The Danish Money Market

Anders Mølgaard Pedersen, Economics, and Michael Sand, Market Operations

INTRODUCTION

This article describing the Danish money market and its development in recent years is based on existing statistics for the money market (trading volumes and interest rates), as well as a number of banks' responses to a questionnaire on the Danish money market1. The article follows up on two previous articles in 1996 and 1997 that considered various aspects of the money market2. The introduction of the single monetary policy for the euro area as of 1 January 1999 was a significant change in the external framework for the Danish money market. An integrated money market for the entire euro area was quickly established, with common interest rates and a large share of cross-border transactions. The European Central Bank, ECB, has regularly studied developments in the money market based on questionnaire surveys among market participants3. Where relevant, the article compares the money markets in Denmark and the euro area. The principal conclusion is that the Danish money market is well-functioning, although it is important that participants continue to act responsibly and participate actively in the development of the market.

THE MONEY MARKET

The Danish money market is often defined as the market for inter-bank loan agreements and interest-rate contracts denominated in kroner with a maturity of up to around one year. However, the definition is not en- tirely clear, since debt securities with a short remaining term to maturity

1 The following banks contributed to the article by answering a number of questions concerning the money market: ABN AMRO Bank, Amtssparekassen Fyn, Arbejdernes Landsbank, Danske Bank, Handelsbanken, Jyske Bank, Nordea Bank Danmark, Nykredit Bank, Skandinaviska Enskilda Banken, Spar Nord Bank and Sydbank. 2 Palle Duvier Mehlbye and Jacob Topp, Money Market Development, Danmarks Nationalbank, Monetary Review, August 1996, and Birgitte Damm and Anne Reinhold Pedersen, New Money- Market Statistics, Danmarks Nationalbank, Monetary Review, 3rd Quarter 1997. 3 The most recent study is published in The Euro Money Market, European Central Bank, July 2001.

19/06/2002 10:17 Antal sider: 18 Rev. nr. 2 H:\kvo\ENG\2002\2qtr\til tryk\side19-36.doc Oprettet af Michael Sand 20 are often traded on money-market terms. Furthermore, the participants in the money market not only comprise banks, but also institutional investors, mortgage-credit institutes and large business enterprises. The money market serves several purposes, such as the exchange of liquidity among participants and the management of short-term interest- rate positions. An efficient money market is also an important basis for the securities market. A well-functioning money market is furthermore essential to the clear transmission from Danmarks Nationalbank's official interest rates to the short-term market rates, and is thereby important to monetary policy. The instruments in the Danish money market can be roughly divided into two groups in terms of their initial impact on cash positions. The first comprises cash market products for which the conclusion of a contract requires immediate exchange of liquidity. These products include deposits, repo agreements, foreign-exchange (fx) swaps and bonds with a short remaining term to maturity. The second group consists of interest-rate derivatives where liquidity is only exchanged as settlement of interest-rate differences at a fixed time in the future. Interest-rate derivatives include Tomorrow/Next interest-rate swaps (T/N IRS) and FRAs (Forward Rate Agreement). They can be standardised or non- standardised products in terms of maturity, settlement and collateral. Annex 1 gives a brief description of the standardised products in the Danish money market. The cash market products are used primarily for the exchange of liquidity. Moreover, certain collateralised transactions in the cash market may be driven by demand for the underlying asset. A repo agreement may, for example, be based on a requirement for a specific paper, in which case it is called a "special", cf. Box 1. Interest-rate derivatives are used to hedge interest-rate risks and to actively take market positions in interest rates. Interest-rate derivatives are normally settled in the money market according to reference interest rates. The most frequently used reference interest rates in the Danish money market are Cibor (Copenhagen Inter Bank Offered Rate) and the Tomorrow/Next interest rate. Annex 2 con- tains a description of various reference interest rates.

MARKET PARTICIPANTS AND TRADING STRUCTURE

Recent years have seen increased concentration of the Danish money market in term of both participants and marketplaces. After mergers in the financial sector the money market is now characterised by two major players.

