How to Write a Derivative Research Note: Describe Only

A note on a derivative arrangement describes it completely and then stops. Six parts get written in a fixed order: the answer in the opening sentence, both sides' obligations, the arithmetic printed rather than asserted, the unknowns inside the body, the direction with no forecast attached, and a cutting pass over whatever was added last.

The agreement has been read and the figures pulled out of it. Somebody who was not in the room now needs to understand what was signed, and the job in front of the writer is to put it on paper for them. The routine below covers the writing, not the gathering, and the order in which the writing happens.

Order sounds like a small thing to build a routine on. It is not. The line between describing an arrangement and telling somebody what to do about it is held by the sequence these six parts are written in, not by the writer remembering to be careful at the end of a long draft. Restraint is exactly what runs out at four in the afternoon on the fourth side of a long draft. A fixed order does not run out.

Everything below is worked against one arrangement. Chitrakoot Cements Limited, an invented manufacturer, has agreed to pay a rate that will not move, 7.20 per cent a year, and to take in whatever the floating benchmarkA published rate that one side follows instead of naming a number of its own. Which published rate, and who administers it, is written into the agreement rather than picked later. reads. Saranga Capital Limited, an invented finance company, has agreed to the mirror of that. A notionalThe figure both sides apply their rates to. It sits under the arrangement and is never handed across; only the difference between the two results moves. of Rs 1,000 crore sits underneath both sides.

What is a note of this kind for, and what line does it hold?

Somebody finishes the note. Ask what they can now say out loud. Four things: what the arrangement obliges each side to do, how large the amounts are, what would move those amounts, and what nobody knows. A fifth thing they should not be able to say is what the writer thinks they ought to do about any of it. The note does not contain that anywhere.

The constraint sounds modest until it has to be held across three printed sides. The vocabulary of this subject gives almost no help. Nothing in the words fixed leg, floating leg, reset, notional or net difference marks the boundary between an account of a thing and a case for it. A writer can produce eleven true sentences and cross the line in the twelfth without changing register, without raising their voice, and without noticing.

A note that describes carefully and then adds a view has not added a view to a description; it has converted the description into a case, and every figure above the added sentence is read differently from that moment on. The conversion is worth sitting with, and it explains why the line is structural rather than cosmetic. The reader does not process the final sentence as a separate item. The reader takes the final sentence as the point the previous three sides were building towards, and retro-fits every number already read into supporting it. The careful arithmetic becomes evidence for a claim made in nine words at the end.

Think about a plumber's note left on the kitchen table. Version one: the tap drips at roughly a mug an hour, the washer is worn through, a new washer costs very little and the job takes ten minutes. Version two is identical, with five words at the foot: so it is worth doing. The facts are the same in both. In the first, the household weighs a mug an hour against ten minutes and decides. In the second, the mug an hour has become an argument, and anybody who decides not to bother now feels they are overruling somebody. Nothing was falsified. Something was still taken away.

What belongs in the first sentence, and how is it tested?

Part one has a name, and the name is doing work. The name is the answer first rule, from Minto, The Pyramid Principle, and the term is borrowed whole rather than paraphrased because a reader who knows it will recognise what is being done. The opening sentence says what the two sides have agreed to and what moves under it. Everything else in the note supports that sentence; nothing in the note builds up to it.

So the opening carries two figures and the words that keep them apart. Write the notional with the word notional fastened to it. Write the first period difference of Rs 12.00 crore next to it. Let a reader meet both together before a single descriptive sentence arrives. Any note that opens with the headline figure alone has misled its reader in its first sentence, and nothing later in the note undoes that.

Here is why the two must arrive together rather than a paragraph apart. Rs 1,000 crore and Rs 12.00 crore differ by a factor of more than eighty. A reader who meets the larger one on its own forms a picture of the scale of this arrangement, and that picture is wrong by that factor. When the smaller figure arrives later, it does not replace the picture; it gets filed as a detail inside it. Written out to the last digit, the two are Rs 10,00,00,00,000/- and Rs 12,00,00,000/-. Only the second one describes money leaving an account.

No writer can judge an opening sentence while the rest of the note is still in their head. So the test for part one is mechanical, and mechanical is the point. The sentence is read alone, with everything after it covered. The question is then whether a reader who stops right there has been misled. Not whether they know everything. Whether what they now believe is wrong.

Writers who half remember the answer first rule produce the exact note this routine exists to prevent. One misreading in particular is common enough to be worth naming. The rule is not a conclusion first rule. The answer is what the arrangement obliges its two sides to do. The answer is not what the writer has made of those obligations. Somebody who opens with a verdict and then supports it for three sides has written a perfectly organised argument for a position, and has followed a rule they have understood backwards.

