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CHAPTER 6

MONEY MARKETS

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MONEY MARKET SECURITIES A. Treasury Bills

Weekly auctions by sealed bid Competitive, Noncompetitive Sold at Discount

Very large and liquid secondary market Computing Annualized Yield (365 day year): YT =

[ (SP – PP) / PP ] * 365 / n Where: SP = sell price, PP = Purchase price, n =

number of days held Computing the Discount: TBD = [ (Par – PP) / Par ] *

360 / n Interest exempt from state and local taxes

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MONEY MARKET SECURITIES

B. Commercial Paper For most creditworthy companies 100 to 150 basis points less than the prime No secondary market (mostly direct

placement) Yield computed the same way as T-Bills Max maturity 270 days

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MONEY MARKET SECURITIES

C. Negotiable Certificates of Deposit (NCD)

Large dollar amount certificates designed to be negotiable

Specialized secondary market YNCD = (SP – PP + Interest) / PP.

D. Banker's Acceptances Finance import activity Products form the collateral for the BA Rates quoted in WSJ and elsewhere

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MONEY MARKET SECURITIES

E. Repurchase Agreements (repo) Underlying instrument is a treasury bill or

bond Contracts designed for very short periods of

investment

F. Federal Funds The market for lending excess reserves,

frequently over-night Some funds lent by the Federal Reserve on

an over-night basis

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MONEY MARKET SECURITIES

G. Comparison of Money Market Securities Most liquid are T-Bills Best yields are from BA's Money Market funds will have all in their portfolio

H. Institutional Use of Money Market Securities Provide method for investors to keep excess cash

balances working Provide a method for limiting interest rate risk Provide an additional investment vehicle for

portfolios

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FOREIGN FINANCIAL MARKETS

A. Eurodollar Deposits and Euro notes Foreign deposits denominated in dollars Notes issued in European financial markets but

denominated in dollars

B. Euro-commercial Paper Potential hedge vehicle Dealers provide a secondary market

C. Lack of Regulatory Oversight Increased risks Source of competitive edge for foreign banks

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HOMEWORK QUESTIONS

A. What are the 4 main types of money market instruments?

B. What premiums do investors extract for reduced liquidity? Increases in default risk?

C. Who issues commercial paper? Why is c-paper preferred to borrowing at prime?

D. How does the Repurchase (repo) agreement work?E. Why are Fed Funds important to financial institutions?F. What are Eurodollar deposits and why are they

important?