps
Using these componentsZero cost and benets from inationbetween 2% and 8%
Covered Linker Switches Sell nominal bond Buy Linker Sell year on year caps @ 2.5% on
coupons and principal
OATei15 OATei22 OATei32
Covered Caps (%) (%) (%)
Upfront Premium 1.59% 3.95% 11.39%
Running Premium(annual, 30/360) 0.40% 0.42% 0.73%
Real Yield Pick-Up 0.32% 0.35% 0.43%
EectiveBreakeven Rate foroutperformance of
nominals
1.25% 1.44% 2.67%
Fig. 1:Sell 0% oor, But 1x/2x Cap SpreadSource: Deutsche Bank
6.6Ination Options
-1.5
3.0
1.5
2.5
1.0
0.5
0.0
-0.5
-1.0
-2 -1 1 20 3 654 7 8 9 10
Payoff (%)
YoY Inflation Print (%)
Expand
Creating Optimal Hedges
Contents
7Deation Tail Risk
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7Deation Tail Risk
Deation Tail Risk: DB 5 Year Note
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Deation tail risk: DB 5 Year NoteInvestors can take advantage of thesubstantial dislocations in the InationOption Market by selling deep out ofthe money Ination Floors.
A 5 year DB Deation Noteprovidesa return over 4% per annumif YoYEuro-zone Ination prints above -2.0%,providing 190 bps of pick up over 5yEUR Swap Rates.
Euro-zone ination printing below-2.0% is an unprecedented event, neverseen in ANY Euro economy.
The below note details indicativeterms and compelling reasons forinvestors to take on this risk for abovemarket returns.The last section looksat variations in USD, GBP in additionto alternate ways of monetizing theopportunity in EURs
The underlying market dislocationsare unsustainable and will soon beremoved by exogenous liquidityprovided by real money accounts.This opportunity represents clear value.
DB Short Deation Risk Note Indicative Trade Terms
Indicatitive Terms
Currency EUR
Format DB Funded Note
Maturity 5 years
Issue Price 100.00
Re-Oer 99.00
Redemption121 - Floor(T), minimum
return of 0.00
Where
FLOOR(T)121 * Sum[ Floor(t) ] for
t = 1,2,3,4,5
Floor(t)12 * Max (Floor Strike - YoY
Ination, 0%)
Floor Strike -2.00%
YoY Ination
CPI(t) / CPI(t-1) -1Where CPI(t) is the EURHICP ex Tobacco Index(CPTFEMU Index) 3m
prior to Observation Date tCPI(t-1) is the EUR HICP exTobacco Index (CPTFEMU
Index) 15m prior toObservation Date t
Reference Rates5y Ination B/E 1.735%5y Swap Rate 2.16%Max IRR 4.065%
7.1Deation Tail Risk
Deation tail risk: DB 5 Year Note
Contents
8Case Study: Zero Coupon Option Trade
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8Case Study: Zero-Coupon Option Trade
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During the rst six months of 2010,a Toronto-based insurer purchaseddeation protection worth $21.539billion in notional, paying $173.7 millionin premium. The 10-year zero-coupon0% options were denominated indollars, euros and sterling, and wereexecuted by Deutsche Bank and Citi.
The other side of the trade was largelytaken by California-based xed-incomemanager Pimco, which reported it had
sold more than $8 billion of 10-yearzero-coupon 0% ination oors in aling dated August 27. The oors weresold in return for more than $70 millionin premium, with Deutsche and Citi ascounterparties.
The transaction made perfect sensefor both participants. For the insurer,the 0% oors acted as a hedge againstdeation and the impact that wouldhave on its equity portfolio. At the
same time, Pimco was able to cash inon 0% ination oors embedded in itssizable portfolio of Treasury ination-protected securities (Tips). Dealers saythe headlines generated by the tradehad a positive impact on the market,encouraging other clients to express
their views on the direction of inationby buying or selling zero-couponoptions.
