Money Markets. I. Money Market Securities Definition Money market securities are financial...
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Transcript of Money Markets. I. Money Market Securities Definition Money market securities are financial...
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Money Markets
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I. Money Market Securities
• Definition
Money market securities are financial instruments with maturity of one year or less.
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• Instruments and Participants– Domestic Money Market
Instruments Principal Borrowers
Treasury bills U.S. Government
Commercial paper Non-financial and financial
businesses
Negotiable CDs Banks
Repurchase agreements Securities dealers, banks, non- financial corporations,
governments
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Instruments Principal Borrowers
Federal funds Banks
Banker’s acceptances Non-financial and financial businesses
Discount window Banks
Municipal Notes State and local governments
Government sponsored Farm Credit System, Federal
Enterprise securities Home Loan Bank System,
Federal National Mortgage Association
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Instruments Principal Borrowers
Shares in money market Money market funds, local
instruments government investment pools,
short-term investment funds
Futures contracts Dealers, banks (principal users)
Futures options Dealers, banks (principal users)
Swaps Banks (principal dealers)
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– International Money Market Instruments
Instruments Principal Borrowers
Eurodollars Banks
Eurodollar CDs Banks
Euronotes
Euro-commercial paper Non-financial and financial businesses
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• Characteristics– High degree of safety– Active secondary market– Telephone network
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II. Treasury Bills
• Maturity– Regular issues
91-day bills Issued weekly
182-day bills Issued weekly
51-week bills Issued monthly– Irregular issues
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• Denominations$10,000
$15,000
$50,000
$100,000
$500,000
$1,000,000
round lot: $5,000,000
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• Auction– Non-competitive Bidding ($1,000,000 or less)
Direct purchase from Federal Reserve Banks
Indirect purchase through brokers
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– Competitive Bidding
Amount
(in bil.) Bid Remark
$0.20 7.55% lowest yield,/highest price
0.26 7.56
0.33 7.57
0.57 7.58 average yield/ average price
0.79 7.59
0.96 7.60
1.25 7.61
1.52 7.62 stop yield/ stop price
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• Dearlers
– Reporting Dealers
Securities firms which are on the Federal Reserve’s regular reporting list.
– Primary Dealers (Recognized Dealers)
Securities firms and commercial banks that the Federal Reserve will deal with in implementing its open market operations.
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– Government Brokers
Brokers used by primary dealers trading Treasury securities with each other.
– Other Dealers and Brokers
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• T-Bill Rate (T-Bill Discount, or Yield on a Bank Discount Basis)
T-bill Rate = [(par - PP) / par] (360 / n)
= [dollar discount/ par] (360 / n),
where
par = par value,
PP = purchase price, and
n = holding period in days.
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Example:
par = $100,000,
PP = $97,569, and
n = 100 days.
Yield = [($100,000- $97,569)/ $100,000]
(360 / 100)
= 8.75%.
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• Dollar Discount
Dollar Discount = T-bill Rate par (n /360)
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Example:
T-bill Rate = 8.75%,
par = $100,000, and
n = 100 days.
Dollar Discount = 0.0875$100,000(100/360)
= $2,431.
Purchase price = par value - dollar discount
= $100,000 - $2,431 = $97,569.
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• Yield
T-bill Yield = [(SP - PP) / PP] (365 / n),
where
SP = selling price,
PP = purchase price, and
n = holding period in days.
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Example:
SP = $10,000,
PP = $9,600, and
n = 182 days.
Yield = [($10,000 - $9,600)/ $9,600](365 / 182)
= 8.36%
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III. Commercial Paper
• IssuersFinance companies
Bank holding companies
Industrial companies
Foreign corporations (Yankee commercial paper)
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• Maturity
– Not Registered
One day to 270 days, normally between 20 and 45 days.
– Registered
Over 270 days
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• Denominations
Minimum $25,000
Minimum round lot $100,000
Typical multiples of $1 million
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• RatingMcCarthy,
Crisanti &
Category Duff & Phelps Fitch Moody’s S&P Maffei
Investment Duff 1+ F-1+ A-1+
Grade Duff 1 F-1 P-1 A-1 MCM 1
Duff 1-
Duff 2 F-2 P-2 A-2 MCM 2
Duff 3 F-3 P-3 A-3 MCM 3
Non-invest.
Grade Duff 4 F-S NP(Not B MCM 4
Prime)
C MCM 5
In default Duff 5 D D MCM 6
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• Placement
– Directly Placed Commercial Paper
– Dealer-Placed Commercial Paper
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• Backing
– Reasons
Credit enhancement
Rollover risk
– Types of Credit-Supported commercial paper
Credit-Supported commercial paper (line of credit paper)
Fee (0.5%)
Compensating balances
Asset-backed commercial paper
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• Yield
Yield = [(par - PP) / PP] (360 / n),
where
par = par value,
PP = purchase price, and
n = holding period in days.
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Example:
par = $5,000,000,
PP = $4,850,000, and
n = 90 days.
