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The Mechanics Of A MTN Private Trading Program

By Marcel Ford

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Published: 17Dec2008
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Considering that top major banks issue Medium Term Notes (known as MTNs and Mid-Term Notes) to raise funds in both U.S. and Euro dollars, we can better understand that they are for the purpose of generating Operating Loans and issuing Letters of Credit to businesses which wish to buy material and products from other business organizations in other countries. To further expand on this in laymen terms, this therefore results in an International Treaty whereby the U.S. Dollar (or the Euro) becomes the common Medium of Exchange for International Trading.

By Federal Law, a European bank is not allowed to sell such Medium Term Notes directly to the Public. They must be issued and sold through a Federal Reserve Licensed Trader; just as in the same context a Corporation or a Municipality must sell Bonds through a Dealer or Underwriter.

The Trader, aiding in the distributional sales of newly issued MTNs from the major sized Bank will have a $50B (Billion) contract (or of equivalent amounts) with the Issuing Bank to purchase MTNs for immediate resale. This Trader would instigate the following:

A Non-Revocable Contract (see further explanation in Paragraph A) with an Exit Buyer, such as a Pension Fund, to buy those MTNs from them immediately, and with a contract with a Participating Investor, acting as the Trader's 'Associate' to furnish the Proof Of Funds (POF) required, simply as a formality, to start and continue the Purchase and Resale series of Transactions.

The Trader also makes contractual arrangements with their own bank, through their bank's 'Back Room' Trading Department, to act for them during the Transactions of $100M (Million) or greater. This $100M amount is the minimum set by the U. S. Federal Reserve for this type of Bank issued MTN Distribution.

The 'Associate' thereby arranges for their own bank to issue to themselves a POF using $100M in Cash Funds, which are wholly owned by them, in their account at their own bank. This enacts the ability to obtain cash credit of $100M for the POF. This POF is then sent to the Trader in accordance with the contract between Trader and their 'Associate'.

It is important to note that Medium Term Note Trading is a very specific process. When less than experienced Associates expect absolute perfection and "up-to-the-minute" communication, these immediate reactions inevitably cause more delays, short-comings and frustrations on behalf of not only the Associate but the Trade Platform as well.

Several factors influence the timing of entering a trade; the current availability of Medium Term Notes, which can easily be in short supply, the timing of the trade submission and the specific programs that cancel without notice. On occasion, these unexpected market trends give a false illusion resulting in the sophisticated MTN Trading Platform to appear chaotic. Nothing is further than the truth.

Below is a typical scenario of a Private Mid-Term Buy/Sell Program.

a. The Trader's Bank communicates with the Issuing Bank as well as with the Exit Buyer's Bank, obtaining a detailed agreement with the Issuing Bank Officer and with the Exit Buyer's Bank that they are both prepared to commence the contracted series of Transactions. The Exit Buyer's Bank forwards a POF to the Trader's Bank for the amount of the first purchase of $100M (Note - When a POF has been issued for the Exit Buyer and forwarded to the Trader's Bank, there is a legal Funding Commitment to complete that Transaction, which may NOT be revoked while the transaction is taking place).

b. The Trader's Bank forwards to the Issuing Bank a POF in the name of the Trader and requests that a MTN be issued in the name of the Trader, along with an Invoice at a discounted price, say for example only $97M, payable in 8 Hours.

c. A copy of the Note and an invoice at $97M, is forwarded to the Trader's Bank, which authenticates signatures and MTN terms to verify compliance with the Purchase Contract.

d. The Trader's Bank then forwards the copy of the MTN, along with a Conditional Assignment of the MTN, to the Exit Buyer's Bank, along with an Invoice at the Exit Buyer's Purchase Contract Price, $100M for example purposes, payable in 4 hours.

e. The Exit Buyer's Bank authenticates signatures, verifies compliance with the Purchase Contract, and pays the $100M Invoice price to the Trader's Bank for credit to Trader's account, within the 4 hour limit.

f.The Trader's Bank pays Issuing Bank's Invoice for $97M within the 8 hour limit, along with instructions for the Original MTN to be sent to the Exit buyer's Bank by courier.

g. The Trader's Bank debits the Trader a Bank Fee (1/4% for example purposes) for their Services Rendered, and forwards the balance, $100M minus $97M minus 1/4 %, to the Trader, who pays the Trader's 'Associate' for their Service Rendered.

h. The Procedure used for this example, typically takes place 4 times each day of a 4 business day week, and repeats until the Trader's Purchase Contract is completed. Using this formula, the weekly payments to the 'Associate', would be equal to 22% of their POF amount. (3% per transaction x 4 per day x 4 days per week = 48% - 4% as Bank Fee = 44% / 2 = 22% = $22M per week)

Note: The Operation described above is a very conservative one. There are other MTN Trade Operations, of the same MTN basis but involving a resale of the MTNs by the 'Exit Buyer', which have a higher Rate of Return to the Trader involved, and therefore an even higher payment to the 'Associate' involved.

An experienced Associate can safely state that with the listed procedure and controls for the Transactions, the only reason for a Transaction failing, once commenced, would be for the Exit Buyer's Bank to default on completing a contracted purchase of a Note, which would result in a jeopardy to their Bank Charter.

Should any default take place, it would be quite simple for the Trader to make the required Payment, using their own Funds, to complete their purchase of the Instrument, and to immediately sell it to a different contracted Exit Buyer. This action by the Trader eliminates any risk of loss by the Buyers and Exit Buyers and 'Associate'.

NOTE: With minor variances in the connection of an Investor's Funds to a Trader's $100M Operating Fund, an Investor may enter into an Operation with $10M, or more, with similar percentage payments to them for services rendered. By the same token, an Investor may enter into a trading operation with as much over $100M as they have available.

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