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Chapter Objectives
Provide a background on money market securities Explain how institutional investors use money markets Explain the globalization of money markets
Maturity of a year or less Debt securities issued by corporations and governments that need short-term funds Large primary market focus Purchased by corporations and financial institutions Secondary market for securities
Treasury Bills Commercial paper Negotiable certificates of deposits Repurchase agreements Federal funds Bankers acceptances
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Treasury bills
Issued to meet the short-term needs of the U.S. government Attractive to investors
Treasury bill auction (fill bids in amount determined by Treasury borrowing needs)
Bid process used to sell T-bills Bids submitted to Federal Reserve banks by the deadline Bid process
No coupon payments Par or face value received at maturity Yield at issue is the difference between the selling price and par or face value adjusted for time If sold prior to maturity in secondary market
Yield based on the difference between price paid for T-bill and selling price adjusted for time
YT =
365 n
YT = The annualized yield from investing in a T-bill SP = Selling price PP = Purchase price n = number of days of the investment (holding period)
T-bill discount =
360 n
T-bill discount = percent discount of the purchase price from par Par = Face value of the T-bills at maturity PP = Purchase price n = number of days to maturity
Short-term debt instrument Alternative to bank loan Dealer placed vs. directly placed Used only by well-known and creditworthy firms Unsecured Minimum denominations of $100,000 Not a large secondary market
Bank line used if company loses credit rating Bank lends to pay off commercial paper Bank charges fees for guaranteed line of credit
YCP =
360 n
YCP = Commercial paper yield Par = Face value at maturity PP = Purchase price n = number of days to maturity
Issued by large commercial banks Minimum denomination of $100,000 but $1 million more common Purchased by nonfinancial corporations or money market funds Secondary markets supported by dealers in security
NCD placement
Direct placement Use a correspondent institution specializing in placement Sell to securities dealers who resell Sell direct to investors at a higher price Rate above T-bill rate to compensate for lower liquidity and safety
NCD premiums
Sell a security with the agreement to repurchase it at a specified date and price Borrower defaults, lender has security Reverse repo name for transaction from lender Negotiated over telecommunications network Dealers and brokers used or direct placement No secondary market
Repo Rate =
360 n
Repo Rate = Yield on the repurchase agreement SP = Selling price PP = Purchase price n = number of days to maturity
Exhibit 6.5
Importer
L/C (Letter of Credit) Application
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Exporter
L/C Notification
L/C
A bank takes responsibility for a future payment of trade bill of exchange Used mostly in international transactions Exporters send goods to a foreign destination and want payment assurance before sending Bank stamps a time draft from the importer ACCEPTED and obligates the bank to make good on the payment at a specific time
Exporter can hold until the date or sell before maturity If sold to get the cash before maturity, price received is a discount from drafts total Return is based on calculations for other discount securities Similar to the commercial paper example
Participants
Commercial banks Finance, industrial, and service companies Federal and state governments Money market mutual funds All other financial institutions (investing)
Short-term investing for income and liquidity Short-term financing for short and permanent needs Large transaction size and telecommunication network
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Present value of future cash flows at maturity (zero coupon) Value (price) inversely related to discount rate or yield Money market security prices more stable than longer term bonds Yields = risk-free rate + default risk premium
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Exhibit 6.7
International Economic Conditions U.S. Fiscal Policy U.S. Monetary Policy U.S. Economic Conditions Issuers Industry Conditions Issuers Unique Conditions Short-Term Risk-Free Interest Rate (T -bill Rate)
Securities are close investment substitutes Investors trade to maintain yield differentials T-Bill is the benchmark yield in money market Yield changes in T-bills quickly impacts other securities via dealer trading Yield differentials determined by risk differences between securities Default risk premiums vary inversely with
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Segmented markets Tax differences Estimated exchange rates Government barriers to capital flows
Performance of international securities Effective yield for international securities has two components
The yield earned on the investment denominated in the currency of the investment The exchange rate effect
Yf
PPf Yf = Foreign investments yield SPf = Investments foreign currency selling price PPf = Investments foreign currency purchase
Ye = (1 + Yf ) (1 + %S ) 1
The exchange rate effect (%S) measures the percentage change in the spot during the investment period
Currency appreciated, % S is positive and adds to net yield Currency depreciated, % S is negative and reduces net yield
Tugas