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MONEY MARKET & CAPITAL
MARKETMONEY MARKET
INSTRUMENTS
GROUP MEMBER
1. Ali Islam (1115)
2. Sohan Majumdar
(1117)
3. Tasnuva Akhter
(1122)
4. Ziaul Islam (1123)
5. Nazmul Hossain
(1124)6. Sumi Rani Majumdar
(1125)
7. Abdul Motaleb (1126)
MONEY MARKET It is a market where money or its equivalent
can be traded. Money is synonym of liquidity. It consists of financial institutions and
dealers in money or credit who wish to generate liquidity.
large institutions and government manage their short term cash needs.
short-term borrowing and lending is done by these financial institutions and dealers.
instruments with high liquidity and very short term maturities are traded.
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MONEY MARKET INSTRUMENTS
The more popular money market securities are Treasury bills Commercial paper Negotiable certificates of deposit Repurchase agreements Federal funds
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INSTITUTIONAL USE OF MONEY MARKETS
Securities Issued by Investors Maturities
Secondary market
activitiesTreasury
billsGovernment Household,
firms and financial institution
Up to 1 years
High
Retail CDS Bank & saving institution
Household 7 days to 1 year or longer
Moderate
NCDS Large bank or saving institution
Firms 2 week to 1 year
Moderate
Commercial Paper
Bank, financing & others companies
Firms 1 to 270 days
Low
Banker acceptances
Bank Firms 30 to 270 days
High
Government funds
Depositors institution
Depositors institutions
1 to 7 days Nonexistent
Repurchase agreement
Financial & nonfinancial firm
Financial & nonfinancial firm
1 to 15 days
Nonexistent
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TREASURY BILLWhen the government needs to borrow fund the treasury frequently issues short term securities which are known as Treasury bill (T-Bill). This are issued weekly through auction. One year T-Bill is issued on a monthly basis.
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• Are issued by the Treasury• Are sold weekly through an auction• Have a par value of $1,000• Are attractive to investors because they are
backed by the federal government and are free of default risk
• Are liquid• Can be sold in the secondary market through
government security dealers• a promise to pay a said sum after a specified
period.• issued with three-month, six-month and one-
year maturity periods.
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at a price less than their face value. on maturity, the government pays the holder
its face value. interest income earned by the purchaser of the
instrument. issued through a bidding process at auctions. bid can be prepared either competitively or
non competitively. T-bills auctions are held on the Negotiated
Dealing System (NDS) and the members electronically submit their bids on the system.
NDS is an electronic platform for facilitating dealing in Government Securities and Money Market Instruments.
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Investors in Treasury bills Depository institutions because T-bills can be easily
liquidated Other financial institutions in case cash outflows
exceed cash inflows Individuals with substantial savings for liquidity
purposes Corporations to have easy access to funding for
unanticipated expensesPricing Treasury bills
The price is dependent on the investor’s required rate of return:
Treasury bills do not pay interest To price a T-bill with a maturity less than one year,
the annualized return can be reduced by the fraction of the year in which funds would be invested
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ESTIMATING THE YIELDT-bills are sold at a discount from par value
The yield is influenced by the difference between the selling price and the purchase price
If a newly-issued T-bill is purchased and held until maturity, the yield is based on the difference between par value and the purchase price
Formula for estimating yield-
Where, Yt = yield from T-billn = number of days of the investment (holding period)
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Estimating the T-bill discountT-bill discount represent the percent of discount of the purchase price from par value for newly issued T-bill and is computed below.
In addition 360 days used instead of 365 days for the discount calculation.
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TREASURY INFLATION-PROTECTION SECURITIES (TIPS)
The U.S. department of the Treasury issued for the first time Treasury securities that adjust for inflation. These securities are popularly referred to as Treasury inflation protection securities (TIPS). This treasury refers to these securities as treasury inflation index securities. The Treasury has issued TIPS that are notes and bonds.
TIPS work as follows The coupon rate is set as a fixed rate and it is determine by
auction process. That rate is determined via the auction process described later in the section. The coupon rate is called the real rate because the investors ultimately earned over the inflation rate.
The adjustment for inflation is as follows The principal on which the treasury will based both the dollar
(BDT) amount of the coupon payment & maturity value is adjusted semi-annually. This is called inflation-adjusted principal.
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BID AND OFFER QUOTES ON TREASURY BILLS
The convention for quoting bids and offers is different for Treasury bills and Treasury coupon securities. The quoting on bids & offers is different for Treasury bills and Treasury coupon securities. Treasury bills values are quoted on a bank discount basis not a price basis. The yield on a bank discount basis is computed as follows:
Where, Y=Annualized yield on a bank discount basis. D= Discount (Face Value - Price) F = Face Value, t= Number of days maturity period. t= number of days remaining to maturities (maturity period)
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NEGOTIABLE CERTIFICATE OF DEPOSITS (NCDS)
A certificate of deposit with a minimum face value of $100,000. These are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed-in before maturity.Due to their large denominations, NCDs are bought most often by large institutional investors. Institutions often use these as a way to invest in a low-risk, low-interest security.
Are issued by large commercial banks and other depository institutions as a short-term source of funds
Have a minimum denomination of $100,000 Are often purchased by nonfinancial corporations Are sometimes purchased by money market funds Have a typical maturity between two weeks and one
year Have a secondary market
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Placement Some issuers place their directly; others use a
correspondent institution that specializes in placing NCDs. Another alternative is to sell NCDs to securities dealers, who in turn resell them. A portion of unusually large issues is commonly sold to NCDs dealers. Normally, however, NCDs can be sold to investors directly at a higher price.
