A Note on the Canadian Money Market

8/12/2019 A Note on the Canadian Money Market

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Fixed Income Securities and the Canadian Money Market

Learning Objectives 3

Overview of Fixed Income Securities 3Factors that Determine the Interest Rate 3Basics of rading Fixed Income Securities !Fixed Income and Stoc" #ar"ets $ %e& Differences !

he #one& #ar"et 'Im(act on )conomic *rowth 'Brief +istor& of the ,anadian #one& #ar"et -.dvantages for Borrowers /.dvantages for Investors 0Im(ortant ,haracteristics of #one& #ar"et Securities 0,a cu ating 2rice and ie d on a Discount 4ote 5

&(es of #one& #ar"et Securities 16,om(osition of the ,anadian #one& #ar"et 16

reasur& Bi s 11 $ ,anada reasur& Bi .uctions 17Ban" 2a(er 13Ban"ers8 .cce(tances 13,ommercia 2a(er 13 $ Information #emorandum 1! $ ,redit Ratings and Defau t Ris" 1- $ DBRS Short erm ,redit Ratings 1-

ie ds and S(reads 1/

rading #one& #ar"et Securities 10De iver& and Sett ement 10Innovation in Securities rading $,DS 15

Securiti9ation: .B,2 and the Financia ,risis of 766/;7660 15.sset Bac"ed ,ommercia 2a(er Resu ts 7!


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FIXED INCOME SECURITIES AND T E CANADIAN MONE! MAR"ET

#earnin$ O%&ecti'es

1? Describe the basic characteristics of fixed income securities

7? @nderstand the features of various t&(es of mone& mar"et securities

3? ,a cu ate the (rice and &ie d of discount notes

!? )x( ain the basics of trading mone& mar"et securities

O'er'ie( o) Fixed Income Securities

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*overnments and cor(orations must freAuent & borrow mone& to finance their o(erations? #ostcor(orations borrow from the ban"ing s&stem: using ban" oans and ban" ines of credit: but the

argest cor(orations and governments a so obtain debt financing direct & through the financiamar"et b& issuing fixed income securities which the& se to investors?

o understand fixed income securities: consider the fo owing three basic (oints

Investors who bu& fixed income securities are oaning mone& direct & to the borrower


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he fact that the interest rate is fixed for the entire term of the securit& creates another source ofris" for investors: es(ecia & when the& bu& a securit& that wi not mature for man& &ears? Iffuture economic conditions: such as strong growth or inf ation: cause interest rates to rise:investors wi receive no additiona return and the& wi suffer an o((ortunit& cost? ocom(ensate investors for that uncertaint&: ong term fixed income securities usua & (a& higher

interest rates than those with shorter terms to maturit&?

*asics o) Tradin$ Fixed Income Securities

@n i"e stoc"s: fixed income securities are not isted or traded on an organi9ed exchange?Instead: transactions are conducted through a networ" of investment dea ers who bu& and sesecurities b& te e(hone or com(uter? his is ca ed the O , or Cover the counter mar"et?

ransaction costs a so differ because commissions are charged on stoc" trades but not ontrades invo ving fixed income securities? On fixed income trades: the on & transaction cost toinvestors is the Cbid as" s(read which is the difference between the (rice at which the dea er

wi bu&


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reAuire short term debt financing: and arge investors who have cash to invest for short time(eriods? he most (o(u ar mone& mar"et investment is government treasur& bi s?

Im,act on economic $ro(th

. iAuid: we $deve o(ed mone& mar"et is essentia for the growth of a modern econom&because it (rovides cor(orations and governments with a re iab e source of short$termfinancing: denominated in oca currenc&?

For arge cor(orations: the mone& mar"et (rovides a stead& su(( & of ow$cost wor"ing ca(ita which the& reAuire to ex(and their domestic business o(erations and ex(ort their (roducts toforeign mar"ets? Businesses and individua s who need to borrow mone& from the ban"ings&stem a so benefit because the mone& mar"et is an additiona source of funding that ban"scan use to ma"e oans whenever their customersG oan demand exceeds the amount of cashthe& can obtain from de(ositors?

