Instruments of Instruments of Finance in Finance in International Money International Money Markets.Markets.

Submitted by:Submitted by:

Ankush Sharma 02-MBA-06Ankush Sharma 02-MBA-06

Sonika Prajapati 30-MBA-Sonika Prajapati 30-MBA-0606

Tanuj Gupta 35-MBA-Tanuj Gupta 35-MBA-0606

International financial markets and International financial markets and operations comprise exchange deals operations comprise exchange deals i.e.i.e. buying, selling currencies, banking buying, selling currencies, banking transactions transactions i.e. i.e. deposit taking and deposit taking and lending, and capital market operations lending, and capital market operations i.e. i.e. issuance of securities. However, market issuance of securities. However, market segments are classified according to nature segments are classified according to nature of financial operations.of financial operations.

Money marketsMoney markets: exchange or exchange : exchange or exchange related transactions.related transactions.

Credit marketCredit market: deposit taking and lending.: deposit taking and lending. Capital marketsCapital markets: issuance of securities.: issuance of securities. Equity marketsEquity markets: issuance of international : issuance of international

securities. securities.

In finance, the money market is the global In finance, the money market is the global financial market for short-term borrowing and financial market for short-term borrowing and lending. lending. It provides short-term liquid funding for It provides short-term liquid funding for the global financial system.the global financial system.

The money market consists of financial The money market consists of financial institutions and dealers in money or credit who institutions and dealers in money or credit who wish to either borrow or lend. wish to either borrow or lend. Participants borrow Participants borrow and lend for short periods of time, typically up to and lend for short periods of time, typically up to thirteen months. thirteen months.

The core money market consists of banks The core money market consists of banks borrowing and lending to each other, using borrowing and lending to each other, using commercial paper, repurchase agreements and commercial paper, repurchase agreements and similar instruments. These instruments are often similar instruments. These instruments are often benchmarked to LIBOR.benchmarked to LIBOR.

Finance companies such as GMAC typically fund Finance companies such as GMAC typically fund themselves by issuing large amounts of asset-themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP by the pledge of eligible assets into an ABCP conduit.conduit.

Certain large corporations with strong credit Certain large corporations with strong credit ratings, such as General Electric, issue commercial ratings, such as General Electric, issue commercial paper on their own credit. Other large corporations paper on their own credit. Other large corporations arrange for banks to issue commercial paper on arrange for banks to issue commercial paper on their behalf via commercial paper lines.their behalf via commercial paper lines.

In the United States, federal, state and local In the United States, federal, state and local governments all issue paper to meet funding governments all issue paper to meet funding needs. States and local governments issue needs. States and local governments issue municipal paper, while the US Treasury issues municipal paper, while the US Treasury issues Treasury bills to fund the US public debt.Treasury bills to fund the US public debt.

Common money market Common money market instrumentsinstruments Euro notes and Euro commercial papers.Euro notes and Euro commercial papers. Bankers’ acceptance and Letters of Bankers’ acceptance and Letters of

credit.credit. Repurchase agreements.Repurchase agreements. Eurodollars.Eurodollars. Federal funds.Federal funds. Municipal notes.Municipal notes. Treasury bills.Treasury bills. Money funds.Money funds. Certificate of deposits.Certificate of deposits. Floating rate notes.Floating rate notes. Euro bonds. Euro bonds.

Euro notes and Euro Euro notes and Euro commercial papers.commercial papers. Both Euro notes and Euro commercial papers are Both Euro notes and Euro commercial papers are

short-term instruments, unsecured promissory notes short-term instruments, unsecured promissory notes issued by corporations and banks. Euro notes, the issued by corporations and banks. Euro notes, the more general term, encompasses note- issuance more general term, encompasses note- issuance facilities, those that are underwritten, as well as facilities, those that are underwritten, as well as those are not underwritten. The term Euro those are not underwritten. The term Euro commercial papers is generally taken to mean notes commercial papers is generally taken to mean notes that are issued without being backed by underwriting that are issued without being backed by underwriting facility- that is without the support of medium term facility- that is without the support of medium term group of banks to provide funds in events that ate group of banks to provide funds in events that ate borrower is unable to role over its Euro notes on borrower is unable to role over its Euro notes on acceptable terms. acceptable terms.

Commercial paperCommercial paper is a money market security issued is a money market security issued by large banks and corporations. It is generally not by large banks and corporations. It is generally not used to finance long-term investments but rather to used to finance long-term investments but rather to purchase inventory or to manage working capital purchase inventory or to manage working capital

Because commercial paper maturities do not Because commercial paper maturities do not exceed nine months and proceeds typically exceed nine months and proceeds typically are used only for current transactions, the are used only for current transactions, the notes are exempt from registration as notes are exempt from registration as securities with the United States Securities securities with the United States Securities and Exchange Commission.and Exchange Commission.

