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An Introduction to Derivative Securities, Financial Markets, and Risk ManagementAdvanced Financial Risk Management, 2nd ed.

 Blog Entries

Kamakura Corporation Named to World Finance 100

August 26, 2014
Transfer Pricing and Valuation Yield Curves without Swap Data: A KeyBank and KeyCorp Example

August 18, 2014
More Evidence on the Funding “Subsidy” of the Too Big to Fail Banks

August 14, 2014
Mortgage Servicing Rights Values Close Mixed for the Week as Current and Forward Mortgage Rates Drop 0.03%

August 13, 2014
Liquidity At Risk – A stochastic look at cashflows

August 12, 2014
Five of Seven Regional Banks Trade at Credit Spreads Better than the Too Big to Fail Banks

August 12, 2014
Kinder Morgan Energy Partners Leads the 20 Best Value Bond Trades with Maturities of 10 Years or More

August 11, 2014
Measuring the Funding Costs of the Too Big to Fail Banks:
The U.S. Dollar Cost of Funds Index™

August 8, 2014
Forward 1 Month T-Bill Rates Plunge 0.26% in 2 Years but Forward 10 Year U.S. Treasury Yield Drops Only 0.04% from Last Week

August 6, 2014
Credit Spreads and Default Probabilities: A Simple Model Validation Example

August 5, 2014
Vodafone Group PLC: Default Risk is Down Sharply But Value Ranks in the Bottom 10% of Bonds

July 30, 2014
American International Group Inc. Bonds:
A Reward to Risk Ratio Twice as High as the Median Bond Issue

July 29,2014
AT&T Inc. Bonds: Ten Times the Risk of IBM and Below Average Value

July 15, 2014
Brazil, Italy, Spain, Credit Default Swaps and the
European Commission Short Sale Ban, 2010-2014

July 14, 2014
Bank of America and MBIA Lead U.S. Bank Credit Default Swap Trading Volume, 2010-2014

March 19, 2014
Stress Testing and Interest Rate Risk Models: A Multi-Factor Stress Testing Example

March 13, 2014
Stress Testing: A Credit Spread Ranking of 12 U.S. and 12 International Banks



Kamakura Blog


Measuring the marginal cost of funds for a financial institution is a critical calculation from both a management perspective and a regulatory perspective. From a management perspective, if one’s own firm faces a funding disadvantage versus a group of banks who are “too big to fail,” that has dramatic implications for corporate strategy. From a regulatory perspective, favoring a group of financial institutions with an implicit guarantee of survival can create an anti-competitive subsidy as an unintended consequence. In this note, we introduce the U.S. Dollar Cost of Funds IndexTM from Kamakura Corporation which makes quantification of funding advantages and disadvantages a practical daily reality. In subsequent notes, we quantify the funding advantages and disadvantages of major financial institutions on a daily basis.

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Long term implied forward 1 month Treasury bill rates more than reversed last week’s increases, plunging this week at intermediate maturities. The largest decrease came in June, 2016 where the forward rate dropped 0.26%. Forward 1 month T-bill rates are now projected to rise steadily until reaching a peak at 3.45% in June, 2021, almost matching the peak of two weeks ago. This peak is 0.17% lower than last week’s peak of 3.62%. The implied forecast shows projected 10 year U.S. Treasury yields rising to 3.72% in 2024, down 0.04% from last week. We also present three potential scenarios consistent with the implied forecast that represent alternative paths for interest rates. This kind of multi-factor scenario generation is essential for comprehensive asset and liability management at banks, insurance firms, pension funds, and endowments.

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One of the most persistently used formulas in fixed income markets is the relationship

Credit Spread = (1 – Recovery Rate)(Default Probability)

This simple formula asserts that the credit spread on a credit default swap or bond is simply the product of the issuer’s or reference name’s default probability times one minus the recovery rate on the transaction. The persuasive belief that this formula, or at least a simple variation on it, is true has led to a wide array of models implying default probabilities from credit spreads. In the popular press, these models are frequently invoked in headlines like “ BP Swaps Put Odds of Default at 39% ,” a June 16, 2010 forecast during the Gulf Oil spill.

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We last reviewed Vodafone Group PLC (VOD) on April 15, 2014.  Since then, the European Commission has approved Vodafone Group PLC’s acquisition of the Spanish cable operator Ono. In order to get an updated bond market view of the firm, we turn to the U.S. dollar bonds issued by Vodafone Group PLC and compare its current default probabilities and credit spreads with those on all heavily traded corporate fixed-rate bonds on August 4, 2014. 

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American International Group Inc. (AIG) was one of the largest beneficiaries of U.S. government supportduring the credit crisis, but the U.S. government’s shareholder status ended in December, 2012. In this note, we turn to the U.S. dollar bonds issued by American International Group Inc. and compare its current default probabilities and credit spreads with those on all heavily traded corporate fixed-rate bonds on July 28, 2014. A total of 38 trades were reported on 9 fixed-rate bond issues of American International Group Inc. with trading volume of $40.4 million on July 28. American International Group Inc. was the 17th most actively traded corporate bond issuer on July 28.

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