Investors: inc uding businesses and cor(orations who have tem(orar& cash sur( uses: a so

benefit because the mone& mar"et (rovides them with an o((ortunit& to invest arge amounts ofcash easi & and safe &: and earn a reasonab e return? For that reason: a we deve o(ed mone&mar"et he (s to create wea th: further contributing to economic growth and confidence?

Fina &: a as(ects of the econom& benefit because a we $deve o(ed mone& mar"et he (s thecentra ban" to im( ement monetar& (o ic&? If the mone& mar"et is active and re iab e: thecentra ban" can easi & se or bu& arge amounts of reasur& bi s to increase or decrease

iAuidit&: and inf uence interest rates?

A *rie) istory o) the Canadian Money Market,anadian financia mar"ets were undeve o(ed unti the Ban" of ,anada was estab ished in153': and the ,anadian mone& mar"et did not exist? Before Hor d Har I: the government of theDominion of ,anada: as our countr& was ca ed then: obtained short term financing b& se ingtreasur& bi s to investors in the London mone& mar"et? Since British investors demanded(a&ment in (ounds ster ing: the ,anadian government cou d not obtain short term funding in itsown currenc&?

Hhi e ,anadaGs historic (o itica ties to Britain caused our government to borrow in the Londonmone& mar"et: ,anadian ban"s turned to 4ew or" for short term funding? #ost ban" financingtransactions were denominated in @S do ars: so the ,anadian ban"s were ex(osed to

exchange rate ris"s? et: des(ite those ris"s: the ac" of ,anadian do ar a ternatives did notseem to deter the ban"s from using the 4ew or" mar"et because it offered good iAuidit& and aconvenient ocation: c ose to ,anadian financia centers of #ontrea and oronto? In fact: theban"sG eas& access to a we $deve o(ed mone& mar"et in 4ew or" (robab & inhibited thedeve o(ment of a mone& mar"et in ,anada for man& &ears?

Because the ,anadian ban"ing industr& focused on 4ew or": our domestic mone& mar"et didnot deve o( unti the Ban" of ,anada and the government of ,anada decided to ta"e action inthe 1536Gs? In its first annua re(ort: re eased in 153'J : the Ban" of ,anada em(hasi9ed that

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effective im( ementation of monetar& (o ic& reAuired the deve o(ment of an active mone&mar"et in ,anada It is universally recognized that a central bank is hampered in its operationswhere an active bill market does not exist ?

he need for a domestic mone& mar"et (rom(ted the *overnment of ,anada to issue treasur&bi s in ,anadian do ars in 153!? Regu ar ,anada treasur& bi auctions started three &ears aterin 153/? +owever: an active mone& mar"et did not begin to deve o( in ,anada unti the 15-6Gsbecause most treasur& bi s were bought b& ban"s which he d them to maturit& and did nottrade? . so: due to ban"ing regu ations that (ersisted through the 15-6Gs: non$governmentissuers were absent from our mone& mar"et?

hen: in 15-/: the Ban" of ,anada initiated a series of changes: inc uding the remova ofinterest rate cei ings on ban" oans: which increased mone& mar"et (artici(ation b& ban"s andinvestment dea ers? Ban"s became more active: cor(orate borrowers began to issue mone&mar"et securities as an a ternative to ban" oans: and ban"ersG acce(tances were introduced?

hese (ivota events (romoted the deve o(ment of the active mone& mar"et that exists in,anada toda&?

Sourcehtt( ;;www?g76?utoronto?ca;docs;ca(ita mar"ets$canada?(df

Ad'anta$es )or *orro(ers

For governments and arge cor(orations who borrow to finance their short term wor"ing ca(itareAuirements: the mone& mar"et (rovides a re iab e source of ow cost debt financing?

heir borrowing costs are reduced because the interest rate the& (a& to issue mone& mar"etsecurities is usua & ower that the rate the& wou d have to (a& on a ban" oan? Savings can besignificant: as i ustrated in ,hart 1? 4ote that mone& mar"et rates are much ower than theC2rime Rate : which determines the interest rate that ban"s charge on oans made to their bestcustomers?

F exibi it& is better: too: because the mone& mar"et a ows borrowers to match the amount andmaturit& date of their borrowing to their cash reAuirements? @nfortunate &: not a borrowers can

access the mone& mar"et? Issuance is imited to borrowers who routine & reAuire arge amountsof short term debt financing: t&(ica & K'6 to K166 mi ion or more: and have strong ba ancesheets?

