Chapter Six Money Markets © 2001 South-Western College Publishing Company.
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Transcript of Chapter Six Money Markets © 2001 South-Western College Publishing Company.
Chapter Six
Money Markets
© 2001 South-Western College Publishing Company
2
Chapter Objectives
Provide a background on money market securities
Explain how institutional investors use money markets
Explain the globalization of money markets
3
Money Market Securities
Maturity of a year or less Issued by corporations and governments that
need short-term funds Investors find out about new issues in the
primary market via a telecommunications network
Purchased by corporations and financial institutions
Secondary market for securities exists
4
Money Market Securities
Treasury bills Issued to meet the short term needs of the
U.S. governmentAttractive to investors
• Liquidity
• Fairly safe from default risk due to government backing
• Strong secondary market exists
5
Money Market Securities
Treasury bill auction competitive bids (Fill bids in amount determined by Treasury borrowing needs)Bid process used to sell T-billsBids submitted to Federal Reserve banks by
the deadlineBid process
• Accepts highest bids
• Accepts bids until generates total needed
6
Money Market Securities
Estimating T-bill yieldNo coupon paymentsPar or face value received at maturityYield at issue is the difference between the
selling price and par or face value If sold prior to maturity in secondary market
• Yield based on the difference between price you paid to buy T-bill and price you sold it for
7
Money Market Securities
Calculating T-bill yields 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)
=
8
Money Market Securities
Calculating T-bill yields T-bill discount 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 =
9
Money Market Securities
Commercial paperShort-term debt instrumentUsed only by well-known and creditworthy
firmsUnsecuredMinimum denominations of $100,000Not an active secondary market
10
Money Market Securities
Commercial paper ratingsPast defaults means a rating for default risk
helps investors evaluate risks and issuers sell the securities
Ratings agencies assign a grade based on credit risk
Commercial paper placement choicesDirect placementCommercial paper dealers
11
Money Market Securities
Backing commercial paper with a line of creditUsed in case they can’t roll over or reissue
new debt at a reasonable rateRating change would affect costBank gives issuer right but not obligation to
borrow a certain amount for a specified period of time
Bank charges fees
12
Money Market Securities
Estimating commercial paper yields
YCP
Par - PP
PP
360
n
YCP = Commercial paper yield
Par = Face value at maturity
PP = Purchase price
n = number of days to maturity
=
13
Money Market Securities
Negotiable certificates of deposit NCDs Issued by large commercial banksMinimum denomination of $100,000 but $1
million more commonPurchased by nonfinancial corporations or
money market fundsSecondary market exists but issuers don’t like
new issues to compete with previous issues in the secondary market
14
Money Market Securities
NCD placementDirect placementUse a correspondent institution specializing in
placementSell to securities dealers who resellSell direct to investors at a higher price
NCD premiumsRate above T-bill rate to compensate for less
liquidity and safety
15
Money Market Securities
Repurchase agreementsSell a security with the agreement to
repurchase it at a specified date and priceBorrower defaults, lender has securityReverse repo name for transaction from
lenderNegotiated over telecommunications networkDealers and brokers used or direct placementNo secondary market
16
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
=
17
Money Market Securities
Federal fundsDepository institutions use to borrow and lend
short-term funds with each otherFederal funds rate usually slightly higher than
T-bill rateFed district bank debits and credits accountsFederal funds brokers may match up buyers
and sellers using telecommunications networkUsually $5 million or more
18
Money Market Securities
Banker’s acceptancesA bank takes responsibility for a future
paymentUsually result from international transactionsExporters send goods to a foreign destination
and want payment assurance before sendingBank stamps a draft from the importer
ACCEPTED and obligates the bank to make good on the payment at a specific time
19
Money Market Securities
Banker’s acceptancesExporter 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 totalReturn is based on calculations for other
discount securities Similar to the commercial paper example
20
Institutional use of Money Markets
Used by many kinds of institutional investors both to invest and borrow
Money market securities enhance liquidityNewly issued securities raise cashBuyers of securities generate cash when
they liquidate they holdings Active secondary market helps liquidity Short-term maturity enhances liquidity
21
Valuation of Market Securities
Many money market securities do not make interest payments
Value is the present value of the security at maturity
Par or face value is the future value of a lump sum
Discount rate is rate investors require Like bonds, an inverse relationship between
price and yield
22
Interaction Among Money Market Yields
Securities in the money market have interrelated yields Investors can substitute among securities Investors trade if a price and yield disparity
occurs among securities Economic uncertainty causes an investor shift to
securities with lower possible risk of default
23
Globalization of Money Markets
Some segmentation remains in the global money market
Rates among countries have become more interrelated over time
Increase in the flow of fundsTax differences among countriesSpeculation on exchange rate changesReduced government barriers
24
Globalization of Money Markets
Eurodollar deposits and EuronotesDollar deposits in banks outside the U.S. Increased because of international trade
growthNo reserve requirements at banks outside
U.S. Eurodollar Loans
Channel funds to other multinationals that need short-term financing
25
Globalization of Money Markets
Eurodollar deposits and Euronotes Eurocurrency market consists of several banks
that with loans and deposits denominated in Eurocurrencies
Eurodollar CDsSecondary marketSome have floating rates tied to LIBOR or
London Interbank Offer Rate Eurocredit market offers longer maturity loans
26
Globalization of Money Markets
Euro-commercial paper Issued without the backing of a banking
syndicateMaturity tailored to investorsDealers that place paper created a secondary
market
27
Globalization of Money Markets
Performance of international securities Effective yield for international securities has
two componentsThe yield earned on the investment
denominated in the currency of the investment
The exchange rate effect