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Pre Test – 2 May 2019

1. These are used to facilitate transfer of short-term funds from investors through the use of
money market securities.
2. T/F. Money market securities have a maturity of less than a year to more than a year.

3 & 4. Please list down two (2) examples of money market securities

5. The value/price of a T-bill is computed by determining the ______________.

For 6 & 7, use the ff. information:

An investor purchased a T-bill with a three-month (92-day) maturity and P1,000 par value for P992.
The money market security is held until maturity.

6. What is the yield rate of the T-bill? (Use 2 decimal places)

7. What is the discount rate of the T-Bill?

8. This involves one party selling to another with an agreement to repurchase the securities at a
specified date and price.

9. For a newly issued T-bill that is held to maturity, the yield will always be higher than the discount.
True or False.

10. A form of money market security that allows depositary institutions to lend or borrow short-
term funds from each other.

Discussion – 2 May 2019

Money markets are used to facilitate the transfer of short-term funds from individuals, corporations, or
governments with excess funds to those with deficient funds. Even investors who focus on long-term
securities tend to hold some money market securities. Money markets enable financial market
participants to maintain liquidity.

Characteristics of Money Market Securities


1. Debt securities
2. It matures
3. Period is less than one year
4. Highly liquid

Examples of Money Market Securities


1. Treasury bills – issued by the govt. treasury department
2. Commercial Paper – issued by well-known & credit worthy firms
3. NCD – issued by banks
4. Repurchase agreements – selling securities with an agreement to repurchase them
5. Federal funds – involves lending and borrowing short term funds among depositary institutions
What is market price?

It is the current price at which an asset could be bought or sold

Market price of Money Market Securities is computed based on the present value of all future cash
flows to be received.

Present Value = FV/(1+r)n

The price that an investor will pay for a T-bill with a particular maturity depends on the investor’s
required rate of return on that T-bill.

What motivates investors?


Investment  Profit

Yield is a key factor when investors decide which money market security they will invest.
Yield is the investor’s required rate of return also called “investment rate”

What is par value?


For T-bills amount to be received when held to maturity is par value. Sometimes the term used is
“Principal”

Examples:
1. An investor is expecting a rate of return for 5% on money market placements within 92 days.
The par value of the money market security is P100. How much will the investor pay to acquire
this security?
2. T-bill with maturity of 182 days and par value of P1,200 was purchased at P1,045.
a. What is the annualized yield?
b. The discount rate for this debt security is?

3. Dina Corporation arranged a repurchase agreement where it purchased P100,000 and will sell
the securities back for P108,000 in 45 days. What is the repo rate?

A. Seatwork – 3 May 2019 (By Group)


I. For each common type of Money Market Security, please identify and discuss the following:
a. Nature/description of the security
b. Uses
c. Parties Involved
d. Risks involved
e. How is price computed?
f. How is yield computed?
II. Answer Problems 1 to 7 page 160 (11th edition)

B. Assignment for 6 May 2019, Monday

Please study how to determine price and yield for money market securities.

To make powerpoint discussion and comparison of each type and discuss on May 6 (Mon)

Seatwork – 6 May 2019 (50 minutes)

Compute what is being asked from the following:

1. Treasury Bills

Price Par Maturity (days) Annualized Discount Annualized Yield


Rate
$4,925 $5,000 182 ?? ??
$9,940 $10,000 91 ?? ??
?? $5,000 91 3.5% ??
$9,900 $10,000 91 ?? ??
?? $10,000 182 1.8% ??
?? $10,000 364 3% ??

2. The annualized discount rate on a money market instrument is 3.75%. The face value is
$200,000 and it matures in 51 days. What is its price?
3. The price of $8,000 face value commercial paper is $7,930. If the annualized yield is 4%, when
will the paper mature?
4. The price of 182-day commercial paper is $7,840. If the annualized investment rate is 4.093%
what will the paper pay at maturity?

Assignment for 7 May 2019

Please study Chapter 7 Bond Markets for a Pre Test on Wednesday, 8 May 2019.

Pretest (Bond Markets) – 7 May 2019

Discussion (Bond Valuation) – 8 May2019


Seatwork (Bond Valuation) – 9 May 2019

Discussion & Seatwork (Bond Valuation) – 10 May 2019

Output – 13 May 2019

Research at least three (3) debt securities existing in the Philippines and discuss the following for each
type of security:

a. Nature/description
b. Usage
c. Parties involved
d. Risks involved
e. How is it valued?