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THE SPECIALS MARKET Box 1

A special is a repurchase agreement based on demand for the underlying paper (a specific securities code). Specials thus differ from GC repos (General Collateral) where the main purpose is to exchange liquidity. The lending rate for a special is normally lower than that for a GC repo, since the provider of cash accepts a lower interest rate in return for the specific paper. In practice, it is often difficult to distinguish whether a repo transaction is a special or a GC repo, since it may meet demand for cash as well as for a specific paper. Furthermore, the type of paper will always play a certain role in a repo. For example, the rate of interest for a GC repo with government bonds is typically marginally lower than the rate of interest for a GC repo with mortgage-credit bonds. A large proportion of turnover on the Danish specials market is due to demand for specific securities for the settlement of bond transactions in the spot market. For example, a bank may have sold a bond that is not in its portfolio so that it needs to ac- quire the bond before settlement. Borrowing the bond in a special gives the bank a little extra time to find a seller of the bond in the spot market. In addition, demand for a securities code in a special can also be attributable to speculation in the price development of the bond. If a bank finds a bond too expensive compared to the rest of the market, the bank can choose to borrow the bond in a special and sell it in the spot market. Should the price then fall, the bank achieves a capital gain when the bond is returned. Such transactions, i.e. selling short, can also be used to hedge the price risk on a bond portfolio for a certain period. In that case the bank will typically prefer to make the transaction in a benchmark bond. The underlying bonds in specials vary over time. Significant criteria are e.g. the amount outstanding and distribution of ownership. If the outstanding amount in a securities code is relatively small and a large proportion is owned by e.g. institutional investors who are less active in the market for securities lending, the paper will often be a special. However, securities which are too difficult to obtain in the market do not trade as specials, since illiquid securities increase the risk in short transactions. Bench- mark bonds are often in demand in specials. This also applies to bonds which are gain- ing status as benchmark securities, but have not yet reached a sufficient outstanding amount. Specials are not covered by the market-maker agreements in the Danish money market. According to market participants the interest-rate differential vis-à-vis GC repos typically varies within 10-40 basis points. Certain government securities, including on-the-run issues, can also be obtained via the securities lending schemes of the central government and Social Pension Fund that are managed by Danmarks Nationalbank. Loans in these schemes are subject to a premium of 50 basis points, and other government securities are required as collateral. There are no statistics solely covering specials. Danmarks Nationalbank's money- market statistics, cf. Box 2, include data on lending of cash in repos, including specials, by a number of banks. Specials account for by far the largest proportion of such lending for maturities of up to one week, while for maturities of more than 1 month by far the largest proportion is GC repos.

Trading in the money market takes place via brokers or directly among the participants. The money-market brokers act as a type of marketplace for the exchange of prices for a number of products.

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The money-market brokers, who are subject to supervision by the Danish Financial Supervisory Authority, provide the best bid and offer prices in the individual products for standardised maturities. With effect from January 2000 the previous two money-market brokers in Denmark merged into one company. This broker today handles most of the broker-based money-market activity in kroner. In addition, several participants use foreign brokers based in e.g. London or Frankfurt. Most of the trading activity in the money market is via direct contact between the counterparties. This saves broker costs and also provides for trading of non-standardised products, maturities and transaction sizes. In addition to the money market there is the special-term market where major business enterprises and institutional investors can deposit surplus funds with the banks on money-market terms. The only broker in the Danish special-term market discontinued its activities as from January 2000. Today, ten banks participate in the market-maker agreements in the Danish money market, compared to 15 in 1996. Under these agreements banks must quote binding two-way prices for fixed amounts and maturities to the group of market makers. The decrease in the number of participants is attributable to mergers in the sector and to the withdrawal of some participants from the agreements, in which the banks participate to varying degrees. The market-maker agreements cover repos, fx swaps, FRAs, T/N IRS and Treasury bills, while deposits are no longer included. The agreements involve several models with varying spreads between bid and offer prices, depending on market conditions. Under normal market conditions the bid-offer spread is typically 5-10 basis points, increasing to 25-30 basis points in the event of market turbulence. The participants agree among themselves when to change models. The market-maker agreements contribute to ensuring a certain level of liquidity in the money market. The general tendency for greater use of fully-automated trading via electronic trading systems and Internet-based systems in the financial markets has not yet gained ground in the money market. Instead, the existing electronic systems, such as Reuters, are used primarily as a means of communication for direct trading between counterparties. Electronic trading system where bid and offer interests are stated openly enhance transparency and reduce search, settlement and docu- mentation costs. One explanation for the absence of such marketplaces as standard in the Danish money market may be that the lack of critical mass makes the development and implementation of the required soft- ware less profitable.