What does each side have to be described as obliged to do?

Part two names both parties, says which leg each one pays and which it takes in, and states the stretch of time the obligation covers. Part two names both sides even when the note is written for one party and nobody on the other side will ever open it.

The reason is not even-handedness. An obligation described from one side alone reads as a position, and a position invites precisely the question this note refuses to answer. Write only that Chitrakoot Cements pays 7.20 per cent a year and takes in the floating benchmark, and a reader is looking at a stance somebody has taken. Write both obligations and the reader is looking at an arrangement. An arrangement has two ends and no opinion in it. The second version does not lecture the reader about staying neutral. The second version simply removes the shape that makes them ask.

Part two also carries the vocabulary discipline, and this part lives or dies by it. The words are not decoration and they are not house preference; each of them prevents one specific misreading that this material has watched happen. Because a list of them written out as prose is a list nobody reads, here it is as rows.

Look at the last two rows together. The last two rows are the same rule twice, and that rule costs the least to follow and the most to skip. A rate carries the stretch of time it is quoted for. A ratio carries the thing it is a share of. Both sit in the same sentence as the number itself, not in a note underneath and not in a heading three paragraphs up.

How much arithmetic goes in, and how is it shown?

A note that states an amount is asking to be believed. A note that prints the multiplication is asking to be checked. Asking to be believed and asking to be checked are two different relationships with a reader, and part three chooses the second one every time.

Showing it does not mean a full side of working. At the length a note allows, it is one line holding six things: the notional, both rates with the stretch of time each is quoted for, the day count fractionThe share of a year a stretch of time is treated as, once the counting rule written into the agreement has been applied to it. A whole year handled that way comes out at 1.0000., each leg, the difference between them, and which way that difference travels. One line. Not a table, not an appendix, and not a sentence that says the calculation is available on request.

Here is that line for this arrangement, broken across rows so the six things can be seen separately before they are written as one. A notional of Rs 1,000 crore at 7.20 per cent a year over a fraction of 1.0000 gives a fixed leg of Rs 72.00 crore grossA leg's own amount before it is set against the other leg. Two gross figures stand in the note and one transfer happens between them.. The same notional at 6.00 per cent a year over the same fraction gives a floating leg of Rs 60.00 crore gross. Take the second from the first and Rs 12.00 crore is left, travelling from Chitrakoot Cements to Saranga Capital.

A reader who meets the two figures separately keeps the larger one, so the share goes in the same line as the amount and is not optional. Rs 12.00 crore read on its own is a big number. Rs 12.00 crore read as 1.2 per cent of the figure it was worked from is a proportion, and a proportion is what the reader actually needs. The two rates differ by 1.20 percentage pointsThe plain gap between two percentages. Seven point two per cent set against six per cent leaves one point two of them, which is a different quantity from a twenty per cent change., and 1.20 percentage points applied to Rs 1,000 crore is the same Rs 12.00 crore reached without either leg being computed at all.

One boundary sits on part three and it is absolute. The arithmetic in a note may not quietly reach into any stretch of time whose reading has not been observed. The Chitrakoot arrangement has one resetThe moment a reading is taken and locked for the stretch of time that follows it. Before that moment the stretch has no number; after it, the number cannot be revised. behind it and one reading, 6.00 per cent a year. There is no second reading anywhere in the record this note is built from. So the note prints one period and no other, and it says that rather than leaving the silence to be interpreted.

Where do the unknowns sit, and why not at the foot?

Part four is the longest of the six, for a reason that has nothing to do with how much there is to say. The position of an unknown decides what a note means without changing one word of what the note says. Everything else in these six parts is about what gets written. Part four is about where the writing goes.

Naming the unknowns makes the placement question concrete, so start with what they actually are here. There are three.

The first is the big one. Stating a value would be a claim the writer cannot support, so the note states none and says so in its own text rather than leaving a gap. A value would need a dated schedule of readings for every future reset. No such schedule stands behind this note. There is one reading, taken at one reset, and that is the whole of it. A writer who produces a value anyway has produced a number a reader cannot audit. The reader cannot see the schedule that is not there.

The refusal rests on how thin the ground is, so it is worth being exact about that. Behind this note there is no history of what the benchmark has read before. No spread of readings. No measure of how much a reading moves about. No likelihood attached to any level. No record of how any earlier arrangement turned out, and no run of past work to point at. The missing readings were not left out to keep the note short. The readings do not exist, and every claim that would need one of them is therefore a claim this note cannot make.

