Money Markets

2003 South-Western/Thomson Learning

Chapter Objectives

Provide a background on money market securities Explain how institutional investors use money markets Explain the globalization of money markets

Money Market Securities

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

Money Market Securities

Treasury Bills Commercial paper Negotiable certificates of deposits Repurchase agreements Federal funds Bankers acceptances
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Money Market Securities

Treasury bills

Issued to meet the short-term needs of the U.S. government Attractive to investors

Minimal default riskbacked by Federal Government Excellent liquidity for investors

Short-term maturity Very good secondary market

Money Market Securities

Competitive Bidding

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

Accepts highest bids

Money Market Securities

Estimating T-bill yield

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

Money Market Securities

Calculating T-Bill Annualized Yield

SP PP PP

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)

Money Market Securities

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

Commercial Paper

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

Money Market Securities

Commercial paper backed by bank lines of credit

Bank line used if company loses credit rating Bank lends to pay off commercial paper Bank charges fees for guaranteed line of credit

Money Market Securities

Estimating commercial paper yields (same as t-bill)

Par PP PP

YCP =

360 n

YCP = Commercial paper yield Par = Face value at maturity PP = Purchase price n = number of days to maturity

Money Market Securities

Negotiable Certificates of Deposit (NCD)

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

Money Market Securities

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

Money Market Securities

Repurchase Agreements

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

Money Market Securities

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

Exhibit 6.5
Importer
L/C (Letter of Credit) Application

1 5

Purchase Order Shipment of Goods

Exporter

L/C Notification

L/C

American Bank (Importers Bank)

Shipping Documents &Time Draft Draft Accepted (B/ACreated)

Japanese Bank (Exporters Bank)

Shipping Documents & Time Draft 6

Money Market Securities

Bankers Acceptance

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

Money Market Securities

Bankers Acceptance

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

Major Participants in Money Market

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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Valuation of Money Market Securities

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)

Risk Premium of Issuer

Required Return on the Money Market Security

Price of the Money Market Security

Interaction Among Money Market Yields

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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Globalization of Money Markets

Money market rates vary by country

Segmented markets Tax differences Estimated exchange rates Government barriers to capital flows

Deregulation Improves Financial Integration Capital Flows To Highest Rate of Return

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Globalization of Money Markets

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

Globalization of Money Markets

Performance of international securities Yield for an international investment

= SPf PPf

Yf

PPf Yf = Foreign investments yield SPf = Investments foreign currency selling price PPf = Investments foreign currency purchase

Globalization of Money Markets

Ye = (1 + Yf ) (1 + %S ) 1

The exchange rate effect (%S) measures the percentage change in the spot during the investment period

% S measures the expected percent change in the currency

Currency appreciated, % S is positive and adds to net yield Currency depreciated, % S is negative and reduces net yield

Tugas

Carilah informasi tentang instrumen pasar uang (money market) di Indonesia.