European Fixed Income Markets: Money, Bond and Interest Rate Derivatives


The introduction of the euro in 1999 cast a new focus on the financial markets of constituent euro-zone countries, which have subsequently emerged with the second largest bond market in the world. This new book offers in depth insights and advice for any practitioner in the European fixed-income and ancillary derivative markets, and includes in-depth analysis of euro and non-euro markets as well as emerging countries.

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The introduction of the euro in 1999 cast a new focus on the financial markets of constituent euro-zone countries, which have subsequently emerged with the second largest bond market in the world. This new book offers in depth insights and advice for any practitioner in the European fixed-income and ancillary derivative markets, and includes in-depth analysis of euro and non-euro markets as well as emerging countries.

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Editorial Reviews

From the Publisher
“Fetherston lends his expertise and insight…”(UAB Alumni magazine, University of Alabama, April 2004)

“…the book provides a useful post-euro update to thefixed-in-come markets…” (NRPN Nordic Region Pensions& Investment News, Issue 1, Winter 2004/2005) 

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Product Details

  • ISBN-13: 9780470850534
  • Publisher: Wiley
  • Publication date: 3/5/2004
  • Series: Wiley Finance Series, #264
  • Edition number: 1
  • Pages: 504
  • Product dimensions: 6.90 (w) x 9.70 (h) x 1.40 (d)

Meet the Author

JONATHAN A. BATTEN is Professor of Finance at Seoul NationalUniversity in Korea and co-editor of the Elsevier JournalResearch in International Business and Finance. His previousbooks include Asia-Pacific Fixed Income Markets: An Analysis ofthe Region's Money, Bond and Interest Derivative Markets,co-edited with Thomas A Fetherston and published by John Wiley& Sons, Singapore.

THOMAS A. FETHERSTON is Professor of Finance at theUniversity of Alabama Birmingham.  He is editor of the journalInternational Review of Financial Analysis and co-editor ofResearch in International Business and Finance. His previousbooks include Asia-Pacific Fixed Income Markets: An Analysis ofthe Region's Money, Bond and Interest Derivative Markets,co-edited with Jonathan A. Batten and published by John Wiley &Sons, Singapore.

PETER G. SZILIAGYI has recently joined TilburgUniversity, the Netherlands.  His main research interestsinclude international capital market develop ment and corporatefinance.  He holds master s degrees from the BudapestUniversity of Economic Sciences and Public Administration and theUniversity of Western Sydney.  He has previously worked as afreeelance broadcaster for the BBC World Service in the U.K. andAustralia.

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Read an Excerpt

European Fixed Income Markets

Money, Bond, and Interest Rate Derivatives

John Wiley & Sons

Copyright © 2004 John Wiley & Sons, Ltd.
All right reserved.

ISBN: 0-470-85053-1

Chapter One

Introduction to the Volume



The dynamic role of capital markets (here fixed income) to efficiently channel savings funds from surplus sectors of the economy and to finance private economic ventures, which promotes economic growth and economic development, is a concept accepted and promoted by governments throughout the world. The role of fixed income markets as an efficient tool in raising finance for government projects (national and local) has been understood and appreciated for centuries (Homer and Sylla, 1996; Kindleberger, 1984). The introduction of the euro in 1999 has cast a new focus on the financial markets of the constituent countries and the critical size of the market, which comes as a result of this harmonization of macroeconomic targets. There has been a paucity of volumes with extensive coverage of the fixed income markets of European countries since the inception of the euro. The goal of this volume is to partially fill that void. The individual countrywise fixed income markets' essential characteristics and institutional details are introduced and discussed in each chapter devoted to a single country. These essential characteristicsare the sine qua non of any viable fixed income market. A shortcoming in any of the essential characteristics threatens the viability of that fixed income market. The essential characteristics are as follows:

A rule of law;

A primary market where new debt issues (government and private) are systematically offered;


A liquid secondary market;

Benchmark indices;

Independent credit-rating bodies;

Interest rate derivative markets for risk management.