Daragh McDevitt, DB Global Head ofInation Structuring said, It sparkedinterest because you have veryintelligent investors on both sides whoare taking opposite sides of the trade.
Since Q2, 2010, quantitative easinghas encouraged more clients to sell
implied ination volatility at levels thatlook expensive. In particular, manymarket players have looked to playination volatility versus interest ratevolatility for example, by buyinginterest rate caps and selling inationcaps at similar strikes. Weve seen alot of clients coming in on the sameside as Pimco, viewing the probabilityof deation priced in by these optionsto be inated. They are either sellingthe options embedded in their bond
portfolios, selling the options outrightor entering into some kind of interestrate options strategy, says McDevitt.
The transaction made perfect sensefor both participants. For the insurer,the 0% oors acted as a hedge againstdeation and the impact that wouldhave on its equity portfolio. At thesame time, Pimco was able to cash inon 0% ination oors embedded in itssizable portfolio of Treasury ination-protected securities.
Case Study
Case Study: Zero-Coupon Option Trade
Contents
9Further Reading
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9Further Reading
ContentsContents
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Ination Hedging for InstitutionalInvestorsExamining dynamic asset allocationstrategies for high ination scenariosand the eect of nancial marketchanges on ination hedginginstruments.
Weekly Ination Research update
Research Ination Markets Guide
Ination Big Picture Study
Further Reading
Further Reading
Contents
Examining dynamicassetallocation
strategies forhigh inflation scenarios and
the effectof financialmarketchanges on
inflation hedging instruments
INFLATION
HEDGING FOR
INSTITUTIONALINVESTORS
PU
B
LISH
ED
BY
ALSO SPONSOREDBY
MEDIA PARTNERS
JUNE | 2011
CLEARPATH ANALYSISINPARTNERSHIPWITH
Global
7 October 2011
DB Inflation Report
Weekly Inflation Update
Deutsche BankAG/London
Allprices are those currentatthe endof the previoustrading session unless otherwise indicated. Prices aresourcedfrom local
exchangesvia Reuters, Bloomberg andother vendors. Data is sourcedfrom Deutsche Bankandsubject companies. DeutscheBankdoes andseeks todobusiness withcompaniescoveredin its researchreports.Thus, investorsshouldbe aware thatthe firm
may have a conflictof interestthatcouldaffect the objectivity of thisreport. Investorsshould considerthisreportas only asinglefactor in making their investmentdecision. DISCLOSURES ANDANALYST CERTIFICATIONSARE LOCATEDIN APPENDIX1.
MICA(P)146/04/2011.
Strategy Update
Change inbreakevens, US& UK
-10
-5
0
5
10
15
20
25
30
2 y 5 y 10 y 3 0y 2 y 5 y 10 y 3 0y
1Wchange inBEI
carryadjusted
GBP USD
Changeinbreakevens,EUR& FRF
-10
-5
0
5
10
15
20
2 y 5 y 1 0 y 3 0y 2 y 5 y 10 y 2 0y
1WchangeinBEI
carryadjusted
EUR FRF
ILB rich/cheap vsnominals
-20
0
20
40
60
80
100
120
2 01 2 2 01 7 2 02 3 2 02 8 2 03 4 2 03 9 2 04 5
G BP D EM
U SD F RF
ITL
Rich(-)/cheap (+)vs nominalcurve
Source: DeutscheBank
Upcoming data
Mkt Indicator Date, GMT
FRF CPISep 12Oct, 05:30
DEM CPI Sep 13 Oct, 06:00
EUR HICP Sep 14 Oct, 09:00
Research Team
MarkusHeider (+44)20754-52167
AlexLi(1) 212 250-5483
Vanshree Verma (+44)20754-77583
Macro
GlobalMarketsResearch
Economics: This weeks PPIdata pointto further upwardpressure on UK and
euroarea consumer core inflation in the coming months. Business survey price
balances havecontinuedto fallin September however, whichis consistentwith
theviewthatCPI inflationwillslow in 2012.
