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This case study "Deutsche Bank: Finding Relative Value Trades" presents the role and activities of the Fixed Income Research Group of Deutsche Bank. The group is divided into two main activities, the first being strategic advice on macroeconomic trends, while the second focuses on relative value activities.
George Chacko; Vincent Dessain; Anders Sjoman; Peter Hecht
Harvard Business Review (205059-PDF-ENG)
November 04, 2004
Case questions answered:
- What is the role of the fixed income research group that works within the large financial institution Deutsche Bank?
- What trading strategies (going long or short) would you recommend for the various maturities depicted in Exhibit 4?
- Discuss possible shortcomings of this approach.
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Case answers for Deutsche Bank: Finding Relative Value Trades
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1.1 What is the role of the fixed income research group that works within the large financial institution Deutsche Bank?
Deutsche Bank as a group divided its fixed-income activities into three different pillars; investor coverage, issuer coverage, and research. The case presented this week focuses on the role and activities of the Fixed Income Research group of Deutsche Bank. The group is divided into two main activities, the first being strategic advice on macroeconomic trends, while the second focuses on relative value activities.
Strategic advice on macroeconomic trends is hard to monetize as the advice given is more for educational purposes and not for advising on which specific trades should be made in order to generate a profit. The role of the group is to inform external clients about macroeconomic trends or forecasts that they predict.
The strategic advice is built on long-term discussions with their external clients, which is especially appealing to clients that have long-term liabilities or assets, such as insurance companies, pension funds, or institutions that need to match their long-term liabilities and assets. It is hard for the strategic advisory group to monetize their work, as the advice and service that they provide for the clients are more to build up their brand value, customer relationship and provide them with new ways of looking at the market.
The second group of the Fixed Income Research group is the department responsible for relative value activities. This service is both provided to internal traders at Deutsche Bank and external clients. The group is responsible for finding lucrative trading strategies that can be made immediately. They compare different kinds of instruments and keep a stern look at the fixed income markets, with regards to prices, yields, and other components that might create new trading opportunities.
To quote the Head of Relative Research for Europe, Jean Dumas their “job is to grab things that don’t seem to be related at first and see if there is a trade to be done”. These new insights are published on a weekly basis for both internal traders and external clients. One way of finding relative-value trade is by comparing the prices of the securities currently traded on the market and the prices that the group thinks, given by an internal model, that the securities should be traded for.
The overall role of the Fixed Income Research Group is to inform on macroeconomic trends and filter possible profitable trading strategies out of the vast data that is provided by the market. The group also does customized work for specific clients that need help analyzing and consulting regarding their clients’ balance sheets and asset-liabilities mismatches.
As mentioned before, it is hard to monetize the work of the Fixed Income Research Group, hence it is evaluated by three different criteria. The first factor is the overall market direction, i.e. was the group able to catch the rates and spread moves. Second, the relative-value trades that the group originated and thirdly how much new customized business from external clients were generated.
1.2 What trading strategies (going long or short) would you recommend for the various maturities depicted in Exhibit 4?
In order to find lucrative trading strategies with respect to a long or short position for the different bonds, one should compare the prices or yields of the predicting model of Deutsche Bank and the zero-coupon prices and yields implied by the current market prices of coupon bonds.
Exhibit 1 gives the current market prices of the coupon paying yields, which are then used to find the implied yield and price of a zero-coupon paying bond. It is necessary to find the implied prices and yields, as the predicting model of Deutsche Bank also calculates the yields predicted for a zero-coupon yield of different bonds with different maturities given in Exhibit 4.
Please find the cash flow and inverted cash flow matrices in Appendix Case 1 Table 1 and find a summary of the results below.
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