Money Market Instruments
Treasury bills
Federal Funds
Repurchase Agreements
Negotiable Certificates
of Deposit
Commercial Paper
Banker’s Acceptance
Eurodollar (Eurocurrency)
-- Russia
1950s only 2 super power that are Russia and United
States. Russia had a lot of deposits in US banks. Take most US
dollars and deposit them in Europe banks which
started Eurodollar
The Money Market
They are usually sold in
large denominations (more than $100,000)
They have low default risk
They mature in one year
or less from their original issue date
Participants in the Money Market
US Treasury Departments
(Seller) of T-bills
Federal Reserve System
(Seller) buying and selling Treasuries
Commercial Banks (Seller)
Certificate of Deposits
Business (Buyer and Seller)
Commercial Paper
Investment and securities
firms (Buyer)
Individuals (Buyer)
Money Market
Debt instruments that at
the time of issuance has a maturity of one year or less
example : T-bills, CD,
MTN, FF, Bankers’ Acceptance, CP, Repo
I
| T-bills | maturity one year or less |
| T notes | 2 years to 10 years |
| T bonds | more than 10 years to 30 years |
The most liquid market in the
world
discount security, T-bills
does not pay interest or coupon
1. Bid and offer quote on T-bills
quoted on a bank discount
basis (not on price basis)
YD = D/F * 360/t
where D : dollar discount (difference between face value and the price)
where F : face value
where t : number of days remaining to maturity
Example : 100 days to maturity
F : $100,000 selling for $97,367
D : 100,000 – 97367 = 2431
2431
360
YD = ------------ X ----------
100,000
100
= 8.75%
2. Primary Market
issued on an auction basis
3 and 6 months : auction
every Monday
1 year : 3rd week of every
month
Auction is conducted on
a yield basis
competitive basis --
yield
Non Competitive basis (tenders)
small banks will use non competitive since
they don’t know how the market is going, they just offer the yield at the
average
of the 4 banks
II
Commercial Paper
Short term unsecured promissory
note
alternative to bank borrowing
for large corporations with strong credit ratings -- less expensive
minimum round lot transaction
$100,000
very little secondary trading
maturity
(a) less than 270 days
(b) common range 30-50 days
Yields
(i) discount instrument
(ii) Commercial paper rate is higher than T-bills
rate because
(a) Credit risk
(b) Less liquid
(c) Interest
earned on T-bills is exempt from state and local income tax
III
Banker’s Acceptance
Purpose facilitate commercial
trade transactions
market has been shrinking
since 1984
sold on a discounted basis
IV
Large denomination Negotiable Certificate of Deposit
Issued by a bank on thrift
raise fund for financing
their business activities
insured by FDIC up to $100,000
Negotiable CD --
initial depositors can sell CD in the market before maturity
large denomination ($1
Million or more) vs. small denomination (less $100,000)
Primary source --
money center banks and large regional bank
Large banks issue CD like
those headquarters in New York but small bank sources are from deposits
Maturity
(a) Most less than one year
(b) maturity more than 1 year are known as term
CD
Yields
(a) the credit rating of the issuing bank
(b) maturity of CD (longer maturity, higher the
yield)
(c) Supply and Demand for CD
Reserve Requirement
V
Repurchase Agreement
Collateralized borrowing
to borrow, you sell securities
overnight, then repurchase in the morning
term of the loan
(a) one day -- overnight repo
(b) more than one day -- term repo
reverse repo : from customer’s
view
repo rate less cost of
bank financing
net borrowers : banks and
trifts
probiders of funds : MMF,
muncipalities corporation, bank trust department
no one repo rate
dollar interest on a repo
transaction
interest = principal X
repo rate X repo term / 360
VI
Federal Funds
Reserves deposited at banks’
district Federal Reserve Banks
no interest
Federal Fund rate and repo
rate tie together (Both are a means for a bank to borrow
most term : Overnight
(a) Repo : Collateralized loan -- below Federal
fund rates
(b) Federal Fund -- Unsecured borrowing, determining
general level of repo rate