Banker’s Acceptance And Banker’s Acceptance And Letters Of CreditLetters Of Credit A A bankers' acceptancebankers' acceptance, or , or BABA, is a time draft drawn , is a time draft drawn

on and accepted by a bank on and accepted by a bank . Before acceptance, the draft is not an obligation of . Before acceptance, the draft is not an obligation of

the bank; it is merely an order by the drawer to the the bank; it is merely an order by the drawer to the bank to pay a specified sum of money on a specified bank to pay a specified sum of money on a specified date to a named person or to the bearer of the draft. date to a named person or to the bearer of the draft.

Upon acceptance, which occurs when an authorized Upon acceptance, which occurs when an authorized bank accepts and signs it, the draft becomes a bank accepts and signs it, the draft becomes a primary and unconditional liability of the bank primary and unconditional liability of the bank

A bankers acceptance is also a money market A bankers acceptance is also a money market instrument instrument –– a short-term discount instrument that a short-term discount instrument that usually arises in the course of international trade usually arises in the course of international trade

Bankers' acceptances are considered very safe assets, as Bankers' acceptances are considered very safe assets, as they allow traders to substitute the bank's credit they allow traders to substitute the bank's credit standing for their own. They are used widely in standing for their own. They are used widely in international trade where the creditworthiness of one international trade where the creditworthiness of one trader is unknown to the trading partner. Acceptances trader is unknown to the trading partner. Acceptances sell at a discount from face value of the payment order, sell at a discount from face value of the payment order, just as US Treasury bills are issued and trade at a just as US Treasury bills are issued and trade at a discount from par value. discount from par value.

Letters of credit are documents issued by banks in which Letters of credit are documents issued by banks in which the bank promises to pay a certain amount on a certain the bank promises to pay a certain amount on a certain date, if and only if documents are presented to bank as date, if and only if documents are presented to bank as specified in terms of the credit. A letter of credit is specified in terms of the credit. A letter of credit is generally regarded as a very strong legal commitment on generally regarded as a very strong legal commitment on the part of banks specified in terms of letters of credit. the part of banks specified in terms of letters of credit.

In typical export transactions, the exporter will want to In typical export transactions, the exporter will want to be paid once the goods arrive in foreign port. So, the be paid once the goods arrive in foreign port. So, the exporter asks for acceptance of importers bank of time exporter asks for acceptance of importers bank of time draft and that essentially would be an invoice that draft and that essentially would be an invoice that requests a money market instruments. requests a money market instruments.

Repurchase AgreementRepurchase Agreement Repurchase agreementsRepurchase agreements ( (RPsRPs or or reposrepos) are ) are

financial instruments used in the money markets financial instruments used in the money markets and capital markets. A more accurate and and capital markets. A more accurate and descriptive term is descriptive term is Sale and Repurchase Sale and Repurchase AgreementAgreement

cash receiver (seller) sells securities cash receiver (seller) sells securities nownow, in , in return for cash, to the cash provider (buyer), and return for cash, to the cash provider (buyer), and agrees to repurchase those securities from the agrees to repurchase those securities from the buyer for a greater sum of cash at some later buyer for a greater sum of cash at some later date, that greater sum being all of the cash lent date, that greater sum being all of the cash lent and some extra cash (constituting interest, and some extra cash (constituting interest, known as the known as the repo raterepo rate). ).

A reverse repo is simply a repurchase agreement as A reverse repo is simply a repurchase agreement as described from the buyer's viewpoint, not the seller's. Hence, described from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a the seller executing the transaction would describe it as a 'repo', while the buyer in the same transaction would 'repo', while the buyer in the same transaction would describe it a 'reverse repo'. So 'repo' and 'reverse repo' are describe it a 'reverse repo'. So 'repo' and 'reverse repo' are exactly the same kind of transaction, just described from exactly the same kind of transaction, just described from opposite viewpoints.opposite viewpoints.

A repo is economically similar to a secured loan, with the A repo is economically similar to a secured loan, with the buyer receiving securities as collateral to protect against buyer receiving securities as collateral to protect against default. However, the legal title to the securities clearly default. However, the legal title to the securities clearly passes from the seller to the buyer, or "investor".passes from the seller to the buyer, or "investor".

Although the underlying nature of the transaction is that of Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking a loan, the terminology differs from that used when talking of loans due to the fact that the seller does actually of loans due to the fact that the seller does actually repurchase the legal ownership of the securities from the repurchase the legal ownership of the securities from the buyer at the end of the agreement. So, although the actual buyer at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in effect of the whole transaction is identical to a cash loan, in using the 'repurchase' terminology, the emphasis is placed using the 'repurchase' terminology, the emphasis is placed upon the current legal ownership of the collateral securities upon the current legal ownership of the collateral securities by the respective parties.by the respective parties.