C ART -

Canadian !ie.ds and Rates

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Latest

2revious Hee"!Hee"s

Da& .go .go

T/%i..s1$month 6?0- 6?0/ 6?05 6?51

3$month 6?00 6?00 6?05 6?5'-$month 6?5' 6?5! 6?53 1?66

1$&ear 1?66 6?55 6?5! 1?63

*anker0s Acce,tances

1$month 1?1- 1?71 1?77 1?71

3$month 1?76 1?7/ 1?7- 6?50-$month 1?70 1?70 1?7/ 1?37*ank #oans 1 De,ositsBan"s8 2rime Rate 3?66 3?66 3?66 3?66

*I,8s 56 da&s 6?-6 6?-6 6?-6 6?-6

Source Financia 2ost une 77: 7617

htt( ;;www?financia (ost?com;mar"ets;data;mone&$&ie ds$canMus?htm

Ad'anta$es )or In'estors

For investors: mone& mar"ets offer the o((ortunit& to invest their cash easi & and safe &: whi ea so earning interest rates that are usua & su(erior to the rates the& can earn on ban" de(osits?

he mone& mar"et a so (rovides investors with the o((ortunit& to invest in securities withdifferent terms to maturit&: ranging from overnight to 3-' da&s: so can se ect the maturities thatbest meet their needs? In addition: most mone& mar"et securities are Cnegotiab e so ownershi(can be transferred from one investor to another? he& are a so Cmar"etab e so investors canse them in the O , mar"et if the& need cash (rior to the maturit& date?

+owever: the fact that a securit& is mar"etab e does not necessari & im( & that investors can sea arge amount at a fair mar"et (rice? he abi it& to rese a arge ho ding of a securit& Auic" & fora good (rice is ca ed C iAuidit& ? LiAuidit& in the mone& mar"et is variab e: de(ending on thesecurit& t&(e? .s we wi see ater in this cha(ter: *overnment of ,anada reasur& Bi s haveexce ent iAuidit&: and trade active & in ver& arge amounts in the secondar& mar"et? B&contrast: most mone& mar"et securities issued b& cor(orations have ow iAuidit& so investorsmust often acce(t a ower (rice if the& se them before the maturit& date?

Investors who bu& mone& mar"et securities inc ude financia intermediaries such as (ensionfunds: insurance com(anies: mutua funds and ban"s: as we as cor(orations and governments

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that have short term cash sur( uses to invest? Individua or Cretai investors ma& a so invest inmone& mar"ets: but their (artici(ation is usua & imited b& the fact that this is a Cwho esa emar"et in which the minimum transaction si9e is ver& arge


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So the Auoted (rice is K55?6733 (er K166 face or (ar va ue

Example ! +ow much must &ou (a& to bu& K1 mi ion face va ue of this discount noteJ

233,990$0233.99$100$

000,000,1$ =

Example " Hhat is the &ie d on a K166:666 ,anadian treasur& bi with 106 da&s untimaturit& and a mar"et (rice of K50:766J

4Exam,.es are ada,ted )rom *ooth 1 C.eary5

In the @nited States: the (rice and &ie d on @S government reasur& bi s ma& be Auoteddifferent &: on what is ca ed a Cban" discount basis : using ca cu ations that are based on a 3-6da& &ear: and use F as the denominator

Example # Hhat is the &ie d on a K166:666 @S treasur& bi with 106 da&s unti maturit&and a mar"et (rice of K50:766: if the &ie d is ex(ressed on a ban" discount basisJ

%60.3180360

000,100$200,98$000,100$360 =

=

=

n F

P F k

BD

$ote how differences in %anadian and &' market convention impacted the results we obtained

in for the treasury bill yield calculations shown in Examples " and #(

Increasing &: the @S is moving to a 3-' da& &ear for mone& mar"et ca cu ations: butmethodo og& cannot be assumed? Hhen trading in @S treasur& bi s: it is im(ortant to confirmthe basis on which ca cu ations are being made because differences wi cause (ricediscre(ancies: eading to significant errors in the (ricing of arge trades?