Global: 10y EURreal rates looktoohigh relative toUSD againstthe recentdata
divergence. We prefer long-endTIPS andUKTi B/Es over OATei.
EUR: Theongoingdeterioration ineconomicdata remainschallenging for B/Es. In
RV, we prefer the 10y sector andthe DBRei-20 in particular.
GBP: While realyield valuations are challenging,the schedulednew 50ylinker
issue shouldlook attractive relative tonominal gilts (in B/Eand ASW), RPIswaps
andB/Es in other markets.
USD: ForwardTIPS B/Eshave divergedfrom survey-basedmeasuresofinflation
expectations,althoughdeclines may be exaggeratedby liquidity factors.
AUD: In our view, the marketi s underpricing inflation riskover the short term, with
the gapbetween RBAinflation expectationsand breakevens extremely wide. Our
preferredtrade is long the bellyin 2y/5y/10y ZCS B/Ebutterfly.
Asia: Inflation in Thailand&South Korea fellmore than expectedin September,
supporting ourexpectations of nopolicy ratechange at the next CB meeting.
InflationMarkets
Bond Yld BEI 1Mfwd ASW ASWdiscnt
ZC Rate SprdZC-BEI
CPI/RPI
fcst
US CPI
T I I Ap r -1 6 - 0 . 65 1 . 53 1 . 51 - 18 1 4 5y 1 . 87 3 4 s p ot 3 . 8
T I I Ja n -2 1 0 . 05 1. 8 3 1 . 82 1 3 3 1 10 y 2 . 30 4 8 D e c- 1 1 2 . 9
T I I F e b- 4 1 0 . 90 2 .0 2 2. 0 2 7 6 5 4 3 0 y 2 . 54 5 2 J u n- 1 2 1 . 7
EAHICPxt
D B Re i 1 6 - 0 . 2 2 1 . 24 1. 1 6 -6 5 2 0 5 y 1 . 69 4 5 s p ot 2 . 5
D B Re i 2 0 0 . 31 1 .4 0 1. 3 6 - 48 2 6 1 0 y 1 . 84 4 4 D e c- 1 1 2 . 7
O A Te i 4 0 1 . 4 4 2 . 07 2 . 06 10 9 3 9 3 0 y 2 . 11 4 J u n- 1 2 1 . 8
FRCPIxt
B T AN i -1 6 0 . 2 3 1 . 52 1 . 47 2 1 3 9 5 y 1 . 88 3 6 s p ot 2 . 2
O A Ti - 19 0 . 68 1 . 68 1 . 65 3 7 3 5 1 0 y 2 . 07 3 9 D e c- 1 1 2 . 1
O A Ti - 29 1 . 29 2 . 10 2 . 09 9 8 37 20 y 2 . 18 7 J u n- 1 2 1 . 5
UKRPI
U K T i- 1 6 - 1 . 5 2 2 . 86 2 . 76 -3 1 15 5 y 3 . 11 2 6 s p ot 5 . 2
U K T i- 2 2 - 0 .3 7 2 . 80 2 . 76 9 3 2 10 y 3 . 21 4 1 D e c- 1 1 5 . 0
U K T i- 4 0 0 . 18 3 . 15 3 . 14 4 4 33 30 y 3 . 50 3 5 J u n- 1 2 3 . 7
Source: Deutsche Bank
March 2011
Global Inflation Markets
A guide
Markus [email protected]
Allprices arethosecurrent at theendof theprevious tradingsessionunless otherwiseindicated.Prices are sourcedfrom localexchangesi R t B l b d th d D t i d f D t h B k d bj t i D t h B kd d kvia euters, loombergand othervendors. ata is sourcedfrom eutsche ank and subjectcompanies. eutsche ank does and seeks
todobusiness withcompanies coveredinits researchreports. Thus, investors shouldbeawarethat thefirm may haveaconflictof interestthatcouldaffecttheobjectivityofthis report. Investors shouldconsider this report as only a singlefactorinmakingtheir investmentdecision.DISCLOSURES AND ANALYST CERTIFICATIONSARELOCATEDIN APPENDIX1.MICA(P)007/05/2010
Global
1March2011
Global Macro Issues
Issues in Inflation
Deutsche BankAG/London
Allprices are those currentat the endof the previous trading session unless otherwise indicated. Prices are sourcedfrom local
exchangesvia Reuters, Bloomberg andother vendors. Data issourcedfrom DeutscheBank andsubject companies. Deutsche
Bankdoes andseeks todobusi nesswithcompanies coveredin its researchreports. Thus, investorsshouldbe aware thatthe
firm may havea conflictof interestthatcould affectthe objectivity of this report. Investors shouldconsider this reportas onlyasinglef actor in making their investmentdecision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATEDIN
