MONEY

MARKET
Chapter 6 GROUP 1 - Presentation

BI THANH XUN
TRN LAN NHI
NGUYN QUNH TRANG

NGUYN TH LAN VY
GROUPS MEMBER

Content
Money Market Securities
Institutional Use of Money
Valuation of Money Market
Securities
Valuation of Money Markets

Chapter Objectives

describe the features of the most popular

money market securities

explain how money markets are used by

institutional investors

explain the valuation and risk of money

market securities

explain how money markets have become

globally integrated

1.
MONEY
MARKET
SECURITIES

Definition:

A market for short term financial assets that

are close substitutes money, facilitates the
exchange of money for new financial claims
in primary market as also for financial
claims, already issued, in the secondary
market

PART 1

MONEY MARKET SECURITIES

Features of a Money Market :

Market purely for shortterm funds or

financial assets

It deals with financial assets having

maturity period up to one year.

It deals with those assets which can be

convert in to cash readily without loss and
mini transaction cost

Transaction have to be conducted without

the help of brokers

PART 1

MONEY MARKET SECURITIES

Objectives of Money Market:

To provide a parking place to employ shortterm surplus

To provide room for overcoming short-term

deficits.

To enable the central bank to influence and

regulate liquidity in the economy through
its intervention in this market.

To provide reasonable access to the users of

short-term funds to meet requirements.

PART 1

MONEY MARKET SECURITIES

Characteristics of a Developed Money

Market:

Highly organized banking system

Presence of a central bank

Availability of proper credit instrument

Existence of sub-brokers

Sufficient resources

Existence of secondary markets

Demand and supply of funds

PART 1

MONEY MARKET SECURITIES

Importance of Money Market:

Development of capital market

Smooth functioning of commercial banks

Effective central bank control

Existence of sub-brokers

Formulation of suitable monetary policy

Non-inflation source of finance to

government

PART 1

MONEY MARKET SECURITIES

The more popular money market securities

are:

Treasury bills (T-bills)

Commercial paper

Negotiable certificates of deposit

Repurchase agreements

Federal funds

Bankers acceptances

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

1. Issued when the U.S. government needs to
borrow funds.
2. The Treasury issues T-bills with 4-week, 13week, and 26-week maturities on a weekly
basis.
3. The par value (amount received by
investors at maturity) of T-bills was
historically a minimum of $10,000, but now
it is $1,000 and multiples of $1,000.
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MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

4. Are sold at a discount from par value, and
the gain is the difference between par
value and the price paid
5. Backed by the federal government and are
virtually free of credit (default) risk.
6. Highly liquid, due to short maturity and
strong secondary market.

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

1. Investors in Treasury Bills:
. Depository institutions retain a portion of their
funds in assets that can be easily liquidated to
accommodate withdrawals.
. Other financial institutions invest in T-bills in case
cash outflows exceed cash inflows.
. Individuals with substantial savings invest indirectly
through money market funds.
. Corporations invest in T-bills to cover unanticipated
expenses.

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

1. Pricing Treasury Bills
a) Priced at a discount from their par value
b) Price depends on the investors required rate of
return
c) Value of a T-bill is the present value of the par
value
Example: If investors require a 7 percent
annualized return on a one-year T-bill with a
$10,000 par value, the price that they are willing to
pay is:
P = $10,000 / (1.07) = $9,345.79

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

2. Pricing Treasury Bills
a) Priced at a discount from their par value
b) Price depends on the investors required rate of
return
c) Value of a T-bill is the present value of the par
value
Example: If investors require a 7 percent
annualized return on a one-year T-bill with a
$10,000 par value, the price that they are willing to
pay is:
P = $10,000 / (1.07) = $9,345.79

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

3. Treasury Bill Auction
a) Investors can submit bids online for newly issued Tbills at www.treasurydirect.gov.
b) Investors have the option of bidding competitively
or noncompetitively.

