5-1 Money Markets Money markets involve debt instruments with original maturities of one year or...
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Transcript of 5-1 Money Markets Money markets involve debt instruments with original maturities of one year or...
5-1
Money MarketsMoney Markets
Money markets involve debt instruments with original maturities of one year or less
Money market debt issued by high-quality (i.e., low default risk) economic units that
require short-term funds purchased by those that have excess short-term funds little or no chance of loss of principal low rates of return
Most money market instruments have active secondary markets to provide liquidity
Money markets involve debt instruments with original maturities of one year or less
Money market debt issued by high-quality (i.e., low default risk) economic units that
require short-term funds purchased by those that have excess short-term funds little or no chance of loss of principal low rates of return
Most money market instruments have active secondary markets to provide liquidity
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Money Market Yields Money Market Yields
Money market securities use special rate quoting conventions: Discount yields (idy): Interest rate is quoted on an annual basis
assuming a 360 day year as a percent of redemption price or face value
Single payment yields (ispy): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of purchase price
Both may be converted to a bond equivalent yield (ibey) for comparison with bonds
Money market securities use special rate quoting conventions: Discount yields (idy): Interest rate is quoted on an annual basis
assuming a 360 day year as a percent of redemption price or face value
Single payment yields (ispy): Interest rate is quoted on an annual basis assuming a 360 day year as a percent of purchase price
Both may be converted to a bond equivalent yield (ibey) for comparison with bonds
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Money Market YieldsMoney Market Yields
Treasury bills and commercial paper rates are quoted as discount yields
Discount yields (idy) use a 360-day year
Pf = the face value of the security
P0 = the discount price of the securityh = the number of days until maturity
Treasury bills and commercial paper rates are quoted as discount yields
Discount yields (idy) use a 360-day year
Pf = the face value of the security
P0 = the discount price of the securityh = the number of days until maturity
hP
PPi
f
f
dy
360)( 0
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Money Market YieldsMoney Market Yields
Compare discount securities to bonds with bond equivalent yields (ibey)
Convert bond equivalent yields into effective annual returns (EAR)
Compare discount securities to bonds with bond equivalent yields (ibey)
Convert bond equivalent yields into effective annual returns (EAR)
hP
PPi fbey
365)(
0
0
1/365
1/365
h
bey
h
iEAR
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Money Market YieldsMoney Market Yields
Negotiable (or jumbo) CDs and fed funds are money market securities that pay interest only at maturity. These use single-payment yields (ispy)
Negotiable (or jumbo) CDs and fed funds are money market securities that pay interest only at maturity. These use single-payment yields (ispy)
hP
PPi fspy
360)(
0
0
5-6
Sample Calculations of Money Sample Calculations of Money Market YieldsMarket Yields
A $1M investment in 90 day commercial paper has a 2% discount yield, what is the current price of the CP?
A $1M investment in 90 day commercial paper has a 2% discount yield, what is the current price of the CP?
hP
PPi
f
f
dy
360)( 0
$995,000P;90
360
$1M
)P($1M0.02 0
0
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Money Market InstrumentsMoney Market Instruments
Treasury bills (T-bills) Federal funds (fed funds) Repurchase agreements (repos or RP) Commercial paper (CP) Negotiable certificates of deposit (CD) Banker acceptances (BA)
Treasury bills (T-bills) Federal funds (fed funds) Repurchase agreements (repos or RP) Commercial paper (CP) Negotiable certificates of deposit (CD) Banker acceptances (BA)
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Treasury Bills (T-Bills)Treasury Bills (T-Bills)
T-Bills are short-term debt obligations issued by the U.S. federal government
T-bills are virtually default risk free, are highly liquid, and have little interest rate risk
The Federal Reserve buys and sells T-bills to implement monetary policy (open market operation)
Strong international demand for T-bills as safe haven investment
T-Bills are short-term debt obligations issued by the U.S. federal government
T-bills are virtually default risk free, are highly liquid, and have little interest rate risk
The Federal Reserve buys and sells T-bills to implement monetary policy (open market operation)
Strong international demand for T-bills as safe haven investment
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T-Bill AuctionsT-Bill Auctions
13- and 26-week T-bills are auctioned weekly Bids are submitted by government securities
dealers, financial and nonfinancial corporations, and individuals
Bids can be competitive or noncompetitive competitive bids specify the bid price and the desired
quantity of T-bills noncompetitive bidders get preferential allocation and
agree to pay the lowest price of the winning competitive bids
13- and 26-week T-bills are auctioned weekly Bids are submitted by government securities
dealers, financial and nonfinancial corporations, and individuals
Bids can be competitive or noncompetitive competitive bids specify the bid price and the desired
quantity of T-bills noncompetitive bidders get preferential allocation and
agree to pay the lowest price of the winning competitive bids
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The Secondary Market for T-BillsThe Secondary Market for T-Bills
The secondary market for T-bills is the largest of any U.S. money market instrument
22 primary dealers “make” a market in T-bills by buying the majority sold at auction and by creating an active secondary market primary dealers trade for themselves and for customers T-bill purchases and sales are book-entry transactions