Present Value – PV Definition


https://www.investopedia.com/terms/p/presentvalue.asp

What Is Present Value – PV


Present value (PV) is the current value of a future sum of money or stream of
cash flows given a specified rate of return. Future cash flows are discounted at
the discount rate, and the higher the discount rate, the lower the present value of
the future cash flows. Determining the appropriate discount rate is the key to
properly valuing future cash flows, whether they be earnings or obligations.
What Does Present Value Tell You?
Present value is the concept that states an amount of money today is worth more
than that same amount in the future. In other words, money received in the future
is not worth as much as an equal amount received today.

Receiving $1,000 today is worth more than $1,000 five years from now. Why?
Two factors impact whether an amount today is worth more than the same
amount in the future.

Interest Rate or Rate of Return


An investor can invest the $1,000 today and presumably earn a rate of return
over the next five years. Present value takes into account any interest rate an
investment might earn.

If an investor receives $1,000 today and can earn a rate of return 5% per year,
the $1,000 today is certainly worth more than receiving $1,000 five years from
now. If an investor waited five years for $1,000, there would be opportunity cost
or the investor would lose out on the rate of return for the five years.

Inflation and Purchasing Power


Inflation is the process in which prices of goods and services rise over time. If
you receive money today, you can buy goods at today's prices. Presumably,
inflation will cause the price of goods to rise in the future, which would lower the
purchasing power of your money.

Money not spent today could be expected to lose value in the future by some
implied annual rate, which could be inflation or the rate of return if the money was
invested. The present value formula discounts the future value to today's dollars
by factoring in the implied annual rate from either inflation or the rate of return
that could be achieved if a sum was invested.

Future Value Compared With Present Value


A comparison of present value with future value (FV) best illustrates the principle
of time value of money and the need for charging or paying additional risk-based
interest rates. Simply put, the money today is worth more than the same money
tomorrow because of the passage of time.

In many scenarios, people would rather have a $1 today versus that same $1
tomorrow. Future value can relate to the future cash inflows from investing
today's money, or the future payment required to repay money borrowed today.

Discount Rate for Finding Present Value


The discount rate is the investment rate of return that is applied to the present
value calculation. In other words, the discount rate would be the forgone rate of
return if an investor chose to accept an amount in the future versus the same
amount today. The discount rate that is chosen for the present value calculation
is highly subjective because it's the expected rate of return you'd receive if you
had invested today's dollars for a period of time.

The discount rate is the sum of the time value and a relevant interest rate that
mathematically increases future value in nominal or absolute terms. Conversely,
the discount rate is used to work out future value in terms of present value,
allowing a lender or capital provider to settle on the fair amount of any future
earnings or obligations in relation to the present value of the capital. The word
"discount" refers to future value being discounted to present value.

The calculation of discounted or present value is extremely important in many


financial calculations. For example, net present value, bond yields, spot rates,
and pension obligations all rely on discounted or present value. Learning how to
use a financial calculator to make present value calculations can help you decide
whether you should accept such offers as a cash rebate, 0% financing on the
purchase of a car, or pay points on a mortgage.

Money Market Yield


REVIEWED BY JAMES CHEN
https://www.investopedia.com/terms/m/money-market-yield.asp

Updated Feb 12, 2018


What is a Money Market Yield
The money market yield is the interest rate earned by investing in securities with
high liquidity and maturities of less than one year such as negotiable certificates
of deposit, U.S. Treasury bills and municipal notes. Money market yield is
calculated by taking the holding period yield and multiplying it by a 360-day bank
year divided by days to maturity. It can also be calculated using bank discount
yield.

The money market yield is also known as the CD-equivalent yield or bond
equivalent yield.

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Money Market

BREAKING DOWN Money Market Yield


The money market is the part of the broader financial markets that deals with
highly liquid and short term financial securities. The market links borrowers and
lenders who are looking to transact in short-term instruments overnight or for
some days, weeks, or months, but always less than a year. Active participants in
this market include banks, money market funds, brokers, and dealers. Examples
of money market securities include Certificates of Deposit (CD), Treasury bills (T-
bills), commercial paper, municipal notes, short-term asset-backed securities,
Eurodollar deposits, and repurchase agreements.

Money market investors receive compensation for lending funds to entities that
need to fulfill their short-term debt obligations. This compensation is typically in
the form of variable interest rates determined by the current interest rate in the
economy. Since money market securities are considered to have low default risk,
the money market yield will be lower than the yield on stocks and bonds but
higher than the interest rates on standard savings accounts.