The second unknown follows from the first. No amount is given for any period after the first. Same reason, stated separately because a reader may accept the first and still expect the second.

The third is routed rather than absent. Whether this arrangement qualifies for hedging treatmentWhether an arrangement may be recorded against the thing it was struck to offset rather than standing on its own. The conditions are set by an authority and move, so none is written here., and what evidence has to stand behind that answer, is set by the Reserve Bank of India at rbi.org.in. The note prints the question and the address, and no answer.

Now the placement. All three sit inside the body of the note, in the same type as everything else, at the point where a reader would first want them. Not in a footnote. Not in a box at the end. Not under a heading called limitations. In the body, in sequence, where the reading eye goes anyway.

The test that decides whether an unknown has been placed honestly is a single question, and it is a question about the reader rather than about the sentence. Could somebody reading only the body, at ordinary speed, finish this note without knowing about this absence? If the answer is yes, the absence is in the wrong place, however completely and however honestly it is stated wherever it currently sits.

How is the direction written without writing a forecast?

A note may say what moves an amount and which way. Direction is a property of the arrangement, sitting in the agreement itself, and leaving it out would make the note less complete rather than more careful. A note may not say which way anything is going to go.

The direction here comes straight out of the structure. Chitrakoot Cements pays a rate that will not move and takes in one that will. So a higher reading at the next reset makes the difference it pays smaller, and a lower reading makes that difference larger. The notional under both legs is the same figure and the fraction applied to both is the same fraction. Only the gap between the two rates can change, so the movement is point for point. The statement stops there, and no amount appears anywhere in it. No reading exists for that period, and an amount would need one.

Three words are absent from this part of every note written this way, and they are absent by rule rather than by taste: likely, expected, and any form of the verb to anticipate. Each of them fastens a view about the future onto what was, one word earlier, a property of the agreement. And a view about the future here would need the very things this record does not hold: a run of past readings, a spread around them, some measure of how much they move. None of that exists behind a note of this kind, so the words have nothing to attach to.

Part five is where notes about rate arrangements go wrong more often than anywhere else, and the lesson that prevents it was settled long ago. A rate written into an agreement is a term of that agreement. A forward price is arithmetic performed on a spot figure and a financing cost. Neither of them is anybody's opinion about what is coming. A note that lets a reader take one for the other has repeated the single most damaging error available in this whole subject, and it has done it inside a document whose purpose was accuracy.

What does the cutting pass hunt for?

Part six is not a proofread. Nothing gets added, nothing gets clarified and no sentence gets improved. The pass has one purpose, removal, and it runs over the sentences that were written last. The last sentences written are the ones that cross the line.

There is a reason for that concentration at the end. By the final paragraph the writer has spent an hour inside this arrangement, understands it better than anyone who will read the note, and a small pressure has built up to give the reader something for their trouble. The pressure produces one sentence. The sentence is almost always the last one written and almost always the one that has to go.

Four shapes are worth hunting for by name, given as shapes rather than as phrases so that a writer recognises their own version rather than looking for somebody else's words.

One test catches all four of them, and it is short enough to run on every sentence in the last paragraph: does this sentence tell somebody what to do? Not does it say so explicitly. Does it, once a reader has read it, leave them with an instruction they did not have before. If yes, it goes, however carefully it was hedged and however much of an afternoon it took to write.

Cut sentences often contain something real, and throwing away the fact along with the framing is a waste. So there is a rule for the material too. The fact goes into part four if what it was really saying is that something is not known. The fact goes into part five if what it was really saying is which way an amount moves. If it fits neither, it goes out, and it goes out without a footnote. A footnote is exactly the move part four exists to refuse.

What does the finished note actually look like, printed end to end?

A routine about writing is worth very little described. Here is the routine run once, all six parts, on the arrangement between Chitrakoot Cements Limited and Saranga Capital Limited. Read it straight through before reading the notes that follow it.

Count what the note contains and what it refuses. Six parts, two figures printed in full, one line of working that a reader can redo with a pencil, three absences stated inside the body, two sentences shown as removed with their reasons, and one refusal written out plainly at the end. Nothing in it is hedged. Hedging and refusing are different acts: a hedge softens a claim, and this note declines to make the claim at all and names the missing thing that is the reason.

The assumptions standing beside the note are worth reading as carefully as the note. One full first period is worked at a fraction of 1.0000. The floating benchmark carries no name and follows no published series. No reading exists for any period after the first. The note states no value for the arrangement anywhere.

Chitrakoot Cements Limited and Saranga Capital Limited are invented.
Educational material. Not advice on any investment, tax, budget or market position.