Directly Through a correspondent institution securities
dealers
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Premium NCDs offer a premium above the T-bill yield to
compensate for less liquidity and safety Premiums are generally higher during recessionary
periods
Yield of NCDs NCDs provide a return in the form of interest and the
difference between the price at which the NCD was redeemed or sold and the purchase price
If investors purchase a NCD and hold it until maturity, their annualized yield is the interest rate
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Commercial Paper Yields
• Like treasury bills, yields on commercial paper are quoted on a discount basis—the discount return to commercial paper holders is the annualized percentage difference between the price paid for the paper and the face value using a 360-day year. Specifically, where is the discount yield, is the face value, is the price paid, and is the term length of the paper in days:
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PLACEMENT OF COMMERCIAL PAPER
Some firms place commercial paper directly with investors
Most firms rely on commercial paper dealers to sell it Some firms (such as finance companies) create in-
house departments to place commercial paper
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Commercial paper outstanding by issuer and placement
Financial Nonfinancial Asset-backed All types
Dealer Directly Total Dealer Directly Total Dealer Directly Total Total
Total (average), $ billions 2001 336.5 280.6 617.0 205.9 38.5 244.4 500.8 127.6 628.4 1489.8 2008 552.2 231.5 783.7 174.6 17.1 191.7 663.1 100.4 763.6 1739.3 Share (percent) 2006 22.6 18.8 41.4 13.8 2.6 16.4 33.6 8.6 42.2 100.0 2008 31.7 13.3 45.1 10.0 1.0 11.0 38.1 5.8 43.9 100.0 SOURCE: Federal Reserve Board, Volume Statistics for Commercial Paper Issuance.
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BACKING COMMERCIAL PAPER
Issuers typically maintain a backup line of credit Allows the company the right to borrow a specified
maximum amount of funds over a specified period of time
Involves a fee in the form of a direct percentage or in the form of required compensating balances
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BANKER ACCEPTANCE A banker acceptance indicates that a bank accepts responsibility for a future payment, normally it used for internationally transection. The banks facilitate international trade by stamping accepted. An exporter that is sending goods to an importer whose credit rating is not known action by stamping ACCEPTED on a draft, which obligates payment at a specific point of time.
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term for these instruments may vary from 30 days to 180 days.
For corporations, it acts as a negotiable time draft for financing imports, exports and other transactions in goods.
It is highly useful when the credit worthiness of the foreign trade party is unknown.
The seller need not hold it until maturity and can sell off the same in secondary market at discount from the face value to liquidate its receivables.
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It is a short term credit investment created by a non financial firm and guaranteed by a bank to make payment.
It is simply a bill of exchange drawn by a person and accepted by a bank.
It is a buyer’s promise to pay to the seller a certain specified amount at certain date.
The same is guaranteed by the banker of the buyer in exchange for a claim on the goods as collateral.
The person drawing the bill must have a good credit rating otherwise the Banker’s Acceptance will not be tradable.
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STEPS INVOLVED IN BANKER’S ACCEPTANCE
Importer
ABC bank(Importer’s
Bank)
Japanese Bank
(Exporter’s Bank)
Exporter
Purchase Order
Shipment of Goods
L/C Ap
plic
atio
n
L/C
Shipping Document & Time Draft Accepted
L/C
N
otifi
cati
on
Ship
ping
D
ocum
ent
&
Tim
e D
raft
1
2
3
4
5
6
7
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One party sells securities to another with an agreement to repurchase them at a specified date and price Essentially a loan backed by securities
A reverse repo refers to the purchase of securities by one party from another with an agreement to sell them
Transactions amounts are usually for $10 million or more
Common maturities are from 1 day to 15 days and for one, three, and six months
There is no secondary market for repos
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It is as called Repo or Reverse Repo are transactions or short term loans.
two parties agree to sell and repurchase the same security.
the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and price.
seller of the security borrows money for a period of time called Repo period.
rate of interest agreed upon is called the Repo rate.
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ADVANTAGE OF THE REPO MARKETThe advantage of the repo market is that the rate is less than the cost of bank financing. From the customers view point the repo market offers attractive yield/ return on a short term second transaction to which is highly liquid. The repo rates vary from transaction to transaction depending upon the two factors:
1. Term of Repo 2. Availability of security.
The more difficult is to obtain collateral the lower is the repo rate and vice versa.
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Placement Repo transactions are negotiated through a
telecommunications network with dealers and repo brokers
When a borrowing firm can find a counterparty to a repo transaction, it avoids the transaction feeSome companies use in-house departments
Estimation of the yieldRepo rate is determined by the difference between initial selling price and the agreed upon repurchase price, annualized with 360 days year.Formula for estimating the yield
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VALUATION OF MONEY MARKET SECURITIES
For money market securities making no interest payments, the value reflects the present value of a future lump-sum payment
The discount rate is the required rate of return by investorsImpact of September 11
The weak economy combined with this event caused investors to transfer funds into money market securities
The additional demand placed upward pressure on their price and downward pressure on their yields
The Fed added liquidity to the banking system and reduced the federal funds rate
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Indicators of future money market security prices
Economic growth is monitored since it signals changes in short-term interest rates and the required return from investing in money market securities
Employment GDP Retail sales Industrial production Consumer confidence Indicators of inflation
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