Welcome to the first article in our series, where we delve into the effective use of Large Language Models (LLMs) such as GPT-4 in treasury, markets, and risk management.
My engagement with GPT-4 has illuminated its "jagged edge," a term Ethan Mollick uses to describe the model's varied effectiveness across different tasks. While LLMs excel in areas like data analysis and enhancing our understanding of complex subjects, their most practical applications often lie in simpler, productivity-enhancing tasks. This series is dedicated to exploring such uses, particularly in treasury, risk, and markets, aiming to elevate the volume and quality of your work with minimal effort and without any more than access to a Foundation Model.
Use Case 1: Streamlining Communication with LLMs
GPT-4, a language-centric model, is particularly adept at managing email correspondence. One effective approach is to input the email text directly into GPT-4’s context window or type in your specific question in the prompt window. The effectiveness hinges on a well-constructed prompt that clearly outlines your requirements, context, and the expected type of response.
For instance, consider an email inquiring about a 2% overnight decrease in a bond's value. The prompt for GPT-4 might be:
"Respond to an email asking why a bond's value fell 2% overnight, attributing it to a rise in interest rates and the bond's long duration."
GPT- 4 responds:
Subject: Explanation for the 2% Decline in Bond Holding Value
Dear [Recipient's Name],
I hope this email finds you well. I understand your concerns regarding the recent 2% decline in the value of your bond holding. There are two primary factors that have contributed to this change:
Overnight Rise in Interest Rates: When interest rates rise, the value of existing bonds typically falls. This is because new bonds are likely to be issued at the higher current interest rate, making older bonds with lower rates less attractive. As a result, the market value of existing bonds decreases.
Bond's Long Duration: The second factor is the long duration of the bond you hold. Bonds with longer durations are more sensitive to changes in interest rates. This means that for a bond with a long duration, even a small increase in interest rates can lead to a significant decrease in its market value.
In summary, the overnight increase in interest rates, coupled with the long duration of your bond, has contributed to the 2% decline in its value. It's important to remember that bond prices and interest rates have an inverse relationship, and long-duration bonds are particularly susceptible to changes in interest rates.
Please feel free to reach out if you have any further questions or need more clarification.
Best regards,
[Your Name]
The response from GPT-4, though stylistically different from my usual writing, aptly addresses the query within seconds. This demonstrates GPT-4’s capability to handle straightforward and complex business inquiries efficiently. Also, the emotion-neutral tone of GPT-4’s responses ensures balanced and helpful communication.
Should the initial response not fully match your perspective, GPT-4 allows for iterative refinement. For example, if you prefer to explain the bond’s fall in value by a decline in present values resulting from rising interest rates, you can modify your prompt to reflect this viewpoint. Let's see this in action, following on and in the same chain of prompts I ask:
"Please would you respond explaining the fall in value as a consequence of rising interest rates decreasing the value of future cash flows and this just led to the value of the bond falling”
GPT-4 Responds:
Subject: Explanation of Your Bond Holding's Decline in Value Due to Rising Interest Rates
Dear [Recipient's Name],
I appreciate your inquiry about the recent 2% decrease in the value of your bond holding. Let me clarify the situation with a focus on the impact of rising interest rates on bond values, especially concerning the future cash flows of the bond.
Rising Interest Rates and Bond Values: The core concept here is that bond prices and interest rates have an inverse relationship. When interest rates rise, the value of existing bonds typically decreases. This is rooted in how bonds are valued. A bond's value is essentially the present value of its future cash flows, which includes periodic interest payments and the return of principal at maturity.
Decreased Value of Future Cash Flows: With the increase in interest rates, the present value of the bond's future cash flows decreases. This is because these future cash flows are now discounted at a higher rate, reflecting the new interest rate environment. In simpler terms, the money that bond investors expect to receive in the future is now worth less in today's terms due to the higher prevailing interest rates.
Immediate Impact on Bond Prices: This recalibration in the present value of future cash flows leads to an immediate adjustment in the market price of the bond. Hence, the bond's value falls in response to the rise in interest rates. This effect is particularly pronounced for bonds with longer durations, as they have more future payments that are affected by the change in interest rates.
In conclusion, the fall in the value of your bond holding is a direct consequence of the rising interest rates, which have reduced the present value of the bond's future cash flows. It's a common market reaction and an important aspect to consider when investing in bonds.
If you need any further clarification or assistance, please don't hesitate to reach out.
Warm regards,
[Your Name]
Beyond Basic Replies: Crafting Detailed Responses
While many emails can be addressed with brief responses, some require more detailed and nuanced replies. This can be challenging for those more attuned to numbers than words. In such scenarios, GPT-4 serves as an invaluable tool for swiftly crafting well-considered responses. I recommend experimenting with LLMs to see if they can improve not just the content of your communications but also the efficiency of your writing process. Their effectiveness in technical areas like treasury is truly noteworthy.
P.S.: A Personal Tip for Using GPT-4
I've found it incredibly straightforward and effective to dictate a rough answer into a Word document and then copy-paste it into GPT-4. This method helps frame the response provided by GPT-4, ensuring it aligns more closely with my initial thoughts and the specific context of the query. This approach streamlines the process, making it more intuitive and aligned with my workflow.