Ty,es o) Money Market Securities

5

%72.3180365

200,98$200,98$000,100$365

= = = n P P F

k BEY


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#one& mar"et securities are c assified b& the t&(e of issuer government: ban" or cor(oration?. are avai ab e for (urchase b& investors in mu ti( es of K1:666 face or (ar va ue: but minimumtransaction amounts var&?

Com,osition o) the Canadian Money Market

he amount outstanding of each t&(e of securit& in the mone& mar"et changes over time: and isinf uenced b& the re ative borrowing needs of governments: ban"s and cor(orations? Hhengovernments run arge deficits: as the& did during the recession that fo owed the financia crisisof 7660: the& must finance those deficits b& borrowing from investors? .s shown in ,hart 7:deficit financing causes the do ar va ue of government securities to increase: so governmentsecurities re(resent a arger (ercentage of tota securities avai ab e for investors to (urchase inthe mone& mar"et? 4ote that short term borrowings b& governments: which re(resented on &!7 of a mone& mar"et securities in 766-: increased to -- b& 7611?

C ART 6 Com,osition o) the Canadian Money Market %y Do..ar 7a.ue o) SecuritiesOutstandin$

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Source DBRS

Treasury %i..s are short term securities issued and guaranteed b& a government? . soca ed $bi s: the& are usua & the safest and most iAuid securities in an& oca mar"et?

$bi s issued b& the federa governments of financia & strong countries: such as ,anadaand the @nited States: are considered Cris" free investments? Due to their ow ris" andhigh iAuidit&: the& (rovide the owest &ie ds: re ative to other mone& mar"et securities

with the same term to maturit&?

,anada reasur& Bi s )%*+,s- are one of the most (o(u ar investment a ternatives in the,anadian mone& mar"et? he& are viewed as the safest investment because the& are adirect ob igation of the *overnment of ,anada? he& are a so the most iAuid: so the&can be so d: even in ver& arge amounts: whenever investors need to raise cash on ver&short notice?

In ,anada: the governments of arge (rovinces: such as Ontario and Puebec: a soissue treasur& bi s on a regu ar basis? 2rovincia $Bi s are guaranteed b& the issuing(rovince and (rovide investors with s ight & higher &ie ds than $bi s issued b& the*overnment of ,anada because the& are ess iAuid and ma& have sma defau t ris"?

o( are ne( Canada treasury %i..s created8

Canada Treasury *i.. Auctions

*overnment of ,anada treasur& bi s are issued through an auction (rocess conductedb& the Ban" of ,anada: which acts in its ca(acit& as the fisca agent of the federa

government? .uctions: which are announced in advance on the Ban" of ,anadaGs website: are he d twice a month on uesda&s: for a (revious & announced do ar amountand range of terms to maturit&: usua & 3 months: - months and one &ear? heannouncement of a recent ,anada treasur& bi auction is shown in .((endix 1?

2artici(ation in the treasur& bi auction is strict & contro ed b& the Ban" of ,anada toensure that the mar"et remains fair: trans(arent and ver& iAuid? On & authori9ed (rimar&dea ers and government securities distributors are (ermitted to bid for the new treasur&bi s: and the& ma& submit bids for their own account and on beha f of their customers?

wo t&(es of bids are a owed

Com,etiti'e %ids : in which the dea er states the (rice and &ie d at which he is wi to bu& an amount of $ bi s: u( to a s(ecified amount: and

Non/com,etiti'e %ids : in which the dea er agrees to bu& a s(ecified amount of$bi s at the weighted average auction (rice of successfu com(etitive bids?

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he amount that a sing e bidder can bu& is imited to (revent one or more dea ers fromdominating the mar"et? Resu ts for a recent *overnment of ,anada $bi auction areshown in .((endix 7?

C ART 9

*ank ,a,er is issued b& chartered ban"s to fund their short term cash needs: and so d

to investors in the mone& mar"et? ,a ed certificates of de(osit


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Ban"ersG acce(tances are a arge and ver& im(ortant com(onent of the ,anadian mone&mar"et? In 7611: the& accounted for K'1 bi ion: or a most '6 of a non$governmentsecurities?