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TRADING-VOLUME STATISTICS FOR CASH MARKET PRODUCTS Box 2

Danmarks Nationalbank's trading-volume statistics for cash market products comprise deposits, repos and fx swaps. The statistics are based on monthly data from the 13 banks in Denmark that also report data for calculation of the T/N rate, cf. Annex 2. The banks only report their loans, not their deposits. Lending in the form of repos also includes specials, cf. Box 1. The statistics are broken down as lending to resident and non-resident banks and as the maturities 1-6 days, 7-33 days and more than 34 days. The statistics are found to cover most of the transactions in deposits, repos and fx swaps in the Danish money market. Money-market lending by other banks in Den- mark is thus relatively limited, which also applies to the krone-denominated lending from banks abroad to banks in Denmark. Turnover in cash market products denominated in Danish kroner between banks abroad is also found to be insignificant.

In the euro area fully-automated trading systems are also considerably less frequently used in the money market than in other parts of the financial markets. One exception is Italy's money market where since the beginning of the 1990s more than 200 banks have used the electronic match system e-MID. The system is now also being marketed at European level1.

TRADING VOLUME IN THE MONEY MARKET

This section first describes recent years' development in the turnover in cash market products, followed by a description of the development in turnover in interest-rate derivatives.

Turnover in cash market products Danmarks Nationalbank collects statistics from 13 banks on their krone- denominated money-market lending in deposits, repos and fx swaps. The statistics are found to cover most of the turnover in these products. Box 2 gives a brief presentation of the statistics. The current total trading volume in the three products roughly corresponds to the volume in 1997, cf. Chart 1. However, the volume of transactions, particularly with foreign banks, has fluctuated strongly during the period. Trading with foreign banks decreased considerably towards the end of 1999, primarily due to fears of computer-related problems in the run-up to the millennium rollover. Transactions with foreign banks then increased significantly up to the Danish referendum

1 See The Euro Money Market, European Central Bank, July 2001.

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TRADING VOLUME IN CASH MARKET PRODUCTS BY COUNTERPARTY – DAILY AVERAGES Chart 1

Kr. billion 90

0 1997 1998 1999 2000 2001

To banks abroad To banks in Denmark Total

Note: Monthly observations. Source: Danmarks Nationalbank's trading-volume statistics. on EMU in September 2000 when many non-residents chose to hedge their krone-denominated asset positions in short-term krone- denominated loans. The trading volume also fluctuated considerably in the summer and autumn of 1998, a period of unrest in the international financial markets and major fluctuations in money-market interest rates. In general, the trading volume has decreased in the 4th quarter of the year, since many non-resident participants tend to reduce their market activity up to the end of the year. Chart 2 shows the development in the trading volume in deposits, repos and fx swaps. The most obvious aspect is the increase in repo transactions in 1997 and the abrupt fall in the volume of these transactions in the autumn of 1998. The increase in 1997 was attributable in particular to non-resident hedge funds' purchases of Danish mortgage- credit bonds, which were largely financed in repos. This activity decreased strongly when it became clear in September 1998 that a large US hedge fund, Long Term Capital Management, was in difficulties after the financial crisis in Russia. Since then, the repo trading volume has been lower than in 1997-98, apart from a temporary increase up to the Danish referendum on EMU. The lower trading volume should be viewed in the light of the declining turnover in bonds on the Copen- hagen Stock Exchange, which may have reduced the trading volume in specials in particular. In view of the decrease in repo transactions after

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TRADING VOLUME IN DEPOSITS, FX SWAPS AND REPOS – DAILY AVERAGES Chart 2

Kr. billion 45

0 1997 1998 1999 2000 2001

Deposits Fx swaps Repos

Note: Monthly observations. Source: Danmarks Nationalbank's trading-volume statistics.