Yield = [($5,000,000 - $4,850,000) / $4,850,000] (360 / 90)
= 12.37%
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IV. Negotiable Certificates of Deposit (NCDs)
• Issuers
– Domestic market
Commercial banks
Thrift institutions (thrift CDs)
U.S. branches of foreign banks (Yankee CDs)– Foreign markets (Euro CDs)
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• Maturity
Short-term: two weeks to one year
Long-term: term CDs
• Denominations
Minimum $100,000
Typical $1,000,000
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• Placement
– Directly placed NCDs – Dealer placed NCDs
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• Yield on a Bank Discount Basis
– Risk premium
Higher premium during recessionary years
Higher premium during financial crises
Higher premium for high-risk issuers– Liquidity premium– Fixed rate vs floating rate
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V. Repurchase Agreements (RPs)
• Issuers
– Financial institutions
Commercial banks
Thrifts
Money market funds
Securities dealers– Non-financial institutions
Municipalities
Businesses
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• Maturity
– Overnight repos– Term repos
Two to fifteen days
One, three and six months
• Denominations
Typical $10 million or higher
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• Yield or Repo Rate
Repo Rate = [(SP - PP) / PP] (360 / n),
where
SP = selling price collected by an investor,
PP = purchase price paid by an investor, and
n = holding period in days.
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Example:
SP = $10,000,000,
PP = $9,852,217, and
n = 60 days.
Yield = [($ 10,000,000-$ 9,852,217)/$ 9,852,217] (360 / 60)
= 9%
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Determinants of repo rates:– Creditworthiness of the issuer– Type of collateral– Federal funds rate
The repo rate is usually 25 basis points below the funds rate because a repo has collateral, while a federal funds transaction is unsecured.
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VI. Federal Funds
• ParticipantsDepository institutions
Brokers
• Characteristics– Short-term borrowing of immediate availability– Borrowed only by depository institutions– Exempted from reserve requirements
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• Maturity
– Overnight federal funds (3/4 of the total federal funds)
– Continuing contract federal funds (automatically renewed overnight federal funds)
– Term federal funds: few days to six months
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• Denominations
Typical $5,000,000
• Placement
– Directly placed– Broker-placed
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• Security
– Unsecured federal funds– Secured federal funds
• Federal Funds Transfer
– Adjusting reserve accounts through Fedwire– Reclassifying the demand deposits of a
respondent bank
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• Federal Funds Rate
– Higher than repo rate and Treasury bill rate.– Higher volatility than other money market
rates because it is affected by changes in monetary policy.
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VII. Banker’s Acceptances
• Issuers
Exporters
Importers
Commercial banks
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1. Purchase order
Importer Exporter
5. Shipment of goods
6. Shipping
2. L/C 4. L/C documents
application notification & time
draft
3. L/C
Importer’s bank Exporter’s bank
7. Shipping
documents & draft acceptance
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Acceptance financing
The use of banker’s acceptances to finance commercial transaction.
– Importing goods into the U.S.– Exporting goods from the U.S.– Storing and shipping goods between foreign
countries (third country acceptances)
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• Maturity
– 30 to 270 days – Federal Reserve eligibility requirement
A Banker’s acceptance with maturity longer than six months do not meet the eligibility requirement as collateral at the discount window.
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• Placement– Directly placed by Accepting banks
An accepting bank is a bank which creates banker’s acceptances.
– Dealer placed* Unsold acceptances created by large
accepting banks* Acceptances created by smaller accepting
banks* Acceptances created by Yankee banks (U.S.
branches of foreign banks)
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• Rates– Higher than T-bill rate
* Risk premium - Higher default risk than T-bills.
* Liquidity premium- Less developed secondary market.
– Commission charged by accepting banks* U.S. banks - 25 to 30 basis points* Japanese banks - 10 to 15 basis points
– Dealer’s Spread - 12.5 to 87.5 basis points
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VIII. Eurocurrency
• ParticipantsGovernments
Large financial institutions
Commercial banks (Eurobanks)
Organized exchanges
Institutional investors
Large corporations
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• Related Markets– Foreign exchange market– Eurocurrency market– Eurocredit market– Euro CD market– Euronote market– Currency forward market– Currency Futures market– Currency options market– Currency swap market
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• Euro CDs– Types
* Fixed -rate CDs* Floating-rate CDs (FRCDs)
The rate adjusts periodically to the London Interbank Offer Rate (LIBOR).
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– Yield
Euro CDs offer a higher yield than domestic CDs for three reasons:* Reserve requirements imposed on domestic
CDs * FDIC insurance premium for covering
domestic CDs* Sovereign risk
Euro CDs are obligations that are payable by an entity operating under a foreign jurisdiction, and their claim may not be enforced by the foreign government.
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• Euronotes– Participants
Borrowers
Underwritten or committed note issuance facility (a syndicate formed by a group of
banks)
Investors
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– Maturity
One month
Three months
Six months
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IX. Euro-Commercial Paper (Euro-CP)
• Participants
Borrowers
Dealers
Investors
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• Maturity
Euro-commercial paper has longer maturity ( i.e., longer than 270 days) than that of U.S. commercial paper, and therefore has a more active secondary market.
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• Placement
Euro-commercial paper is almost always dealer-placed. The commission ranges between 5 and 10 basis points of the face value.
• Yield
Euro-commercial paper is typically between 50 and 100 basis points above LIBOR.
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VIII. Valuation of Money Market Instruments
• Market Value
P = Par / (1 + i)n,
where
P = price of the money market instrument,
Par = par value,
i = required annual rate of return, and
n = time to maturity (a fraction of one year).
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Example:
Par = $10,000,
i = 7%, and
n = 1 year.
P = $10,000/ (1 + 0.07)1
= $9,345.79.
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• Price Determinants
P = ƒ( i) = ƒ(Rf, DP, LP) ,
where
P = change in price,
i = change in required rate of return,
Rf = change in risk-free rate,
DP = change in default risk premium, and
LP = change in liquidity premium.
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– Determinants of risk-free rate* Economic growth* Inflation* Money supply
– Determinants of default risk premium* Economic conditions* Conditions in the firm’s industry (degree of
competition, etc.)* Firm-specific conditions (debt level,
management, etc.)