PART 1

MONEY MARKET SECURITIES

TREASURY BILL (T-BILL)

4. Estimating the Yield

5. Estimating the Treasury Bill Discount

PART 1

MONEY MARKET SECURITIES

COMMERCIAL PAPER
Short-term debt instrument issued by wellknown, creditworthy firms and is typically
unsecured.
Normally issued to provide liquidity or to
finance a firms investment in inventory and
accounts receivable.
The minimum denomination of commercial
paper is usually $100,000.
Maturities are normally between 20 and 45
days but can be as short as 1 day or as long as
PART
1
MONEY MARKET SECURITIES
270 days.

COMMERCIAL PAPER
1. Ratings
.Assigned by rating agencies such as Moodys
Investors Service, Standard & Poors
Corporation, and Fitch Investor Service.
.Serves as an indicator of the potential risk of
default.

PART 1

MONEY MARKET SECURITIES

COMMERCIAL PAPER
2. Credit Risk during the Credit Crisis
.Historically the percentage of issues that have
defaulted is very low.
.During the credit crisis in 2008, Lehman
Brothers (a large securities firm) failed.
.This made investors more cautious before
purchasing securities

PART 1

MONEY MARKET SECURITIES

COMMERCIAL PAPER
3. Placement
.Firms place commercial paper directly with
investors or rely on commercial paper dealers
to sell their commercial paper.
4. Backing Commercial Paper
.Issuers of commercial paper typically maintain
backup lines of credit.

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MONEY MARKET SECURITIES

COMMERCIAL PAPER
5. Estimating the Yield
.Commercial paper does not pay interest and is
priced at a discount from par value.
.The yield on commercial paper is higher than
the yield on a T-bill with the same maturity
because of credit risk and less liquidity.

PART 1

MONEY MARKET SECURITIES

COMMERCIAL PAPER
6. Commercial Paper Yield Curve
.Represents the yield offered on commercial
paper at various maturities.
.The same factors that affect the Treasury yield
curve affect the commercial paper yield curve,
but they are applied to very short-term
horizons.

PART 1

MONEY MARKET SECURITIES

NEGOTIABLE CERTIFICATES OF
DEPOSIT

Certificates issued by large commercial banks

and other depository institutions as a shortterm source of funds.

The minimum denomination is $100,000.

Maturities on NCDs normally range from two
weeks to one year.
A secondary market for NCDs exists, providing
investors with some liquidity.

PART 1

MONEY MARKET SECURITIES

NEGOTIABLE CERTIFICATES OF
DEPOSIT

1. Placement
.Some issuers place their NCDs directly; others
use a correspondent institution that specializes
in placing NCDs.
2. Premium
.Offer a premium above the T-bill yield in order
to compensate for less liquidity and safety.

PART 1

MONEY MARKET SECURITIES

NEGOTIABLE CERTIFICATES OF
DEPOSIT

3. Yield
.Provide a return in the form of interest along
with the difference between the price at which
the NCD is redeemed (or sold in the secondary
market) and the purchase price.

PART 1

MONEY MARKET SECURITIES

REPURCHASE AGREEMENTS
With a repurchase agreement (repo), one party
sells securities to another with an agreement
to repurchase the securities at a specified date
and price.
A reverse repo is the purchase of securities by
one party with an agreement to sell them.
A repurchase agreement (or repo) represents a
loan backed by the securities.

PART 1

MONEY MARKET SECURITIES

REPURCHASE AGREEMENTS
Financial institutions often participate in repos.
The size of the repo market is about $4.5
trillion. Transaction amounts are usually for
$10 million or more.
The most common maturities are from 1 day to
15 days and for one, three, and six months.

PART 1

MONEY MARKET SECURITIES

REPURCHASE AGREEMENTS
1. Placement
. Negotiated through a telecommunications
network.
. Dealers and repo brokers act as financial
intermediaries to create repos for firms with
deficient or excess funds, receiving a
commission for their services.