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Hhich investment dea ers shou d &ou contact if

&ou want to bu& +ome De(ot ,anadaGs

commercia (a(erJ

Hhat is the credit ratingJ

In &our o(inion: how safe is it to invest in +ome

De(ot ,anada commercia (a(erJ

C ART ;

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Credit Ratin$s and De)au.t Risk

he financia strength of the issuer is ver& im(ortant because investors who bu& commercia

(a(er are ma"ing an unsecured oan to the issuing cor(oration? Since the oan is bac"ed on &

b& the issuerGs (romise to (a&


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vu nerab e to future events?

R/- 4.o(5*ood credit Aua it&? he ca(acit& for the (a&ment of short$term financia ob igations as the& fadue is substantia ? Overa strength is not as favourab e as higher rating categories? #a& bevu nerab e to future events: but Aua if&ing negative factors are considered manageab e?

R/6 4hi$h5@((er end of adeAuate credit Aua it&? he ca(acit& for the (a&ment of short$term financiaob igations as the& fa due is acce(tab e? #a& be vu nerab e to future events?

R/6 4midd.e5.deAuate credit Aua it&? he ca(acit& for the (a&ment of short$term financia ob igations as the&fa due is acce(tab e? #a& be vu nerab e to future events or ma& be ex(osed to other factorsthatcou d reduce credit Aua it&?

R/6 4.o(5Lower end of adeAuate credit Aua it&? he ca(acit& for the (a&ment of short$term financiaob igations as the& fa due is acce(tab e? #a& be vu nerab e to future events? . number ofcha enges are (resent that cou d affect the issuerGs abi it& to meet such ob igations?

Source DBRS

.ccording to records maintained b& DBRS: a commercia (a(er current & outstanding in the,anadian mone& mar"et is rated R$1? 2 .$1?=

he data (resented in ,hart ' c ear & indicates that investors wi not acce(t the defau t ris"

associated with bu&ing non$ investment grade (a(er: rated R$7 or ower? he im( ication is thatcor(orations with ower credit ratings cannot borrow direct & through the mone& mar"et?Instead: the& must obtain a ban" guarantee and issue ban"erGs acce(tances?

C ART S,reads ?

Di))erence %et(een the yie.ds on C3 1 T/*i..s

Tradin$ Money Market Securities + De.i'ery and Sett.ement

In the (ast: reasur& bi s were (h&sica (a(er certificates: issued in Cbearer form to faci itateiAuidit& and fast trading? 4o records of ownershi( were "e(t and whoever had (h&sica

(ossession of the treasur& bi certificate was deemed to be the owner? @nderstandab &: the use

1/

Money Market Spreads(CansimV121812,V121778,V121796)

0

50

100

150

200

250

300

1 / 4 / 2 0 0 6

3 / 4 / 2 0 0 6

5 / 4 / 2 0 0 6

7 / 4 / 2 0 0 6

9 / 4 / 2 0 0 6

1 1 / 4 / 2 0 0 6

1 / 4 / 2 0 0 7

3 / 4 / 2 0 0 7

5 / 4 / 2 0 0 7

7 / 4 / 2 0 0 7

9 / 4 / 2 0 0 7

1 1 / 4 / 2 0 0 7

1 / 4 / 2 0 0 8

3 / 4 / 2 0 0 8

5 / 4 / 2 0 0 8

7 / 4 / 2 0 0 8

9 / 4 / 2 0 0 8

1 1 / 4 / 2 0 0 8

1 / 4 / 2 0 0 9

3 / 4 / 2 0 0 9

5 / 4 / 2 0 0 9

7 / 4 / 2 0 0 9

9 / 4 / 2 0 0 9

1 1 / 4 / 2 0 0 9

1 / 4 / 2 0 1 0

3 / 4 / 2 0 1 0

CP BA


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of bearer certificates created an unsafe situation that eft the financia s&stem o(en to theft andfraud? For safet&: other t&(es of mone& mar"et securities were registered in the name of theowner: using (a(er records which reAuired time$consuming manua adjustment whenever thesecurities were bought or so d?