1998 several banks have withdrawn from the market-maker agreement for repos. This has further contributed to reducing liquidity and trading volume in the repo market. Turnover in fx swaps has increased in recent years and today exceeds turnover in repos. One explanation is that non-resident investors increas- ingly tend to use fx swaps to finance their purchases of krone- denominated bonds. For major non-resident participants with favour- able access to e.g. dollar-denominated funding this is often more profitable than borrowing kroner against Danish securities as collateral (i.e. as repo agreements). Furthermore, many market participants perceive fx swaps as a more simple and flexible product than repos. The reason is that the underlying asset, i.e. foreign exchange, has more applications than a specific securities code and is easier to manage when the transaction expires. The trading volume in deposits has been stable in the period under review. In general, it is difficult to compare the trading volume in deposits with that in repos and fx swaps due to a somewhat shorter average maturity, with by far the majority of deposit transactions taking place in the O/N (OverNight) or T/N segments. By contrast, deposits are not a widely used instrument for longer maturities as a result of the higher credit risk. The greater part of trading in repos and fx swaps is also placed in the short maturities, although this is less pronounced than for deposits.

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Measured in terms of outstanding amounts, deposits thus normally account for a smaller proportion of the three products than the turnover figures in Chart 2 would indicate. The turnover in short-term bonds in the money market is moderate compared to the other cash market products. According to the trading- volume statistics of the Copenhagen Stock Exchange1 Treasury bills are generally not traded very actively between auctions. Turnover in short- term mortgage-credit bonds is normally also considerably below trading volume in the other cash market products. According to the banks, however, short-term mortgage-credit bonds denominated in kroner have gained importance as money-market instruments in recent years. This has taken place in parallel to the significant growth of adjustable-rate mortgages, leading to an increase in the outstanding amount of these bonds. The short-term krone-denominated mortgage-credit bonds are used especially in the exchange of cash positions as an alternative to other products. One advantage of these bonds is that they can be pro- vided as collateral for loans from Danmarks Nationalbank. The increasing volume of short-term mortgage-credit bonds may also have stimulated turnover in other money-market products, e.g. for hedging interest-rate risks. The development in the trading volume in the Danish money market deviates in several respects from the euro-area money market. Accord- ing to the ECB's surveys of the money market in the euro area turnover in cash market products has increased since the commencement of the third stage of EMU2. This especially reflects the considerable growth in repo transactions in the light of the growing integration of securities markets in the euro area. Turnover in deposits also increased strongly immediately after the commencement of the third stage of EMU, particularly for short maturities, but has since stagnated. On the other hand, the trading volume in fx swaps decreased at the beginning of 1999 when transactions among the euro-area currencies lapsed. The ECB's most recent survey shows that deposits accounted for just under half of the trading volume in cash market products, while turnover in fx swaps accounted for the smallest share.

Turnover in interest-rate derivatives There is limited information about turnover in interest-rate derivatives in the Danish money market. The only official statistics derive from the regular survey of the foreign-exchange and derivatives markets co- ordinated by Bank for International Settlements, BIS. This survey is con-

1 The statistics from the Copenhagen Stock Exchange also include transactions outside the money market, e.g. transactions between non-banks. 2 The most recent data for the trading volume in cash market products in the money market relate to the 2nd quarter of 2000, cf. The Euro Money Market, ECB, July 2001.