Although repos are typically short-term, it is not unusual to Although repos are typically short-term, it is not unusual to see repos with a maturity as long as two years.see repos with a maturity as long as two years.

Money market Money market instruments instruments

EurodollarsEurodollars Treasury securitiesTreasury securities Federal bondsFederal bonds Municipal bonds.Municipal bonds.

EurodollarsEurodollars Eurodollar: Eurodollar: U.S. dollars held as deposits in foreign banksU.S. dollars held as deposits in foreign banks

• Corporations often find it more convenient to hold deposits at foreign banks to Corporations often find it more convenient to hold deposits at foreign banks to facilitate payments in their foreign operationsfacilitate payments in their foreign operations

• Can be held in U.S. bank branches or foreign banksCan be held in U.S. bank branches or foreign banks• Dollar denominated deposits are referred to as EurodollarsDollar denominated deposits are referred to as Eurodollars

RiskRisk::• They are not subject to reserve requirements They are not subject to reserve requirements • Nor are they eligible for FDIC depositor insurance (U.S. government is not Nor are they eligible for FDIC depositor insurance (U.S. government is not

interested in protecting foreign depositors)interested in protecting foreign depositors)• The resulting rates paid on Euro dollars are higher (higher risk)The resulting rates paid on Euro dollars are higher (higher risk)

TradingTrading::• Over night trading as in the Federal Funds marketOver night trading as in the Federal Funds market• Eurodollars are traded in London, and the rates offered are referred to as LIBOR Eurodollars are traded in London, and the rates offered are referred to as LIBOR

(London Interbank Offered Rate)(London Interbank Offered Rate)• Rates are tied closely to the Fed Funds rateRates are tied closely to the Fed Funds rate• Should the LIBOR rate drop relative to the Fed Funds rate, U.S. banks can balance Should the LIBOR rate drop relative to the Fed Funds rate, U.S. banks can balance

their reserves in the Eurodollar market (arbitrage)their reserves in the Eurodollar market (arbitrage)

Treasury SecuritiesTreasury Securities Issued by Federal Government:Issued by Federal Government:

Finance annual deficits (budget shortfalls)Finance annual deficits (budget shortfalls)Refinance maturing debtRefinance maturing debt

Standard maturities:Standard maturities: 4, 13, 26 or 52 weeks (1, 3, 6, 12 months)4, 13, 26 or 52 weeks (1, 3, 6, 12 months)

Interest rateInterest rate::No coupon paymentNo coupon paymentT-bills sold at a discount to face value (implied rate of T-bills sold at a discount to face value (implied rate of return)return)

• Four types of treasury securitiesFour types of treasury securitiesTreasury BillsTreasury BillsTreasury NotesTreasury NotesTreasury BondsTreasury BondsSavings BondsSavings Bonds

Treasury BillsTreasury Bills T-bills are short term securities issued by the T-bills are short term securities issued by the

US Treasury.US Treasury.

T-bills mature in one year or less (usually 28 , T-bills mature in one year or less (usually 28 , 91,and 182 days).91,and 182 days).

Banks and financial institutions are the Banks and financial institutions are the largest purchasers of T-bills.largest purchasers of T-bills.

Yield (%)= [ ( face value – purchase price )/ Yield (%)= [ ( face value – purchase price )/ purchase price ] * (360 / days till maturity) purchase price ] * (360 / days till maturity)

Treasury NotesTreasury Notes Treasury Notes mature in 2 to 10 years.Treasury Notes mature in 2 to 10 years. They have coupon payment every six months.They have coupon payment every six months. Commonly issued with maturities dates of 2,5,10 years , for denominations Commonly issued with maturities dates of 2,5,10 years , for denominations

from $1000 to $ 1000000.from $1000 to $ 1000000.

Treasury Bonds (T-bonds or the Long Bonds)Treasury Bonds (T-bonds or the Long Bonds) Have longest maturity from 10 to 30 years.Have longest maturity from 10 to 30 years. Have coupon payments every six months.Have coupon payments every six months.

Savings BondsSavings Bonds Are Treasury Securities for individual investors.Are Treasury Securities for individual investors. These are registered , no callable bond issued by the US government and These are registered , no callable bond issued by the US government and

are backed by its full faith and credit.are backed by its full faith and credit. There is no active secondary market for savings bondsThere is no active secondary market for savings bonds Saving Bonds do not have coupons.Saving Bonds do not have coupons.

Federal fundsFederal funds Short-term funds transferred (loaned or borrowed) Short-term funds transferred (loaned or borrowed)

between financial institutions, usually for a period between financial institutions, usually for a period of one day.of one day.

Used by banks to meet short-term needs to meet Used by banks to meet short-term needs to meet reserve requirements (over night).reserve requirements (over night).

Banks loan because they would not make any Banks loan because they would not make any interest at all on excess reserves held with the interest at all on excess reserves held with the Fed.Fed.