Hith the advent of com(uter techno og& in the 1506Gs: trading became safer and more efficient?) ectronic ownershi( records: maintained b& the ,anadian De(ositor& for Securities


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Securiti@ation Asset *acked Commercia. 3a,er and the Financia. Crisis o) 6BB

Asset *acked Commercia. 3a,er 4A*C35 is a t&(e of commercia (a(er issued b& a trustor a s(ecia (ur(ose vehic e


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good returns: combined with ow defau t ris"? #ost were rated R$1


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'ource 0+ '

#essons #earned )rom the US Financia. Crisis

He earn good essons from ever& financia crisis? he oss of confidence in securiti9ationsthat occurred during the crisis was c eansing for the mar"et because it focused investorsGattention on the need to ana &9e and understand ever& securit& the& (urchase: and not tore & so e & on (ub ished credit ratings? For most individua investors and others who ac"s(ecific ex(ertise: treasur& bi s are the usua & the best a ternative for investing short termfunds?

ABCP maker misled investors: OSC

Financia 2ost

John Greenwood Sep 28, 2011 12:33 PM ET | Last Updated: Sep 29, 2011 11:52 AM ET

Four years after Canadas asset backed commercial paper market froze up leaving holders with huge losses, theOntario Securities Commission has ruled that the company at the centre of the mess and two of its top executivesbreached provincial securities laws by misleading investors.

The judgement means that the maker of much of the supposedly-safe investment vehicle knew the market was indeep trouble, but failed in its duty as a public company to give investor a public warning.The regulator said thecompany was aware of important invents that would impact the investments liquidity and, It is unlikely that any

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http://business.financialpost.com/author/johngreenwood/http://business.financialpost.com/author/johngreenwood/


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investor would have purchased Coventree-sponsored ABCP if they had been aware of those market events anddevelopments.

The Toronto-based boutique investment bank was the largest sponsor of third-party ABCP, a $35-billion market thatstopped functioning in September 2007 after worried investors dumped their holdings because of fears that it mightcontain U.S. sub-prime mortgages.

Following a marathon restructuring, the ABCP market was revamped, with investors ranging from averagemiddle-class individuals to giant pension funds swapping stalled paper for longer-term notes that now trade forsignificantly less than face value. ABCP markets around the world froze up around the same time but Canada wasthe only country where holders ended up shouldering the losses after banks that agreed to provide emergencyliquidity declined to step up. Indeed part of the government bailouts of banks in the United States and Europe wereused to pay for ABCP losses taken as a result of making investors whole.

Critics say sophisticated players involved in the Canadian market were aware of flaws such as weak liquidityagreements and took advantage. Holders thought they were buying liquid, short-term notes almost equivalent tocash but in fact much of what they owned was opaque derivatives linked to dodgy U.S. home loans. As theimplosion of the subprime mortgage market gathered speed in early 2007 some of these sophisticated investors gotnervous and started shifting out of ABCP linked to U.S. mortgages. When the market finally stopped on Sept. 13,2007, it was mostly the out-of-the-loop investors who ended up holding the frozen ABCP.

The OSC found that Coventree failed to alert the market of key events affecting its business plan as well as thebroader ABCP market. For instance, in January 2007 it failed to put out a news release when it learned of changesat the ratings agency DBRS that would severely impact its business. And over the course of the next few months asconcern over the sub-prime mortgage meltdown grew, it failed to advise shareholders of emerging problems in theABCP market that ultimately led to the freeze up.

Wednesdays ruling is contained in a 188-page document including detailed testimony submitted during 45 days ofhearings that took place last year. The OSC said penalties for Coventree and the two executives will be consideredat a later date.

"ey Terms

.sset Bac"ed ,ommercia2a(er LiAuidit&Ban" 2a(er #ar"etab eBan"ers8 .cce(tances #one& #ar"etBearer Form 4egotiab eBid$.s" S(read O , #ar"etBond )Auiva ent ie d 2ar a ue

,ommercia 2a(er Securiti9ation,redit Rating Sett ement Date

,redit S(readS(ecia 2ur(ose

ehic eDefau t erm to #aturit&Discount 4ote rade DateFace a ue ransaction ,ostFixed Income Securities rans(arenc&

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Information #emorandum reasur& Bi sIssuer

A33ENDIX Announcement o) Treasury *i.. Auction

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Auction Resu.ts

7!


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C ARTS AND TA*#ES FOR USE IN T IS C A3TER

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7-

A Note on the Canadian Money Market

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Transcript of A Note on the Canadian Money Market