conducted over Fedwire
T-Bills are sold on a discount basis
The secondary market for T-bills is the largest of any U.S. money market instrument
22 primary dealers “make” a market in T-bills by buying the majority sold at auction and by creating an active secondary market primary dealers trade for themselves and for customers T-bill purchases and sales are book-entry transactions
conducted over Fedwire
T-Bills are sold on a discount basis
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Federal FundsFederal Funds
The federal funds (fed funds) rate is the target rate in the conduct of monetary policy
Fed fund transactions are short-term (mostly overnight) unsecured loans
Banks with excess reserves lend fed funds, while banks with deficient reserves borrow fed funds
Multimillion dollar loans may be arranged in a matter of minutes
The federal funds (fed funds) rate is the target rate in the conduct of monetary policy
Fed fund transactions are short-term (mostly overnight) unsecured loans
Banks with excess reserves lend fed funds, while banks with deficient reserves borrow fed funds
Multimillion dollar loans may be arranged in a matter of minutes
5-12
Repurchase AgreementRepurchase Agreement
A repurchase agreement (repo or RP) is the sale of a security with an agreement to buy the security back at a set price in the future
Repos are short-term collateralized loans (typical collateral is U.S. Treasury securities) Similar to a fed fund loan, but collateralized Funds may be transferred over FedWire system If collateralized by risky assets, the repo may involve a
‘haircut’
A repurchase agreement (repo or RP) is the sale of a security with an agreement to buy the security back at a set price in the future
Repos are short-term collateralized loans (typical collateral is U.S. Treasury securities) Similar to a fed fund loan, but collateralized Funds may be transferred over FedWire system If collateralized by risky assets, the repo may involve a
‘haircut’
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Repurchase AgreementRepurchase Agreement
Typical denominations on repos of one week or less are $25 million and longer term repos usually have $10 million denominations
A reverse repurchase agreement is the purchase of a security with an agreement to sell it back in the future
Typical denominations on repos of one week or less are $25 million and longer term repos usually have $10 million denominations
A reverse repurchase agreement is the purchase of a security with an agreement to sell it back in the future
5-14
Commercial PaperCommercial Paper
Commercial Paper (CP) is unsecured short-term corporate debt issued by financially reputable companies to raise short-term funds (e.g., for working capital)
Generally sold in denominations of $100,000 to $1 million with maturities between 1 and 270 days
CP is usually sold to investors indirectly CP is usually held by investors until maturity and has no
active secondary market
Commercial Paper (CP) is unsecured short-term corporate debt issued by financially reputable companies to raise short-term funds (e.g., for working capital)
Generally sold in denominations of $100,000 to $1 million with maturities between 1 and 270 days
CP is usually sold to investors indirectly CP is usually held by investors until maturity and has no
active secondary market
5-15
Negotiable Certificate of DepositNegotiable Certificate of Deposit
A negotiable certificate of deposit (CD) is a bank-issued time deposit that specifies the interest rate and the maturity date
CDs are bearer instruments and thus are salable Denominations range from $100,000 to $10 million;
$1 million being the most common. Smaller denomination CDs you can normally see are not negotiable.
Often purchased by money market mutual funds with pools of funds from individual investors
A negotiable certificate of deposit (CD) is a bank-issued time deposit that specifies the interest rate and the maturity date
CDs are bearer instruments and thus are salable Denominations range from $100,000 to $10 million;
$1 million being the most common. Smaller denomination CDs you can normally see are not negotiable.
Often purchased by money market mutual funds with pools of funds from individual investors
5-16
Banker’s AcceptanceBanker’s Acceptance
A Banker’s Acceptance (BA) is a time draft payable (IOU) to a seller of goods with payment guaranteed by a bank
Used in international trade transactions to finance – you may not trust your counterpart, so a bank is involved.
Banker’s acceptances are bearer instruments and salable
A Banker’s Acceptance (BA) is a time draft payable (IOU) to a seller of goods with payment guaranteed by a bank
Used in international trade transactions to finance – you may not trust your counterpart, so a bank is involved.
Banker’s acceptances are bearer instruments and salable
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2011 Money Market Yields2011 Money Market Yields
InstrumentFederal Funds*
CommercialPaper CDs Euro CP
Rate 0.11% 0.17% 0.23% 1.18%
Instrument LIBORBanker’s
Acceptances Euro$ Repo*
Rate 0.27375% 0.22% 0.25% 0.08%
InstrumentTreasury
Bills**Inflation***
Rate 0.060 2.7%
Data from the Wall Street Journal Online Money Rates Section April 2011. Rates are for 3 month maturities except as noted.•Overnight; ** 13 week, *** Year over year, all items as measured by the CPI•LIBOR=London Interbank Offered Rate=the rate the banks in London charge for their short-term lending/borrowing
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Money Market Securities Money Market Securities OutstandingOutstanding
Billions $Instrument 1990 2004 2007 2010Treasury Bills $ 527 $ 982 $1,010 $1,856Fed funds & Repos 372 1,585 2,731 1,656Commercial Paper 538 1,310 2,109 1.083Negotiable CDs 547 1,379 2,149 1,822Banker's Acceptances 52 4 1 1 Total $2,036 $5,260 $8,000 $6,418 % of Total in Given YearInstrument 1990 2004 2007 2010Treasury Bills 26% 19% 13% 29%Fed funds & Repos 18% 30% 34% 26%Commercial Paper 26% 25% 26% 17%Negotiable CDs 27% 26% 27% 28%Banker's Acceptances 3% 0.1% 0.0% 0.0% 100% 100% 100% 100%
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