Transcript Money Markets - Bryant University

Money Markets
I. Money Market Securities
• Definition
Money market securities are financial
instruments with maturity of one year or
less.
• Instruments and Participants
– Domestic Money Market
Instruments
Treasury bills
Commercial paper
Negotiable CDs
Repurchase agreements
Principal Borrowers
U.S. Government
Non-financial and financial
businesses
Banks
Securities dealers, banks, nonfinancial corporations,
governments
Instruments
Federal funds
Banker’s acceptances
Discount window
Municipal Notes
Government sponsored
Enterprise securities
Principal Borrowers
Banks
Non-financial and financial
businesses
Banks
State and local governments
Farm Credit System, Federal
Home Loan Bank System,
Federal National Mortgage
Association
Instruments
Principal Borrowers
Shares in money market Money market funds, local
instruments
government investment pools,
short-term investment funds
Futures contracts
Dealers, banks (principal users)
Futures options
Dealers, banks (principal users)
Swaps
Banks (principal dealers)
– International Money Market Instruments
Instruments
Eurodollars
Eurodollar CDs
Euronotes
Euro-commercial paper
Principal Borrowers
Banks
Banks
Non-financial and financial
businesses
• Characteristics
– High degree of safety
– Active secondary market
– Telephone network
II. Treasury Bills
• Maturity
– Regular issues
91-day bills
182-day bills
51-week bills
– Irregular issues
Issued weekly
Issued weekly
Issued monthly
• Denominations
$10,000
$15,000
$50,000
$100,000
$500,000
$1,000,000
round lot: $5,000,000
• Auction
– Non-competitive Bidding ($1,000,000 or less)
 Direct purchase from Federal Reserve Banks
 Indirect purchase through brokers
– Competitive Bidding
Amount
(in bil.)
$0.20
0.26
0.33
0.57
0.79
0.96
1.25
1.52
Bid
7.55%
7.56
7.57
7.58
7.59
7.60
7.61
7.62
Remark
lowest yield,/highest price
average yield/ average price
stop yield/ stop price
• Dearlers
– Reporting Dealers
Securities firms which are on the Federal
Reserve’s regular reporting list.
– Primary Dealers (Recognized Dealers)
Securities firms and commercial banks that the
Federal Reserve will deal with in implementing
its open market operations.
– Government Brokers
Brokers used by primary dealers trading
Treasury securities with each other.
– Other Dealers and Brokers
• T-Bill Rate (T-Bill Discount, or Yield on a
Bank Discount Basis)
T-bill Rate = [(par - PP) / par]  (360 / n)
= [dollar discount/ par]  (360 / n),
where
par = par value,
PP = purchase price, and
n = holding period in days.
Example:
par = $100,000,
PP = $97,569, and
n = 100 days.
Yield = [($100,000- $97,569)/ $100,000]
 (360 / 100)
= 8.75%.
• Dollar Discount
Dollar Discount = T-bill Rate  par  (n /360)
Example:
T-bill Rate = 8.75%,
par = $100,000, and
n = 100 days.
Dollar Discount = 0.0875$100,000(100/360)
= $2,431.
Purchase price = par value - dollar discount
= $100,000 - $2,431 = $97,569.
• Yield
T-bill Yield = [(SP - PP) / PP]  (365 / n),
where
SP = selling price,
PP = purchase price, and
n = holding period in days.
Example:
SP = $10,000,
PP = $9,600, and
n = 182 days.
Yield = [($10,000 - $9,600)/ $9,600](365 / 182)
= 8.36%
III. Commercial Paper
• Issuers
Finance companies
Bank holding companies
Industrial companies
Foreign corporations (Yankee commercial paper)
• Maturity
– Not Registered
One day to 270 days, normally between 20 and
45 days.
– Registered
Over 270 days
• Denominations
Minimum
Minimum round lot
Typical
$25,000
$100,000
multiples of $1 million
• Rating
Category
Duff & Phelps
Investment Duff 1+
Grade
Duff 1
Duff 1Duff 2
Duff 3
Non-invest.
Grade
Duff 4
In default
Duff 5
Fitch
F-1+
F-1
P-1
S&P
A-1+
A-1
F-2
F-3
P-2
P-3
A-2
A-3
MCM 2
MCM 3
F-S
NP(Not
Prime)
B
MCM 4
C
MCM 5
MCM 6
D
Moody’s
McCarthy,
Crisanti &
Maffei
D
MCM 1
• Placement
– Directly Placed Commercial Paper
– Dealer-Placed Commercial Paper
• Backing
– Reasons
Credit enhancement
Rollover risk
– Types of Credit-Supported commercial paper
 Credit-Supported commercial paper (line of credit paper)
Fee (0.5%)
Compensating balances
 Asset-backed commercial paper
• Yield
Yield = [(par - PP) / PP]  (360 / n),
where
par = par value,
PP = purchase price, and
n = holding period in days.