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TRADING VOLUME IN INTEREST-RATE DERIVATIVES – DAILY AVERAGES Chart 3

Kr. billion 5 25

4 20

3 15

2 10

1 5

0 0 1995 1998 2001 1995 1998 2001

Interest-rate swaps FRA (right-hand axis)

Note: Average for April of the year in question. Source: The triennial BIS survey of foreign exchange and derivatives market activity.

ducted in April of every third year, most recently in 20011, and covers OTC products2. The survey comprises interest-rate derivatives in all currencies, but the following only concerns the derivatives denominated in Danish kroner. Chart 3 shows the average daily turnover in FRAs and interest-rate swaps in the last three BIS surveys3. Even though the data on trading volume concerns only one month, and should therefore be interpreted with caution, it nevertheless shows a clear trend. Viewed over the entire period from 1995 to 2001 turnover in both FRAs and interest-rate swaps increased considerably. The increase was particularly strong from 1995 to 1998 when the trading volume in interest-rate swaps increased almost tenfold, particularly due to the introduction of T/N IRS in 1997. In the same period the trading volume in FRAs more than trebled. Today FRAs and interest-rate swaps (primarily T/N IRS) are the pre- ferred money-market instruments for the management of short-term

1 See Tina Christoffersen and Martin Seneca, Turnover in the Foreign-Exchange and Derivatives Markets in April 2001, Danmarks Nationalbank, Monetary Review, 4th Quarter 2001. 2 OTC (Over-The-Counter) transactions are direct transactions between two parties, i.e. not involving a

3 stock exchange. The trading volumes shown in Charts 2 and 3 cannot be compared directly. The trading volume in Chart 2 thus only includes loans, while the trading volume in Chart 3 covers both purchase and sale of contracts. Chart 3 also includes transactions with all customers, while Chart 2 covers only lending to other banks. Finally, the average maturity of interest-rate derivatives is somewhat longer than for cash market products, so that the significance of interest-rate derivatives is underestimated when trading volume alone is considered.

19/06/2002 10:17 Antal sider: 18 Rev. nr. 2 H:\kvo\ENG\2002\2qtr\til tryk\side19-36.doc Oprettet af Michael Sand 28 interest-rate positions. The most important advantage of these products is the limited credit risk. As a result, the capital requirement for this type of transaction is normally less than for most cash market products1. In addition, both the FRA market and the market for T/N IRS are very liquid markets with many participants and narrow bid-offer spreads, which has a self-reinforcing effect on turnover and liquidity. Furthermore, both are similar to products on money markets abroad, which facilitates trade with non-resident participants. The euro-area money market has also seen a strong increase in trading volume in interest-rate derivatives. According to the latest BIS survey turnover in both interest-rate swaps and FRAs denominated in euro by and large doubled from April 1998 to April 20012. The increase in transactions was particularly strong for interest-rate swaps based on Eonia (Euro OverNight Index Average), corresponding to T/N IRS in the Danish money market. Besides, futures and option contracts based on Euribor (Euro Inter-bank Offered Rate) are traded extensively on stock ex- changes. The principal marketplace for this trade is Liffe (London Inter- national Futures and Options Exchange), where it accounts for most of the trading volume. Cibor futures and options were previously traded on the Copenhagen Stock Exchange, but due to low turnover this trading was discontinued in June 2001.

PRICE OFFERING IN THE MONEY MARKET

Price offering can be used as a measure of the efficiency of the money market and its various segments. An efficient market will normally be characterised by small deviations between the bid and offer prices of each participant (the bid-offer spread). The data available regarding bid and offer prices is limited to prices from the broker in Denmark. These prices could come from two different banks, so that the individual participants' bid-offer spreads are underestimated. The prices can also sometimes overestimate the bid-offer spread, since the banks can trade directly with each other at narrower prices than the bid-offer spread given to the broker. Chart 4 shows the development in bid-offer spreads for a number of products (deposit, repo, FRA and T/N IRS) with a maturity of 3 months. The 1996 article concluded that price offering had improved since

1 The capital required for each transaction is difficult to quantify. Besides the type of instrument, the capital required for the transaction also depends on e.g. counterparty, maturity and currency, according to the executive order on the banks' capital adequacy. The capital required for the transaction also depends on the bank's other positions, i.e. the effect of the transaction on the bank's net positions. 2 As compared to the trading volume in 1998 in the legacy currencies of the euro area member states.