The essential characteristics do not define a successful fixed income market, but their absence will inhibit the growth and development of one. The rule of law implies that nothing more than contractual relationships will be clearly understood and enforceable through normal existing legal institutions and means. A primary market is also needed where debt offerings for the governmental and corporate bodies are publicly announced and the procedures to participate in these offerings are fair and well understood. There should be a cadre of investors, both institutional and private, who would find the instruments offered to be suitable to their portfolio interests. The existence of a liquid secondary market lowers the cost of raising money in the primary market, as it relieves the burden of having to hold a fixed income obligation to maturity (see Committee on the Global Financial System, 1999, 2000). Trading in the secondary market should be transparent and trading costs should be minimal. Benchmark indices (yield curves) are of utmost importance for any market for pricing and to reference individual portfolio performance. The role of independent credit-rating agencies partially relieves investors of the burden of ascertaining the ability and willingness of the borrower to repay the amount borrowed. The role and methodology followed by these independent institutions in determining their credit ratings is well understood. However, the credit rating is not a guarantee, only a guideline. Although futures and options contracts have a historical lineage centuries old, interest rate derivatives are a modern phenomenon. A very important ancillary function to raise fixed income capital and invest in the same is interest rate risk management. The interest rate derivative products first introduced in the 1970s play an integral part in interest rate risk management.

The efforts of the authors who have contributed to this volume will measurably add to the understanding of the fixed income markets of Europe. This volume is structured into two parts: a global overview section and a section focusing on the individual countries and their fixed income markets characteristics. There are 25 chapters in the volume with 30 authors, many of whom are prominent in academic and practitioner aspects of the fixed income markets field, contributing their insight to this volume.

1.1.1 European Market Data

A sense of the scope of the European fixed income markets can be captured from the data provided in Tables 1.1-1.8. The fixed income data provide intermarket comparisons for countries in the region as well as the United States. The size of the fixed income markets of Europe is presented in Table 1.1. The size of each market and the aggregate of the European developed fixed income markets are presented for the years 2000-2002. The dominant European market is the United Kingdom, whose average size and average percentage of market share for the 3 years are US$661.6 billion and 17.5%, respectively. The size of the European developed market averages US$3799.5 billion for the 3 years. The average aggregate European numbers compare well with the US market and are 42.8% of the US market size.

The emerging country markets are covered in Table 1.2. Their average aggregate size for the 3 years covered pale in comparison to the US market, which is 12.54 times as large.

The issuer classification for the developed markets is presented in Table 1.3. The data covers the period between December 2000 and December 2001. The issuing groups are governments, financial institutions, and corporate issuers. For the government category, Europe dominates the United States with a 54.8% average market share to a 28.2% average market share. For the financial institutions, the average concentration for Europe is 36.7% compared to the United States's 55.7%. For the corporate issuers, Europe lags the United States 8.5% to 16.1%. Table 1.4 breaks out European developed market country issuing data in terms of international money market instruments and notes and bonds. The notes and bonds segment of the markets dominates the money market end of the maturity range by 92.1% to 7.9%

Dimson et al.'s long term study of capital markets and their returns provides a view of European fixed income market risk-return characteristics from the turn of the twentieth century to the turn of the twenty-first century (Dimson et al., 2002). Table 1.5 provides a snapshot of market characteristics in 2000. The size of the European market is 62% of the US market, the largest debt market in the world. The average ratio of debt to gross domestic product (GDP) for Europe (94.2%) is significantly more manageable than the US measure (159%). A surprising measure is the relative importance of government debt issues for Europe (44%) as opposed to the United States (53%). The aggregate European data seem to more evenly balance the importance and concentration of national government issues and issuers in the individual country chapters. In Table 1.6 the impact on fixed income returns from inflation are provided by Dimson et al. (2002) for the period of 1900-2000. The inflation rate for European countries is substantially higher than that of the United States. As a result, the real returns for the European fixed income instruments (government bonds and bills) are substantially lower. The US arithmetic bond and bill return for the period are 2.1% and 1%. For the European markets available, the return for bonds ranges from a high of 3.1% (Sweden and Switzerland) to a low of -0.8% (Italy). For bills, the return ranges from a high of 3% (Denmark) to a low of -2.9% (Italy), followed closely by a -2.6% return for France. The average bill return for European markets included was 0.5%. If you remove the negative outliers for the bond and bill returns, the average returns for the European bond and bill returns rise to 1.8% and 0.98%, respectively, which are close to the US measures.

