Trading and Capital-Markets Activities Manual
Profiles: French Government Bonds and Notes
The French Treasury is an active issuer of three types of government debt securities, which cover all maturities. Obligation Assimilable du Tresor (OATs), issued since 1985, are the French government's long-term debt instruments with maturities of up to 30 years. Bons du Tresor a Taux Fixe et Interest Annuel (BTANs) are medium-term, fixed-rate notes with maturities of up to five years. The French Treasury also issues discount Treasury bills, Bons du Tresor a Taux Fixe et Interest Precomptes (BTFs), with maturities of up to one year. In addition, an active market for stripped OATs has developed since May 1991. Stripping involves separating a bond's interest and principal payments into several zero-coupon bonds.
French government securities are mainly denominated in French francs (FFr). However, the Treasury has also been issuing OATs and BTANs in European Currency Units (ECUs) since 1989 and 1993, respectively. Until 1985, the French Treasury issued bonds known as Emprunts d'Etats. However, these bonds are approaching the end of their trading life and are illiquid. The following discussion will focus on OATs, BTANs, BTFs, and stripped securities.
CHARACTERISTICS AND FEATURES
The French Treasury issues OATs in units of FFr 2,000 (ECU 500), with maturities of up to 30 years. Most OATs carry a fixed interest rate and have bullet maturities. However, some OATs are issued with floating rates that are referenced to various short-term or long-term indexes. OATs generally pay interest annually. OATs are settled three days after the trade date (T+3), both domestically and internationally. OATs are cleared through the SICOVAMs Relit system domestically, while OATs that settle internationally are cleared through Euroclear or Cedel.
BTANs and BTFs are issued in units of FFr 1 million (ECU 1,000). All BTANs are fixed-rate, bullet maturity notes with maturities of up to five years. Interest on BTANs is paid annually on the 12th of the month. Domestic settlement for BTANs and BTFs usually occurs one day after the trade date (T+1) through the Bank of France's Saturne system. Internationally, BTANs and BTFs settle three days after the trade date. Like OATS, BTANs and BTFs may also be cleared through Euroclear or Cedel. Interest on all government bonds and notes is calculated using a 30/360-day count convention in which each month is assumed to have 30 days.
Since May 1991, French government securities primary dealers, Specialistes en Valuers du Tresor (SVTs), have been allowed to strip most long-term OATs. Primary dealers may strip OATs denominated in either FFr or ECUs and subsequently reconstitute them. All stripped coupons carry a face value of FFr 5 (ECU 1.25). This is done to ensure the fungibility of receipts that have the same maturities but are derived from OATs of different maturities.
French government securities are used for investment, hedging, and speculative purposes. They are considered attractive for investment purposes by foreign and domestic investors because of the market's liquidity, lack of credit risk, and wide range of maturities and structures (for example, fixed vs. floating rate). Foreign investors often choose to invest internationally to enhance the diversification of their investment portfolios or derive higher returns. Stripped OATs can be used as tools for hedging or asset liability management purposes, for example, to immunize a portfolio in terms of interest-rate risk. Speculators also use OATs, BTANs, and stripped OATs to take positions on the direction of interest-rate changes and yield curve shifts. Finally, there is an active market for futures and options on French government securities traded on the Marche a terme international de France (Matif), the Paris financial futures exchange.
DESCRIPTION OF MARKETPLACE
The French Treasury issues OATs, BTANs, and BTFs through Dutch Auction. The Treasury usually issues tranches of securities that are part of a single borrowing line. The auction schedule is generally announced several months in advance. Securities are supplied at the price or effective rate tendered by the bidder rather than the marginal price or rate. The highest bids are filled first, followed by lower bids. Although bidding is open to any institution that has an account with the SICOVAM, Saturne, or Bank of France, SVTs account for 90 percent of the securities bought in the primary market. SVTs also quote two-way prices on a when-issued basis several business days before an auction.
There is an active secondary market for most issues of French government securities. OATs, BTANs, and BTFs are listed on the Paris Stock Exchange, but are principally traded over the counter. SVTs are responsible for making markets in these securities and account for most of the trading activity. However, other broker-dealers, banks, and specialized financial institutions are also active participants in the secondary market. Since 1994, the repo market in French government securities has grown considerably. The repo market, also managed by the SVTs, allows investors to finance short-term positions.
Since 1987, a network of primary government securities dealers, known as Specialistes en Valuers de Tresor (SVTs), has managed the market for French government securities. The SVTs work closely with the French Treasury in determining issuance policy, market conditions, and prices. SVTs are required to quote prices for clients and other primary dealers in tradeable securities and are responsible for the maintenance of liquid primary and secondary markets. In exchange, the French Treasury permits SVTs to strip and reconstitute OATs and participate in noncompetitive bidding.