Although interest rates are quoted annually, the quoted interest may actually be
compounded semi-annually, quarterly, monthly, or even daily. The money market
yield is calculated using the bond equivalent yield (BEY) based on a 360-day
year, which helps an investor compare the return of a bond that pays a coupon
on an annual basis with a bond that pays semi-annual, quarterly, or any other
coupons. The formula for the money market yield is:

Money market yield = Holding period yield x (360/Time to maturity)

Money market yield = [(Face value – Purchase price)/Purchase price] x


(360/Time to maturity)

For example, a T-bill with $100,000 face value is issued for $98,000 and due to
mature in 180 days. The money market yield is:

= ($100,000 - $98,000/$98,000) x 360/180

= 0.0204 x 2

= 0.0408, or 4.08%
The money market yield differs slightly from the bank discount yield, which is
computed on the face value, not the purchase price. However, the money market
yield can also be calculated using the bank discount yield as seen in this formula:

Money market yield = Bank discount yield x (Face value/Purchase price)

Money market yield = Bank discount yield / [1 – (Face value – Purchase


price/Face value)]

Where bank discount yield = (Face value – Purchase price)/Face value x


(360/Time to maturity)

To earn a money market yield, it is necessary to have a money market account.


Banks, for example, offer money market accounts because they need to borrow
funds on a short-term basis to meet reserve requirements and to participate in
interbank lending.

Bank Discount Rate


REVIEWED BY JAMES CHEN
https://www.investopedia.com/terms/b/bank-discount-rate.asp

Updated Feb 23, 2018


What is the Bank Discount Rate
The bank discount rate is the interest rate for short-term money-market
instruments like commercial paper and Treasury bills. The bank discount rate is
based on the instrument's par value and the amount of the discount.

The bank discount rate is the required rate of return of a safe investment
guaranteed by the bank.

BREAKING DOWN Bank Discount Rate


Some securities are issued at a discount to par, meaning that investors can
purchase these securities at a price lower than the stated par value. For
example, Treasury bills, which are backed by the full faith and credit of the U.S.
government, are pure discount securities. These short-term non-interest bearing
money market instruments do not pay coupons, but investors can purchase them
at a discount and receive the full face value of the T-bill at maturity. For example,
a Treasury bill is issued for $95. At maturity, the debtholders will receive the face
value of $100. The difference between the discount purchase price and the par
value is the dollar rate of return. This is the rate at which the central bank
discounts Treasury bills, and it is referred to as the bank discount rate.

The bank discount rate method is the primary method used for calculating the
interest earned on non-coupon discount investments. It is important to note that
the bank discount rate factors in simple interest, not compound interest. In
addition, the bank discount rate is discounted relative to the par value, and not
relative to the purchase price. For example, assume a commercial paper matures
in 270 days with a face value of $1,000 and a purchase price of $970.

First, divide the difference between the purchase value and the par value by the
par value.

($1,000 - $970)/$1,000 = 0.03, or 3%

Next, divide 360 days by the number of days left to maturity. To simplify
calculations when determining the bank discount rate, a 360-day year is often
used.

360/270 = 1.33

Finally, multiply both figures calculated above together.

3% x 1.33 = 3.99%

The bank discount rate is, therefore, 3.99%.

Following our example above, the formula for calculating the bank discount rate
is:

Bank Discount Rate = (Dollar Discount/Face Value) x (360/Time to Maturity)

Since the formula uses 360 days instead of 365 days or 366 days in a year, the
bank discount rate calculated will be lower than the actual yield you receive on
your short-term money market investment. The rate should, therefore, not be
used as an exact measurement of the yield that will be received.
Money Market
REVIEWED BY JAMES CHEN
https://www.investopedia.com/terms/m/moneymarket.asp

Updated Nov 6, 2018


What is a Money Market
The money market is where financial instruments with high liquidity and very
short maturities are traded. It is used by participants as a means for borrowing
and lending in the short term, with maturities that usually range from overnight to
just under a year. Among the most common money market instruments are
eurodollar deposits, negotiable certificates of deposit (CDs), banker's
acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal
funds and repurchase agreements (repos).

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Money Market

BREAKING DOWN Money Market


Money market transactions are wholesale, meaning that they are for large
denominations and take place between financial institutions and companies
rather than individuals. Money market funds offer individuals the opportunity to
invest smaller amounts in these assets.

Market Participants
Institutions that participate in the money market include banks that lend to one
another and to large companies in the eurocurrency and time deposit markets;
companies that raise money by selling commercial paper into the market, which
can be bought by other companies or funds; and investors who purchase bank
CDs as a safe place to park money in the short term.