PART 1

MONEY MARKET SECURITIES

REPURCHASE AGREEMENTS
2. Impact of the Credit Crisis
. Many financial institutions that relied on the
market for funding were not able to obtain
funds.
. Investors became more concerned about the
securities that were posted as collateral
3. Estimating the Yield

PART 1

MONEY MARKET SECURITIES

FEDERAL FUNDS

The federal funds market allows depository

institutions to effectively lend or borrow short
term from each other at the federal funds rate

The federal funds rate is normally slightly

higher than the T-bill rate at any point in time

A lender in the federal funds market is subject

to credit risk

PART 1

MONEY MARKET SECURITIES

FEDERAL FUNDS

Federal funds market includes commercial

banks and other financial institutions under
Federal Reserve regulations. It also includes a
small group of firms that act as brokers

Commercial banks art the most active

participants in the federal funds market

PART 1

MONEY MARKET SECURITIES

BANKERS ACCEPTANCES

Means that a bank accepts responsibility for

future payment

Is commonly used for international trade

transactions

Maturities on bankers acceptances often

range from 30 to 270 days because there is a
possibility that a bank will default on payment

PART 1

MONEY MARKET SECURITIES

PART 1

MONEY MARKET SECURITIES

2.
INSTITUTIONAL
USE OF MONEY

PART 2

INSTITUTIONAL USE OF MONEY

Money market securities can be used to

enhance liquidity in 2 ways:

newly issued securities generate cash.

institutions that previously purchased money

market securities will generate cash upon
liquidation of the securities

PART 2

INSTITUTIONAL USE OF MONEY

Most financial institutions maintain sufficient

liquidity by holding securities that have very
active secondary markets or securities with
short term maturities

T-bills are the most popular money market

instrument because of their marketability,
safety, and short term maturity

PART 2

INSTITUTIONAL USE OF MONEY

Financial institutions whose future inflows and

outflows are more uncertain will maintain
additional money market instrument for
liquidity

Some issue their own money market

instruments to obtain cash. Ex: depository
institutions issue NCDs, bank holding
companies and finance companies issue
commercial paper

PART 2

INSTITUTIONAL USE OF MONEY

3.
VALUATION OF
MONEY
MARKET
SECURITIES

The market price of Money market securities

(Pm)

Pm = PV (present value)

MMS normally do not make periodic interest

payments, they make one lump-sum payment
of principal.

PART 3

VALUATION OF MONEY MARKET

SECURITIES

PART 3

VALUATION OF MONEY MARKET

SECURITIES

In general, the money markets are widely

perceived to be efficient, in that the prices
reflect all available public information.

Economic indicators may signal future

changes in the strength of economy, which can
affect short term interest rate and required
return.

Including:
employment

GDP

retail sales

industrial production

consumer confidence
PART 3

VALUATION OF MONEY MARKET

SECURITIES

Indicators of Inflation:
CPI (consumer price index)
PPI (producer price index)

An increase in these index

higher interest rates

lower money market prices

Investors also assess the financial condition

of the firms that are issuing commercial paper.

to ensure those firms are financial healthy and

capable of paying off the debt at maturity.

PART 3

VALUATION OF MONEY MARKET

SECURITIES

1.

IMPACT OF CHANGES IN CREDIT

RISK

Risk Premiums among Money Market

Securities
During periods of heightened uncertainty
about the economy
investors tend to shift from risky money
market securities to Treasury securities.
risky MMS must provide a larger risk
premium to attract investors.
PART 3

VALUATION OF MONEY MARKET

SECURITIES

1.

IMPACT OF CHANGES IN CREDIT

RISK

PART 3

VALUATION OF MONEY MARKET

SECURITIES

2.

INTEREST RATE RISK

Money market security values are not as

sensitive as bond values in interest rate
movements.
The lower degree of sensitivity is primarily
attributed to shorter term to maturity.
MMS: 1 year, while bonds: 10 or 20 years.
An increase in interest rate is not as harmful
to a MMS, because it will mature soon and the
investors can reinvest the proceeds at the
prevailing rate at that time.
PART 3

VALUATION OF MONEY MARKET

SECURITIES

2.