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BID-OFFER SPREADS FOR 3-MONTH MONEY-MARKET PRODUCTS Chart 4

Basis points Deposit 100 90 80 70 60 50 40 30 20 10 0 19921993 1994 1995 1996 1997 1998 1998 2000 2001

Basis points Repo 100 90 80 70 60 50 40 30 20 10 0 19921993 1994 1995 1996 1997 1998 1998 2000 2001

FRA Basis points 100 90 80 70 60 50 40 30 20 10 0 19921993 1994 1995 1996 1997 1998 1998 2000 2001

T/N IRS Basis points 100 90 80 70 60 50 40 30 20 10 0 19921993 1994 1995 1996 1997 1998 1998 2000 2001

Note: Weekly averages. The FRA contract is the contract with the nearest settlement date at any time. T/N IRS was introduced in May 1997. Data on FRA are only available back to September 1996. For repo and deposit a number of observations in 1992 and 1993 are cut off at a bid-offer spread of 100 basis points. Source: The money-market broker in Denmark.

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INTEREST-RATE DIFFERENCE BETWEEN CIBOR AND DEPOSIT, REPO AND T/N IRS Chart 5

Basis points 50

-10 1995 1996 1997 1998 1999 2000 2001

Cibor - Deposit Cibor - Repo Cibor - T/N IRS

Note: Daily observations. 3-month interest rates for deposit, repo and T/N IRS are offer rates. Source: The money-market broker in Denmark.

1992-93, as the spreads had become narrower and more stable. This has generally been maintained, as shown in Chart 4. In periods of strong fluctuations in money-market interest rates, e.g. in the autumn of 1998 and 2000, the bid-offer spreads widened, but were quickly restored to normal. FRAs account for the narrowest bid-offer spread, which confirms that the market is highly liquid. The wider and more volatile spread for deposits reflects the absence of market-maker agreements for deposits and the low liquidity in long-term deposits. The bid-offer spreads in the Danish money market are wider than in the money market of the euro area, where they can be as narrow as 1-2 basis points for certain products and maturities. The difference should be viewed in the light of e.g. the significantly larger trading volumes and the larger transaction sizes in the euro-area money market. How- ever, in general, the bid-offer spreads in the Danish money market are not significantly wider than the spreads in comparable money markets such as Sweden's. There are no signs either of any inconsistencies in connection with the prices offered for the individual products. Chart 5 shows the interest-rate difference between 3-month Cibor and 3-month deposit, repo and T/N IRS. Since Cibor and the deposit rate are rates of interest for uncollateralised loans, they are normally higher than the repo rate. In the mid-1990s the interest-rate difference between uncollateralised

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SPREAD BETWEEN HIGHEST AND LOWEST OFFERED CIBOR RATES Chart 6

Basis points 60

0 1996 1997 1998 1999 2000 2001

3 months 12 months

and collateralised loans narrowed to approximately 10 basis points in normal periods. However, in certain periods this spread can widen considerably, such as during the unrest on the financial markets in the summer and autumn of 1998, and up to the millennium rollover. Cibor and the deposit rate are normally also higher than the T/N IRS rate, for which the credit risk solely relates to the settlement of the future interest-rate difference, not the principal. Price offering in the money market can also be assessed by comparing the rate for an FRA with a "synthetic" FRA rate calculated on the basis of other money-market interest rates. For example, a synthetic FRA rate for a 3-month loan 3 months ahead can be calculated by combining a 6-month Cibor (lending rate) with a 3-month Cibor (deposit rate)1. This type of comparison normally results in only small deviations between the FRA rate and the synthetic FRA rate, without any systematic pattern. The calculated Cibor is thus normally consistent with the price offering for other money-market products. However, from time to time there can be a certain spread between the individual prices offered by the Cibor participants. This spread may have negative consequences for the money market if it becomes too significant. Viewed over a longer period these spreads have been relatively stable, cf. Chart 6. Measures to strengthen

1 The two transactions are not quite identical for several reasons. For example, the credit risks are different and the synthetic interest rate is based on two offer rates. Furthermore, the calculation can only be sufficiently accurate on the days of settlement of FRAs (IMM days).

