Ch06, Money Market Jeff Madura

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Money Markets © 2003 South-W estern/Thom son Learning

Transcript of Ch06, Money Market Jeff Madura

Money

Markets

© 2003 South-Western/Thomson Learning

Chapter Objectives Provide a background on money market

securities Explain how institutional investors use money

markets Explain the globalization of money markets

Money Market Securities Maturity of a year or less Debt securities issued by corporations and

governments that need short-term funds Large primary market focus Purchased by corporations and financial

institutions Secondary market for securities

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Money Market Securities

Treasury Bills Commercial paper Negotiable certificates of deposits Repurchase agreements Federal funds Banker’s acceptances

Money Market Securities Treasury bills

Issued to meet the short-term needs of the U.S. government

Attractive to investors Minimal default risk—backed by Federal Government Excellent liquidity for investors

Short-term maturity Very good secondary market

Money Market Securities

Treasury bill auction (fill bids in amount determined by Treasury borrowing needs) Bid process used to sell T-bills Bids submitted to Federal Reserve banks by the

deadline Bid process

Accepts highest bids

Competitive Bidding

Money Market Securities Estimating T-bill yield

No coupon payments Par or face value received at maturity Yield at issue is the difference between the selling

price and par or face value adjusted for time If sold prior to maturity in secondary market

Yield based on the difference between price paid for T-bill and selling price adjusted for time

Money Market Securities Calculating T-Bill Annualized Yield

YT SP – PP

PP

365

n

YT = The annualized yield from investing in a T-bill

SP = Selling price

PP = Purchase price

n = number of days of the investment (holding period)

=

Money Market Securities T-bill yield for a newly issued security

Par – PP

PP

360

n

T-bill discount = percent discount of the purchase price from par

Par = Face value of the T-bills at maturity

PP = Purchase price

n = number of days to maturity

T-bill discount =

Money Market Securities

Short-term debt instrument Alternative to bank loan Dealer placed vs. directly placed Used only by well-known and creditworthy firms Unsecured Minimum denominations of $100,000 Not a large secondary market

Commercial Paper

Money Market Securities Commercial paper backed by bank lines of

credit Bank line used if company loses credit rating Bank lends to pay off commercial paper Bank charges fees for guaranteed line of credit

Money Market Securities Estimating commercial paper yields (same as t-bill)

YCP

Par – PP

PP

360

n

YCP = Commercial paper yield

Par = Face value at maturity

PP = Purchase price

n = number of days to maturity

=

Money Market Securities

Issued by large commercial banks Minimum denomination of $100,000 but $1 million more

common Purchased by nonfinancial corporations or money market

funds Secondary markets supported by dealers in security

Negotiable Certificates of Deposit (NCD)

Money Market Securities NCD placement

Direct placement Use a correspondent institution specializing in

placement Sell to securities dealers who resell Sell direct to investors at a higher price

NCD premiums Rate above T-bill rate to compensate for lower

liquidity and safety

Money Market Securities

Sell a security with the agreement to repurchase it at a specified date and price

Borrower defaults, lender has security Reverse repo name for transaction from lender Negotiated over telecommunications network Dealers and brokers used or direct placement No secondary market

Repurchase Agreements

Money Market Securities Estimating repurchase agreement yields

Repo RateSP – PP

PP

360

n

Repo Rate = Yield on the repurchase agreement

SP = Selling price

PP = Purchase price

n = number of days to maturity

=

Exhibit 6.51 Purchase Order

Shipment of Goods5

L/C3

Shipping Documents & Time DraftDraft Accepted (B/A Created)

7Japanese Bank

(Exporter’s Bank)American Bank

(Importer’s Bank)

Importer Exporter

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L/C

(Le

tter

of C

redi

t) A

pplic

atio

n

4

L/C

Not

ifica

tion

6

Shi

ppin

g D

ocum

ents

& T

ime

Dra

ft

Money Market Securities

A bank takes responsibility for a future payment of trade bill of exchange

Used mostly in international transactions Exporters send goods to a foreign destination and want

payment assurance before sending Bank stamps a time draft from the importer

ACCEPTED and obligates the bank to make good on the payment at a specific time

Bankers Acceptance

Money Market Securities

Exporter can hold until the date or sell before maturity

If sold to get the cash before maturity, price received is a discount from draft’s total

Return is based on calculations for other discount securities

Similar to the commercial paper example

Bankers Acceptance

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Major Participants in Money Market

Participants Commercial banks Finance, industrial, and service companies Federal and state governments Money market mutual funds All other financial institutions (investing)

Short-term investing for income and liquidity Short-term financing for short and permanent needs Large transaction size and telecommunication network

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Valuation of Money Market Securities Present value of future cash flows at maturity

(zero coupon) Value (price) inversely related to discount

rate or yield Money market security prices more stable

than longer term bonds Yields = risk-free rate + default risk premium

Exhibit 6.7InternationalEconomicConditions

U.S.FiscalPolicy

Issuer’sIndustry

Conditions

RiskPremiumof Issuer

Short-TermRisk-Free

InterestRate

(T -bill Rate)

Issuer’sUnique

Conditions

U.S.Monetary

Policy

U.S.Economic

Conditions

Required Returnon the Money

Market Security

Price of theMoney Market

Security

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Interaction Among Money Market Yields Securities are close investment substitutes Investors trade to maintain yield differentials T-Bill is the benchmark yield in money market Yield changes in T-bills quickly impacts other

securities via dealer trading Yield differentials determined by risk differences

between securities Default risk premiums vary inversely with economic

conditions

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Globalization of Money Markets

Money market rates vary by country Segmented markets Tax differences Estimated exchange rates Government barriers to capital flows

Deregulation Improves Financial Integration Capital Flows To Highest Rate of Return

Globalization of Money Markets Performance of international securities Effective yield for international securities has

two components The yield earned on the investment denominated

in the currency of the investment The exchange rate effect

Globalization of Money Markets Performance of international securities Yield for an international investment Yf

SPf – PPf

PPf

Yf = Foreign investment’s yield

SPf = Investment’s foreign currency selling price

PPf = Investment’s foreign currency purchase

=

Globalization of Money Markets The exchange rate effect (%ΔS) measures the

percentage change in the spot during the investment period

% ΔS measures the expected percent change in the currency Currency appreciated, % ΔS is positive and adds to net yield Currency depreciated, % ΔS is negative and reduces net yield

111 )%()( SYY fe

Tugas Carilah informasi tentang instrumen pasar

uang (money market) di Indonesia.