Banks may borrow the funds to meet the reserves Banks may borrow the funds to meet the reserves required to back their deposits.required to back their deposits.

Participants in federal funds market include Participants in federal funds market include commercial banks , savings and loan associations , commercial banks , savings and loan associations , government sponsored enterprises , branches of government sponsored enterprises , branches of foreign banks in the US , federal agencies and foreign banks in the US , federal agencies and securities firmssecurities firms..

Fed funds rates and T-bill rates 1990 Fed funds rates and T-bill rates 1990 through 2004through 2004

Municipal bondsMunicipal bonds Bond issues by a state , city , or other local govt. or their Bond issues by a state , city , or other local govt. or their

agencies.agencies. The method and practices of issuing debt are governed The method and practices of issuing debt are governed

by an extensive system of laws and regulations , which by an extensive system of laws and regulations , which vary by state.vary by state.

The issuer of the municipal bond receive a cash payment The issuer of the municipal bond receive a cash payment at the time of issuance in exchange for a promise too at the time of issuance in exchange for a promise too repay the investor over time.repay the investor over time.

Repayment period can be as short as few months to 20 , Repayment period can be as short as few months to 20 , 30 , 40 years or even longer.30 , 40 years or even longer.

Bond bear interest at either fixed or variable rate of Bond bear interest at either fixed or variable rate of interest.interest.

Interest income received by bond holders is often exempt Interest income received by bond holders is often exempt from the federal income tax and income tax of state.from the federal income tax and income tax of state.

Investors usually accept lower interest payments than n Investors usually accept lower interest payments than n other types of borrowing.other types of borrowing.

Municipal bond holders may purchase bonds either Municipal bond holders may purchase bonds either directly from the issuer at the time of issuance or from directly from the issuer at the time of issuance or from other bond holders after issuance.other bond holders after issuance.

Municipal bonds typically pay interest semi-annually.Municipal bonds typically pay interest semi-annually.

Interest earnings on bonds that fund projects that are Interest earnings on bonds that fund projects that are constructed for the public good are generally exempt constructed for the public good are generally exempt from federal income tax.from federal income tax.

But , not all municipal bonds are tax-exempt.But , not all municipal bonds are tax-exempt.

Municipal bonds may be general obligations of issuer or Municipal bonds may be general obligations of issuer or secured by specified revenues.secured by specified revenues.

Comparing Money Market Comparing Money Market Securities : A comparison of Securities : A comparison of

ratesrates

Certificate of DepositCertificate of Deposit

A certificate of deposit is a A certificate of deposit is a promissory note issued by a bank or promissory note issued by a bank or a credit uniona credit union

The insurer are FDIC or NCUAThe insurer are FDIC or NCUA

Usually a fixed interest rate is paid Usually a fixed interest rate is paid by the institution by the institution

Rates Rates

General rules for interest ratesGeneral rules for interest rates The larger the principal, the higher the The larger the principal, the higher the

interestinterest

The longer the term, higher the The longer the term, higher the interestinterest

The smaller the bank the higher the The smaller the bank the higher the interestinterest

WorkingWorking

A passbook is received by the A passbook is received by the purchaserpurchaser

No certificate as suchNo certificate as such

At maturity the investors are informedAt maturity the investors are informed Callback optionCallback option

LadderLadder

To get lock in with the interest rates To get lock in with the interest rates of rising rates of economy ladder of rising rates of economy ladder strategy is practicedstrategy is practiced

Invest diversifiableInvest diversifiable

Other products Other products

Callable BondsCallable Bonds

Brokered BondsBrokered Bonds

EurobondsEurobonds

The Eurobonds are the international The Eurobonds are the international bonds which is issued in a currency bonds which is issued in a currency other than the currency or market it other than the currency or market it is issuedis issued

Generally issued by international Generally issued by international sydicate of banks and financial sydicate of banks and financial institutionsinstitutions

Issuer of the EurobondsIssuer of the Eurobonds

Usually a bank specifies the followsUsually a bank specifies the follows Desired currency of denominationDesired currency of denomination The amountThe amount The target rateThe target rate

Benefits Benefits

Small par value and high liquiditySmall par value and high liquidity Flexibility to the issuer Flexibility to the issuer For both individual and institutional For both individual and institutional

investorsinvestors No impact on Balance of paymentsNo impact on Balance of payments

Floating rate notesFloating rate notes

The interest rate is floating and set The interest rate is floating and set above or below the LIBORabove or below the LIBOR

Interest rates are revised every 3-6 Interest rates are revised every 3-6 monthsmonths

ContentsContents

IssuesIssues

VariationsVariations

RiskRisk

TradingTrading

Features of FRNsFeatures of FRNs

The reference rateThe reference rate

The marginThe margin

The reference periodThe reference period

MaturityMaturity