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Cibor are continuously being discussed under the auspices of the Danish Bankers Association. In the light of Cibor's great significance as a reference interest rate it is important that the Cibor offering always provides a credible and accurate picture of the level of interest rates in the Danish money market.

CONCLUSION

On the basis of the analysis in the article it can be concluded that the Danish money market is generally well-functioning. The enhanced price offering since 1992-1993 with narrower and more stable bid-offer spreads has generally been maintained. The bid-offer spreads in the Danish money market are wider than euro-area spreads, but not significantly wider than in comparable money markets. Furthermore, there are no indications of any inconsistencies related to the price offerings for individual products, including the calculated Cibor. The money market plays an important role in many respects such as for the banks' liquidity management and as basis for the securities market. In view of the importance of the money market it is important that the participants continue to show responsibility and participate actively in the development of the market. This also applies to day-to-day activities such as the exchange of liquidity among banks and in Cibor offering.

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ANNEX 1

Standardised products in the Danish money market The instruments in the Danish money market can be divided into cash market products or interest-rate derivatives. Trading of cash market products entails immediate exchange of liquidity on conclusion of the agreement. In the case of interest-rate derivatives the exchange of liquidity takes place as settlement of interest-rate differences at a fixed time in the future. The standardised products in the Danish money market are outlined in the following.

Cash market products • Deposits are uncollateralised krone-denominated loans with standardised maturities from one day up to 12 months. • Repos are collateralised krone-denominated loans with standardised maturities from 1 day up to 6 months. The collateral consists of debt securities, typically bonds. These transactions are also called repurchase agreements, since the seller of the bonds (recipient of cash) on conclusion of the agreement undertakes to repurchase the securities at a fixed future time at a fixed price. Repos can thus be viewed as simultaneous spot and forward transactions in bonds whereby both transactions entail a change of ownership of the securities. • Foreign-exchange swaps or fx swaps are collateralised krone-denominated loans with standardised maturities from 1 day up to 12 months. The collateral is foreign exchange, typically dollars. The fx swap entails simultaneous spot and forward transactions in foreign exchange on conclusion of the contract. The buyer receives kroner and delivers foreign exchange to the seller, while on expiry the buyer receives the foreign-exchange amount against payment of the seller's outstanding krone amount. • Bonds with a short remaining term to maturity are often traded on money-market terms and may be included in the group of money- market instruments. This group of bonds includes e.g. short-term mortgage-credit bonds issued to finance adjustable-rate mortgages, and Treasury bills. Treasury bills are listed securities issued at auction via Danmarks Nationalbank on behalf of the central government. These are zero-coupon securities sold at below par and redeemed at par on the expiry date. On 1 May 2001 a 12-month Treasury bill was introduced, i.e. the maturity is 12 months from issue. A new series is opened for issue four times a year and the monthly auctions normally only comprise series with a remaining term to maturity of at least 3 months.

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• Certificates of deposit are issued by Danmarks Nationalbank as an element of the management of liquidity in the money market. The certificates of deposit are zero-coupon securities sold at a price below par and redeemed at par, whereby the yield corresponds to the rate of interest for certificates of deposit. The certificates of deposit normally have a maturity of 14 days and can solely be traded among Danmarks Nationalbank's monetary-policy counterparties.

Interest-rate derivatives • T/N IRS (Tomorrow/Next Interest-Rate Swap) is a short-term interest- rate swap using the T/N rate as a reference interest rate, cf. Annex 2. On conclusion of a T/N interest-rate swap the parties agree to swap a variable interest rate (the T/N interest rate) for a fixed interest rate. The agreement can be concluded for standardised maturities of between 1 and 12 months. The buyer undertakes to pay a fixed interest rate to the seller against receipt of the T/N rate from the seller for the term of the agreed maturity. Initially the agreement entails no payment of principal between the parties, and on expiry only a net amount is settled, depending on the development in the T/N interest rate. Cita (Copenhagen Interest T/N average) is often used synonym- ously with T/N IRS. • FRAs (Forward Rate Agreement) entail the freezing of an interest rate for an agreed principal for a given period in the future. Purchase of an FRA fixes the financing interest rate for a floating-rate loan, while sale of an FRA fixes the interest rate for a floating-rate deposit. Standard- ised FRAs run for 3 or 6 months with settlement on IMM (International Monetary Market) days 4 times a year. No payments are exchanged on conclusion of the agreement. Cibor, cf. Annex 2, is used as the reference interest rate for standardised FRAs, and on the date of commencement the discounted difference between the agreed fixed interest rate and 3- or 6-month Cibor is settled.