INTEREST RATE RISK

Measuring Interest Rate Risk

Participants in the money markets can use
sensitivity analysis to determine how the value
of money market securities may change in
response to a change in interest rate

PART 3

VALUATION OF MONEY MARKET

SECURITIES

2.

INTEREST RATE RISK

PART 3

VALUATION OF MONEY MARKET

SECURITIES

4.
GLOBALIZATIO
N OF MONEY
MARKET

 As international trade has grown, money

markets have developed in Europe, Asia, and
South Africa.
Corporations commonly accept foreign
currencies as revenue if they will need those
currencies to pay for imports in the future.

PART 4

GLOBALIZATION OF MONEY
MARKET

 International banks facilitate the international

money markets by accepting deposits and
providing loans in a wide variety of
currencies.
The flow of funds between countries has
increased as a results of tax differences
among countries, exchange rate movements,
and a reduction in government barriers.

PART 4

GLOBALIZATION OF MONEY
MARKET

PART 4

GLOBALIZATION OF MONEY
MARKET

1.

EURODOLLAR SECURITIES

As corporations outside the US (especially in

Europe) increasingly engaged in international
trade transactions in the US dollars, US dollar
deposits in non-US banks grew.
Corporations with large dollar balances
often deposited their funds in Europe to
receive a higher yield.
it calls Eurodollars (many several types)

PART 4

GLOBALIZATION OF MONEY MARKET

1.

EURODOLLAR SECURITIES

Eurodollar CDs
Eurodollar certificates of deposit are large
dollar-denominated deposits (such as $1
million) accepted by banks in Europe.
Is used as a medium of exchange in
international trade and investment
transactions (payment for exports, invest in
Eurodollar CDs)

PART 4

GLOBALIZATION OF MONEY MARKET

1.

EURODOLLAR SECURITIES

Eurodollar CDs
Eurodollar CDs are not subject to reserve
requirements.
Eurodollar floating-rate CDs have been used
in recent years.

PART 4

GLOBALIZATION OF MONEY MARKET

1.

EURODOLLAR SECURITIES

Euronotes
are short-term securities issued in bearer form,
with common maturities of 1, 3 and 6 months.
Typical investors: Eurobanks.
are sometime underwritten in a manner that
guarantees the issuer a specific price

PART 4

GLOBALIZATION OF MONEY MARKET

1.

EURODOLLAR SECURITIES

Euro-Commercial Paper
is issued without the backing of a banking
syndicate.
Maturities can be tailored to satisfy investors.
Dealers that place commercial paper have
created a secondary market.
Some European companies that want shortterm funding in dollars can more easily place
their paper here, where they have a household
name.
PART 4

GLOBALIZATION OF MONEY MARKET

2.

INTERNATIONAL INTERBANK
MARKET

An international interbank market facilitates

the transfer of funds from banks with excess
funds to those with deficient funds.
It is worldwide and conducts transactions in a
wide variety of currencies.
Could be direct or indirect.
The rate charged for a loan from 1 bank to
another in IIM is the LIBOR usually in line with
the prevailing money market rates in the
currency.
PART 4

GLOBALIZATION OF MONEY MARKET

3.

PERFORMANCE OF FOREIGN
MMS

Is measured by the effective yield (yield

adjusted for the exchange rate), which is
dependent on 2 things:
(1) Yield earned on the money market
securities (Yf)

PART 4

GLOBALIZATION OF MONEY MARKET

3.

PERFORMANCE OF FOREIGN
MMS

(2) The exchange rate effect (denoted as %

S) measures the percentage change in spot
exchange rate (in dollars) from the time the
foreign currency was obtained to invest in the
foreign money market security until the time
the security was sold and the foreign currency
was converted into the investors home
currency.
Thus, the effective yield is:
PART 4

GLOBALIZATION OF MONEY MARKET

3.

PERFORMANCE OF FOREIGN
MMS

PART 4

GLOBALIZATION OF MONEY MARKET

SUMMAR
Y