The U.S. government issues Treasury bills in the money market, and the bills
have maturities that range from a few days to one year. Only primary dealers can
buy them directly from the government; dealers trade them between themselves
and sell retail amounts to individual investors. State, county and municipal
governments also issue short-term notes.

Commercial paper is a popular borrowing mechanism because it is exempt


from SEC registration requirements. It's attractive to corporate investors because
rates are higher than for bank time deposits or Treasury bills, and a range of
maturities is available, from overnight to 270 days. However, the risk of default is
significantly higher for commercial paper than for bank or government
instruments.

Money Market Funds


The money market itself is limited to companies and financial institutions that
lend and borrow wholesale amounts, which range from $5 million to well over $1
billion per transaction. Mutual funds offer baskets of these instruments, which are
generally considered to be safe, to individual investors. The net asset value
(NAV)of such funds is intended to stay at $1, but during the 2008 financial crisis,
one fund fell below that level. That triggered market panic and a mass exodus
from the funds, which ultimately led to restrictions on them holding higher-
yielding investments in order to raise returns.

Money Market vs. Capital Market


The money market is different from the capital market, which is the sale and
purchase of long-term debt and equity instruments. A discussion of the
differences between the two markets is available in the articles Financial
Markets: Capital vs. Money Market and Getting to Know the Money Market.

Money Market Accounts


Money market accounts are high interest rate accounts targeted at retail
investors that also allow limited withdrawal facilities, meaning you can write
checks from the account and, in some instances, also get a debit card linked to it.
The accounts are meant to incentivize customers to save money for important
purposes, such as down payment for a home. They can also be used for
overdraft protection in some cases. Thus, funds from your money market
accounts are used if you overdraw on your regular accounts. Funds in money
market accounts are insured by the Federal Deposit Insurance
Corporation (FDIC) at banks and the National Credit Union
Administration (NCUA) in credit unions.

In typical money market accounts, banks calculate interest for an account holder
on a daily basis and make a monthly credit to his or her account. Average
interest rates for money market accounts vary based on the amount deposited.
Typically, larger deposit amounts beget higher interest rates. For example,
interest rates for Jumbo money market accounts are high because they require a
larger deposit amount, such as $100,000.

In the majority of cases, money market accounts require a minimum deposit.


Depending on the mode of withdrawal, Regulation D limits the number of such
transactions to six. If an account holder passes the transaction limit, banks
charge them a fee or convert their account to checking.
Money Market Accounts Vs. Savings Accounts Vs. Certificates of Deposit
The concept and design of money market accounts is similar to that of savings
accounts. Both offer higher yields as compared to standard checking accounts
and have limited to no withdrawal facilities. In general, money market accounts
have better interest rates. But the difference in rates between savings and money
market accounts has narrowed considerably since last decade’s financial crisis.
The latter also require higher minimum deposit amounts. You can also see a
discussion of the differences between the two types of accounts in the
video Money Market Accounts Vs. Savings Accounts.

Certificate of Deposits (CDs) are another investment instrument frequently


compared to money market accounts. They offer higher interest rates as
compared to money market accounts but there is a penalty associated with early
withdrawal of funds before the CD term ends. For savings accumulated over a
longer period, however, CDs offer better returns as compared to money market
accounts.

A drawback of money market accounts in relation to certificates of deposit is that


their interest rates are subject to revision. With a CD, the interest rate remains
constant and does not change throughout the duration of the deposit period.

Commercial Paper
https://www.investopedia.com/video/play/commercial-paper/

Commercial paper is a short-term debt security issued by financial companies


and large corporations. The corporation promises the buyer a return, or profit, for
making the loan. The return is stated as an interest rate or percentage of the
loan, such as 5%.Companies sell commercial paper when they need a short-term
loan to pay for such things as accounts payable and inventories. The security is
generally sold at a discount, and redeemed at full value. The gain is the interest
payment. Most commercial paper matures in one to six months, but some mature
in up to nine months. Debt that matures in less than 270 days – the money
markets -- does not require registration with the SEC. Debt maturing in more than
270 days – the capital markets -- must be registered with the SEC. Commercial
paper is part of the money markets. By avoiding SEC registration, it is less costly
- a major benefit for companies. By issuing commercial paper to raise short term
funds, companies avoid the time and cost of applying for business loans, as well
as SEC registration. Commercial paper is unsecured, meaning buyers have no
claim on a company’s assets if the company fails to pay up at maturity.
Therefore, only firms with good credit can successfully sell commercial paper.
Commercial paper is traditionally sold in large denominations of $100,000 or
more to large institutions and wealthy individuals. However, it is increasingly
becoming more available to retail investors.

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