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ANNEX 2

Reference interest rates Reference interest rates or interest-rate indices play an important role in the money market as a benchmark in loan agreements and in the settlement of interest-rate derivatives. The most important reference interest rates in the Danish money market are Cibor (Copenhagen Inter Bank Offered Rate) and the T/N (Tomorrow/Next) rate. Both reference interest rates are calculated and published by Danmarks Nationalbank on a daily basis against the background of reported data from a group of banks. Cibor and the T/N rate have no monetary-policy significance. Cibor is a reference interest rate for provision of krone-denominated liquidity on an uncollateralised basis to a creditworthy bank (a prime bank). None of the current 8 Cibor participants is obliged to lend liquidity subject to its individual interest rates. For the calculation of Cibor the individual participants at 10.30 a.m. to Danmarks Nationalbank report a Cibor rate to two decimal places for the maturities 1-6, 9 and 12 months. Cibor is then fixed by excluding the two highest and the two lowest rates for each maturity and calculating a simple average of the four remaining interest rates. The Cibor rates are published at 11.00 a.m. on the reporting date. With a view to enhanced transparency in the Cibor fixing process, since 26 March 2001 the individual interest rates have been published on the Web site of the Danish Bankers Association www.finansraadet.dk. Cibor corresponds to Euribor (Euro Inter Bank Offered Rate) in the euro-area money market. Euribor is a reference interest rate for uncollateralised euro-denominated lending from one creditworthy bank to another. There are currently 49 Euribor participants. A private information agency is responsible for calculating and publishing Euribor. Euribor is fixed by excluding the highest and the lowest 15 per cent of the reported interest rates for each maturity and calculating a simple average of the remaining interest rates. Euribor is published at 11.00 a.m. on the reporting date when the individual interest rates of the Euribor participants are also published. The Euribor participants are under no obliga- tion to lend liquidity subject to these interest rates. While Cibor and Euribor are calculated on the basis of reported offered interest rates the T/N rate is based on actual trading data. The T/N rate is fixed on the basis of reporting by 13 major participants in the Danish money market of their uncollateralised krone-denominated inter-bank lending in the T/N segment on the previous banking day, and the average rate of interest for the loans. On this basis, Danmarks Na- tionalbank calculates a trading-weighted T/N rate published at noon on

19/06/2002 10:17 Antal sider: 18 Rev. nr. 2 H:\kvo\ENG\2002\2qtr\til tryk\side19-36.doc Oprettet af Michael Sand 36 the reporting date. This interest rate has been selected as the day-to-day reference interest rate in the Danish money market since by far the largest part of the market for uncollateralised inter-bank lending occurs in the T/N segment. The corresponding interest rate in the euro area is Eonia (Euro Over- Night Index Average) which is the reference interest rate for uncollateralised inter-bank lending in the O/N segment, which is dominant in the euro area. The reporting populations for Euribor and Eonia are identical. Eonia is calculated by the European Central Bank and published by a private information agency between 6.45 p.m. and 7.00 p.m. on the reporting date. 4 March 2002 saw the commencement of publication of a reference interest rate for provision of euro-denominated liquidity against collateral for selected maturities. This reference interest rate is called Eurepo. Cal- culation and publication are subject to the same principles as Euribor. The Web site www.euribor.org provides further information on Eurepo, Eonia and Euribor.

19/06/2002 10:17 Antal sider: 18 Rev. nr. 2 H:\kvo\ENG\2002\2qtr\til tryk\side19-36.doc Oprettet af Michael Sand