APPENDIX1.MICA(P)007/05/2010
Economics
Research Team
MarkusHeider
(+44)20754- 52167
Macro
GlobalMarketsResearch
Economics
Abstract
The uncertainty aboutthe longer-term inflation outlookhas risen substantially since
theonsetof thef inancialcr isisin 2008.Af ter15yearsormoreof lowandstable
inflation, professional forecasters, investors andindeedcentralba nks themselves
now consider below andabove targetoutcomes as possible, even probable. The
non-standardreaction of economic policy duringthecrisi s, thediscussion about
potentialchanges tomonetary policyobjectives, the run-up in public debt, butalso
apparentchanges to the inflation process itself during the GreatModeration as
well as theopen inflation implicationsof structural trends like globalisation all have
contributedto the rise in uncertainty. In this notewe look atsome of the main
issues surrounding the inflation outlookand conclude that inflation risks for the
coming yearsseem tobe skewedtothe upside of centralbanktargets.
10Contacts
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ContentsInationHedging it & Trading it Deutsche Bank
10Contacts
ContentsContents
10.1
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InationHedging it & Trading it Deutsche Bank
SalesHaroon [email protected] +44 20 754 73671
Matthew [email protected]+31 2 8258 2010
Michael [email protected]+44 20 754 73671
David [email protected]+44 20 754 74159
Matthew [email protected]+65 68 83 16 20
Ed [email protected]+1 212 250 0551
Tai-Zhong Jiang (Tai-Chu)[email protected]+81 3 5156 6186
StructuringDaragh [email protected]+44 20 754 52750
Xavier [email protected] +44 20 754 72731
Michael [email protected] +65 68 83 08 88
Josh [email protected] +61 2 8258 3619
Research
Markus [email protected] +44 20 754 2167
Alex [email protected]+1 212 250 5483
TradingStephane [email protected] +44 20 754 78809
Nicolas [email protected]+44 20 754 55748
Allan [email protected] +1 212 250 7105
Katsuya [email protected] +81 3 5156 6205
Vaughan [email protected] +61 2 8258 1848
Integrated trading, structuringand research
Unlike some of our competitors, DeutscheBanks ination trading, structuring andresearch professionals work closely together,combining strategic and technical expertisewith the macro-economic insights so
important with this oering.
Contacts
Contacts Deutsche Bank Global Ination Team
Contents
mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Daragh.McDevitt%40db.com?subject=mailto:Xavier.Avila%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Stephane.Salas%40db.com?subject=mailto:Nicolas.Tabardel%40db.com?subject=mailto:Allan.Levin%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Vaughan.Harvey%40db.com?subject=mailto:Vaughan.Harvey%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Allan.Levin%40db.com?subject=mailto:Nicolas.Tabardel%40db.com?subject=mailto:Stephane.Salas%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Michael.Parker%40db.com?subject=mailto:Xavier.Avila%40db.com?subject=mailto:Daragh.McDevitt%40db.com?subject=mailto:Katsuya.Miyoshi%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject=mailto:Dominic.Konstam%40db.com?subject=mailto:Markus.Heider%40db.com?subject= -
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