Changing yields and bond prices produce interest rate risk that must be confronted and managed. Interest rate derivative securities have filled that need and provided the tools to manage interest rate risk. The existence of viable (liquid) interest derivative instruments and markets is necessary - these are also sufficient vehicles to provide risk management tools for risk managers. Generically, these tools (instruments) fall into a few broadly defined channels: forwards, futures, options, and swaps. They may trade on organized exchanges or over-the-counter (OTC). The data for global and European listed and OTC interest rate derivative activity for the past few years, as provided by the Bank for International Settlements (BIS, 2003), are presented in Tables 1.7 and 1.8. Table 1.7 shows that the annual average amount of listed interest rate futures contracts outstanding for Europe during the period between December 1999 and December 2002 was US$2491.3 billion. This average amount constituted 28.4% of the annual amount of listed interest rate futures contracts outstanding for all interest rate futures markets. Over the same period, the annual average amount of listed interest rate options contracts outstanding for Europe was US$2787.2 billion, which constituted 34.1% of contracts outstanding for all interest rate options markets. Rather similarly, the annual average number of listed futures contracts outstanding for Europe was 4.4 million or 26.4% of extant contracts for all interest rate futures markets. The annual average number of listed options contracts outstanding for Europe was 4 million or 37.3% of those outstanding for all interest rate futures markets. The average listed turnover share for Europe in 2001-2002 was 50.6% in futures and 32.8% in options. The importance of Europe in the OTC interest rate derivatives market can be seen from Table 1.8. Between June 2000 and June 2002, the average amount of euro-denominated interest rate derivatives (forwards, swaps, and options) comprised 34.4% of the annual notional values and 32% of the gross market value of extant OTC interest rate contracts.


Chapter 2 (Szilagyi) provides a capsule analysis of Euro area market integration. Financial integration can be expected to improve economic performance by developing the financial system through two main channels: (i) the exploitation of the scale and scope effects inherent in financial activity and (ii) increased competitive pressure on financial intermediaries. In this context, it is also reasonable to conclude that bond market integration, and development thereof, may also bring advantages in broad economic terms, as it should (i) lower the average cost of external finance; (ii) help build a more efficient capital structure and reduce maturity mismatches; (iii) provide better managing control in the corporate sector; (iv) improve the efficiency of resource allocation; (v) encourage the financing of innovation; and (vi) help distribute financial risks and potential losses more widely and possibly more efficiently.

The European Commission has now established the ambitious Financial Services Action Plan (FSAP) to create an efficient and integrated European financial market with a unified legislative framework by 2005, with measures relating to securities markets to be implemented by 2003. These efforts are consistent with the conclusion that an efficient financial sector is indeed pivotal for realizing the full-growth potential of the European Union (EU) economy. In particular, financial market integration should certainly contribute to an efficient financial sector, since many financial activities display scale economies and benefit from increased competition under Monetary Union.

The single currency environment has already brought about fundamental changes to the Euro area bond market. The euro and the implementation of the FSAP have worked toward the emergence of an integrated framework for investors and issuers alike, instigating growth and development on a pan-European level. The integrating powers of the single currency have worked through laying the foundations for a single integrated pool of European investors, which has boosted demand in the market. Market structures are being amalgamated accordingly, which is mirrored in more closely integrated investment and trading possibilities, improved price transparency, and growing liquidity. These improvements have provided substantial benefits for both public and private borrowers, such as lower transaction costs amid a lower interest rate environment. Of course, this process is being further facilitated by the fact that banks, which have historically dominated the financial system of continental Europe, now face increasingly tough competition from the bond market. This also implies that the Euro area financial system, traditionally described as bank-based, is slowly moving toward becoming more market-based, much like that in the United States.

The chapter identifies the primary trends and developments observed in the market. Of course, these trends are not solely a result of Monetary Union, but also of various other structural factors currently affecting financial markets, such as technological, regulatory, and demographic developments, as well as the gradual implementation of the single market for financial services. On the whole, the Euro area bond market is indeed significantly larger, more diverse, and more integrated than ever before. Nonetheless, the European Central Bank (2002) warns that market participants and regulators remain unhappy with the various on-going impediments to realizing the full potential benefits of the integration process. The chief obstacles include the enduring national segmentation of the government bond market, the rather fragmented nature of trading, clearing, and settlement systems, as well as the complex patchwork of legal and regulatory requirements and nonuniform tax treatment. This suggests that the benefits so far accrued from the integration process are just a fraction of those that may be eventually realized.

