Money Market Securities
s
Estimating repurchase agreement yields
SP – PP PP
Repo Rate =
×
360 n
Repo Rate = Yield on the repurchase agreement SP = Selling price PP = Purchase price n = number of days to maturity
s
Money Market Securities
Maturity of a year or less s Debt securities issued by corporations and governments that need short-term funds s Large primary market focus s Purchased by corporations and financial institutions s Secondary market for securities
Money Market Securities
Negotiable Certificates of Deposit (NCD)
q Issued
by large commercial banks q Minimum denomination of $100,000 but $1 million more common q Purchased by nonfinancial corporations or money market funds q Secondary markets supported by dealers in security
s
NCD premiums
q Rate
above T-bill rate to compensate for lower liquidity and safety
Money Market Securities
Repurchase Agreements
q Sell
a security with the agreement to repurchase it at a specified date and price q Borrower defaults, lender has security q Reverse repo name for transaction from lender q Negotiated over telecommunications network q Dealers and brokers used or direct placement q No secondary market
Japanese Bank (Exporter’s Bank)
Shipping Documents & Time Draft 6
L/C Notification
Money Market Securities
Bankers Acceptance
qA
bank takes responsibility for a future payment of trade bill of exchange q Used mostly in international transactions q Exporters send goods to a foreign destination and want payment assurance before sending q Bank stamps a time draft from the importer ACCEPTED and obligates the bank to make good on the payment at a specific time
Money Market Securities
s
Estimating T-bill yield
q No
coupon payments q Par or face value received at maturity q Yield at issue is the difference between the selling price and par or face value adjusted for time q If sold prior to maturity in secondary market
s
Money Market Securities
s
Treasury bills
q Issued
to meet the short-term needs of the U.S. government q Attractive to investors
x Minimal
default risk—backed by Federal Government x Excellent liquidity for investors
s
Money Market Securities
Treasury Bills s Commercial paper s Negotiable certificates of deposits s Repurchase agreements s Federal funds s Banker’s acceptances
Money Market Securities
s
T-bill yield for a newly issued security
Par – PP PP
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
Money Market Securities
s
Commercial paper backed by bank lines of credit
q Bank
line used if company loses credit rating q Bank lends to pay off commercial paper q Bank charges fees for guaranteed line of credit
Money Market Securities
s
NCD placement
q Direct
placement q Use a correspondent institution specializing in placement q Sell to securities dealers who resell q Sell direct to investors at a higher price
Money Market Securities
Federal Funds
q Interbank
lending and borrowing q Federal funds rate usually slightly higher than Tbill rate q Fed district bank debits and credits accounts for purchase (borrowing) and sale (lending) q Federal funds brokers may match up buyers and sellers using telecommunications network q Usually $5 million or more
Money Market Securities
Commercial Paper
q Short-term
debt instrument q Alternative to bank loan q Dealer placed vs. directly placed q Used only by well-known and creditworthy firms q Unsecured q Minimum denominations of $100,000 q Not a large secondary market
q Bid
process used to sell T-bills q Bids submitted to Federal Reserve banks by the deadline q Bid process
x Accepts
highest bids x Accepts bids until Treasury needs generated
CHAPTER
Money Markets
Chapter Objectives
Provide a background on money market securities s Explain how institutional investors use money markets s Explain the globalization of money markets
Money Market Securities
Noncompetitive Bidding
s
Treasury bill auction—noncompetitive bids ($1 million limit)
q q q q
May be used to make sure bid is accepted Price is the weighted average of the accepted competitive bids Investors do not know the price in advance so they submit check for full par value After the auction, investor receives check from the Treasury covering the difference between par and the actual price