French government securities are used for investment, hedging, and speculative purposes by a wide range of institutional investors, both international and domestic. This includes insurance companies, pension funds, mutual funds, and commercial and investment banks.
The market of French government bonds is active and market transparency is relatively high for most issues. The French Treasury regularly publishes the debt issuance schedule and other information on the management of its debt. Auction results, trading information, and prices for most issues are available on inter-dealer broker screens such as Reuters, Telerate, and Bloomberg.
OATs are quoted as a percentage of par to two decimal places. For example, the price quote of 106.85 refers to an OAT that is trading at 106.85 percent of its par value. Strips are quoted on the basis of their yield. BTANs and BTFs are quoted on an annual-yield basis to two decimal places.
The interest-rate risk of French government securities can be hedged in the futures or options market at the Matif or by taking a contra position in another French government security. Swaps and options can also be used to hedge interest-rate risk. The effectiveness of a particular hedge is dependent on yield curve and basis risk. For example, hedging a position in a five-year note with an over-hedged position in a three-year note may expose the dealer to yield curve risk. Hedging a 30-year bond with a treasury bond future exposes the dealer to basis risk if historical price relationships between futures and cash markets are not stable. Also, if a position in notes or bonds is hedged using an OTC option, the relative illiquidity of the option may diminish the effectiveness of the hedge. International investors are also exposed to foreign-exchange risk. Foreign-exchange risk can be hedged using currency forwards, futures, swaps, or options. An international investor can use a series of forward foreign-exchange contracts corresponding to each of the coupon payments and the final principal payment to hedge this risk. Swaps, futures contracts, or currency options, traded either on the Matif or OTC, can also be used to hedge currency risk.
French bonds are among the most liquid in Europe. Because the French Treasury issues OATs and BTANs as tranches of existing bonds, most bond issues have sizable reserves and liquidity. SVTs make a market in French government bonds, a practice that enhances liquidity of the market. The most recently issued 10-year OAT generally serves as the benchmark, and is thus the most liquid of these issues. For the medium-term market, the most recent issues of two- and five-year BTANs serve as the benchmark. Next to the U.S. Treasury strip market, French strips are the most liquid in the world. As stated above, the face value of all stripped OATs is FFr 5 ensuring the fungibility of coupons of different maturities. Because primary dealers may reconstitute strips at any time, their liquidity is comparable to the reference OAT.
From the perspective of an international investor, the market risk of French government bonds consists primarily of interest-rate risk and foreign-exchange risk. The interest-rate risk of a French government bond depends on its duration and the volatility of French interest rates. Bonds with longer durations are more price sensitive to changes in interest rates than bonds with shorter durations. Because they are zero-coupon instruments, French strips have longer durations than OATs of comparable maturity, and they are more volatile.
From the perspective of an international investor, the total return from investing in French government securities is partly dependent on the exchange rate between the U.S. dollar and the French franc. Several factors affect the volatility of a foreign-exchange rate, including the country's balance of payments and prospective changes in that balance, inflation and interest-rate differentials between countries, the social and political environment, relative changes in the money supply, and central bank intervention in the currency markets. Traditionally, the French foreign-exchange rate has been relatively stable.
Political Risk A change in the political environment, withholding tax laws, or market regulation can have an adverse impact on the value and liquidity of an investment in foreign bonds. Investors should be familiar with the local laws and regulations governing foreign bond issuance, trading, transactions, and authorized counterparties.
The accounting treatment for investments in foreign debt is determined by the Financial Accounting Standards Board's Statement of Financial Acounting Standards (SFAS) No. 115, ''Accounting for Certain Investments in Debt and Equity Securities,'' as amended by SFAS 125, ''Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.'' SFAS 125 has been replaced by SFAS 140, which has the same title. Accounting treatment for derivatives used as investments or for hedging purposes is determined by SFAS 133, ''Accounting for Derivatives and Hedging Activities.'' (See section 2120.1, ''Accounting,'' for further discussion.)
RISK-BASED CAPITAL WEIGHTING
French government bonds and notes are assigned to the 0 percent risk-weight category.
LEGAL LIMITATIONS FOR BANK INVESTMENT
French government bonds and notes are type III securities. A bank's investment in them is limited to 10 percent of its equity capital and reserves.
Fabozzi, Frank J., and Franco Modigliani.
Capital Markets: Institutions and Instruments. Englewood Cliffs, N.J.:
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