Chapter 3 (Szilagyi, Fetherston, and Batten) ties the course of bond market development in emerging Europe to the level of economic and financial development in different countries in the region. The chapter examines and compares the three major forms of debt financing in the emerging European economies over the period since the mid-1990s. To facilitate cross-country comparisons, the study groups the region's economies into three groups based on their level of development. The advanced economies group includes those functioning market economies that are practically ready to meet the highly competitive pressures within the EU. This group is marked by the high quality investment grade credit ratings for these countries. The frontrunners of this group are the Czech Republic, Estonia, Hungary, Poland, and Slovenia, as well as the non-excommunist countries of Cyprus and Malta. These countries are all in the process of graduating from the emerging market class.


Excerpted from European Fixed Income Markets Copyright © 2004 by John Wiley & Sons, Ltd. . Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents


1 Introduction to the Volume (Jonathan A. Batten, ThomasA. Fetherston, and Peter G. Szilagyi).

1.1 Overview.

1.2 Chapter overview.


2 The Euro Area Bond Market: Integration and DevelopmentUnder Monetary Union (Peter G. Szilagyi).

2.1 Introduction.

2.2 Theoretical underpinnings of financial integration.

2.3 Bond market development under monetary union.

2.4 Proposals and initiatives for reducing marketfragmentation.

2.5 Conclusion.


3 Perspective on the Emerging European Financial Markets(Peter G. Szilagyi, Thomas A. Fetherston, and Jonathan A.Batten).

3.1 Introduction.

3.2 Financial structures in emerging Europe.

3.3 International bank borrowing.

3.4 International debt issues.

3.5 Domestic debt issues.

3.6 Conclusion.


4 Perspectives on European Derivative Markets (MartinYoung).

4.1 Introduction and a brief history of the European derivativemarkets.

4.2 Europe’s major derivative markets.

4.3 An overview of the contracts traded on EUREX andEuronext.Liffe.

4.4 Europe’s other derivative markets.

4.5 What the future holds.

5 Benchmark Yield Curves in the Euro Market (Philip D.Wooldridge).

5.1 Introduction.

5.2 Characteristics of benchmark yield curves.

5.3 Benchmark tipping in European bond markets.

5.4 Government securities as benchmarks.

5.5 Interest rate swaps compete for benchmark status.

5.6 Prospects for other nongovernment benchmarks.


6 Some Facts on Pfandbrief Products in Europe (OrazioMastroeni).

6.1 Introduction.

6.2 Covered bonds, Pfandbrief products, and securitization.

6.3 The German traditional and jumbo Pfandbrief markets.

6.4 The French “Obligations Fonci˙eres”.

6.5 The Spanish “Cedulas Hipotecarias”.

6.6 The Luxembourg “Lettres de Gage”.

6.7 Common aspects of Pfandbriefe products.

6.8 Aspects characterizing the “quality” ofPfandbrief products.

6.9 Conclusions and prospects.



7 Austria (Vanessa Seconnino and Alham Yusuf).

7.1 Introduction.

7.2 Regulation.

7.3 Credit ratings.

7.4 Taxation.

7.5 Austrian Stock Exchange (Wiener Börse).

7.6 The Austrian bond market.

7.7 Conclusion.


8 Belgium (Jan Annaert and Marc J.K. De Ceuster).

8.1 Introduction.

8.2 History and structure of the Belgian public debt.

8.3 Government bonds.

8.4 Corporate bonds.

8.5 Derivative products.


9 Czech Republic (Guan-Chye Ooi and Jonathan A.Batten).

9.1 Introduction.

9.2 Financial market regulation.

9.3 Financial market participants.

9.4 Money and fixed income instruments.

9.5 Conclusion.


10 Denmark (Charlotte Christiansen, Tom Engsted, SvendJakobsen, and Carsten Tanggaard).

10.1 Introduction.

10.2 History and structure of the Danish bond market.

10.3 The Danish government bond market.

10.4 The market for Danish mortgage-backed securities.

10.5 Other fixed income instruments.

10.6 Market participants, regulation, and trading.


11 An Empirical Study of the Term Structure of Interest Ratesin Denmark (1993–2002) (Charlotte Christiansen, TomEngsted, Svend Jakobsen, and Carsten Tanggaard).

11.1 Introduction.

11.2 The EHTS and its testable implications.

11.3 Empirical results for Denmark (1993–2002).

11.4 Concluding remarks.


12 Finland, Iceland, Norway, and Sweden (SeppoPynnönen).

12.1 Introduction.

12.2 Structure of the markets.

12.3 Finland.

12.4 Iceland.

12.5 Norway.

12.6 Sweden.

12.7 Norex alliance.

Additional reading.

13 France (David Edwards and Cameron Makepeace).

13.1 Introduction.

13.2 Financial system regulation.

13.3 The French government bond market.

13.4 The French nongovernment bond market.


14 Germany (Niklas Wagner).

14.1 Introduction.

14.2 Structure of the German bond market.

14.3 Participants of the German bond market.

14.4 The market for government bonds.

14.5 Conclusion.


15 Greece (Thomas A. Fetherston).

15.1 Introduction.

15.2 The Greek bond market.

15.3 Market participants and structure.

15.4 The Greek government bond market.

15.5 The nongovernment bond market.


16 Hungary (Nóra Németh andLászló Szilágyi).

16.1 Introduction.

16.2 History and structure of the Hungarian financialmarket.

16.3 Participants and structure of the Hungarian bondmarket.

16.4 The Hungarian government bond market.

16.5 Semigovernment and corporate bond markets.

16.6 Conclusions.


17 Italy (Walter Vecchiato).

17.1 Introduction.

17.2 The Italian government bond market.

17.3 Italian Stock Exchange (Borsa Italiana).

17.4 Conclusion.


18 The Netherlands (Albert Mentink).

18.1 Introduction.

18.2 The Netherlands.

18.3 Dutch government bonds.

18.4 Credit bonds.

18.5 Categories of investors.

18.6 Euronext Amsterdam and OTC market.

18.7 Regulators.

18.8 Conclusions.

Appendix: Useful websites.


19 Poland (Peter G. Szilagyi).

19.1 Introduction.

19.2 History and structure of the Polish bond market.

19.3 Market participants and structure.

19.4 The Polish Treasury market.

19.5 The nongovernment bond market.

19.6 Conclusion.


20 Portugal (Peter G. Szilagyi).

20.1 Introduction.

20.2 Recent history and structure of the Portuguese bondmarket.

20.3 Market participants and structure.

20.4 The Portuguese government bond market.

20.5 Nongovernment bond market.


21 Russia (Leonid V. Philosophov and Vladimir L.Philosophov).

21.1 History of the Russian bond market.

21.2 The Russian economy in the postcrisis period.

21.3 Regulation of the Russian bond market and itsparticipants.

21.4 Market for Russian state bonds.

21.5 Corporate bonds.

21.6 The market for Russian eurobonds.

21.7 Conclusion.

22 Spain (Petra Pénzes).

22.1 Introduction.

22.2 History and structure of the Spanish bond market.

22.3 Participants and structure of the Spanish bond market.

22.4 The Spanish government bond market.

22.5 Semigovernment and corporate bond markets.

22.6 Conclusions.


23 Switzerland (Heinz R. Kubli).

23.1 Introduction.

23.2 Size and ratings of the Swiss bond market.

23.3 Market participants and structure.

23.4 Market conventions.

23.5 Benchmarks.

23.6 The Swiss federal bond market.

23.7 Other bonds.

23.8 Swiss and foreign convertible and “cumwarrants” bonds.

23.9 Foreign currency bonds.

23.10 SWX Eurobonds.

23.11 The Swiss repo market.

23.12 Bank debentures (cash bonds or kassenobligationen).

23.13 Interest rate futures on the European Exchange(EUREX).

23.14 Conclusions.


24 Turkey (Caner Bakir and Kym Brown).

24.1 Introduction.

24.2 Recent history and structure of the Turkish bondmarket.

24.3 Market participants and structure.

24.4 The Turkish government bond market.

24.5 Nongovernment bond market.


25 United Kingdom (Frank S. Skinner).

25.1 Introduction.

25.2 History and structure of the UK bond market.

25.3 Market participants and structure.

25.4 The United Kingdom government bond market.

25.5 Corporate and semigovernment bond markets.

25.6 Conclusions.



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