Example:
par = $5,000,000,
PP = $4,850,000, and
n = 90 days.
Yield = [($5,000,000 - $4,850,000) / $4,850,000]
 (360 / 90)
= 12.37%
IV. Negotiable Certificates of Deposit
(NCDs)
• Issuers
– Domestic market
Commercial banks
Thrift institutions (thrift CDs)
U.S. branches of foreign banks (Yankee CDs)
– Foreign markets (Euro CDs)
• Maturity
Short-term: two weeks to one year
Long-term: term CDs
• Denominations
Minimum
Typical
$100,000
$1,000,000
• Placement
– Directly placed NCDs
– Dealer placed NCDs
• Yield on a Bank Discount Basis
– Risk premium
 Higher premium during recessionary years
 Higher premium during financial crises
 Higher premium for high-risk issuers
– Liquidity premium
– Fixed rate vs floating rate
V. Repurchase Agreements (RPs)
• Issuers
– Financial institutions
Commercial banks
Thrifts
Money market funds
Securities dealers
– Non-financial institutions
Municipalities
Businesses
• Maturity
– Overnight repos
– Term repos
Two to fifteen days
One, three and six months
• Denominations
Typical
$10 million or higher
• Yield or Repo Rate
Repo Rate = [(SP - PP) / PP]  (360 / n),
where
SP = selling price collected by an investor,
PP = purchase price paid by an investor, and
n = holding period in days.
Example:
SP = $10,000,000,
PP = $9,852,217, and
n = 60 days.
Yield = [($ 10,000,000-$ 9,852,217)/$ 9,852,217]
 (360 / 60)
= 9%
Determinants of repo rates:
– Creditworthiness of the issuer
– Type of collateral
– Federal funds rate
The repo rate is usually 25 basis points below
the funds rate because a repo has collateral,
while a federal funds transaction is unsecured.
VI. Federal Funds
• Participants
Depository institutions
Brokers
• Characteristics
– Short-term borrowing of immediate availability
– Borrowed only by depository institutions
– Exempted from reserve requirements
• Maturity
– Overnight federal funds (3/4 of the total federal
funds)
– Continuing contract federal funds
(automatically renewed overnight federal
funds)
– Term federal funds: few days to six months
• Denominations
Typical
• Placement
– Directly placed
– Broker-placed
$5,000,000
• Security
– Unsecured federal funds
– Secured federal funds
• Federal Funds Transfer
– Adjusting reserve accounts through Fedwire
– Reclassifying the demand deposits of a
respondent bank
• Federal Funds Rate
– Higher than repo rate and Treasury bill rate.
– Higher volatility than other money market
rates because it is affected by changes in
monetary policy.
VII. Banker’s Acceptances
• Issuers
Exporters
Importers
Commercial banks
1. Purchase order
Importer
Exporter
5. Shipment of goods
2. L/C
application
4. L/C
notification
6. Shipping
documents
& time
draft
3. L/C
Importer’s bank
Exporter’s bank
7. Shipping
documents & draft acceptance
Acceptance financing
The use of banker’s acceptances to finance
commercial transaction.
– Importing goods into the U.S.
– Exporting goods from the U.S.
– Storing and shipping goods between foreign
countries (third country acceptances)
• Maturity
– 30 to 270 days
– Federal Reserve eligibility requirement
A Banker’s acceptance with maturity longer
than six months do not meet the eligibility
requirement as collateral at the discount
window.
• Placement
– Directly placed by Accepting banks
An accepting bank is a bank which creates
banker’s acceptances.
– Dealer placed
* Unsold acceptances created by large
accepting banks
* Acceptances created by smaller accepting
banks
* Acceptances created by Yankee banks (U.S.
branches of foreign banks)
• Rates
– Higher than T-bill rate
* Risk premium - Higher default risk than Tbills.
* Liquidity premium- Less developed
secondary market.
– Commission charged by accepting banks
* U.S. banks - 25 to 30 basis points
* Japanese banks - 10 to 15 basis points
– Dealer’s Spread - 12.5 to 87.5 basis points
VIII. Eurocurrency
• Participants
Governments
Large financial institutions
Commercial banks (Eurobanks)
Organized exchanges
Institutional investors
Large corporations
• Related Markets
–
–
–
–
–
–
–
–
–
Foreign exchange market
Eurocurrency market
Eurocredit market
Euro CD market
Euronote market
Currency forward market
Currency Futures market
Currency options market
Currency swap market
• Euro CDs
– Types
* Fixed -rate CDs
* Floating-rate CDs (FRCDs)
The rate adjusts periodically to the London
Interbank Offer Rate (LIBOR).
– Yield
Euro CDs offer a higher yield than domestic
CDs for three reasons:
* Reserve requirements imposed on domestic
CDs
* FDIC insurance premium for covering
domestic CDs
* Sovereign risk
Euro CDs are obligations that are payable by an
entity operating under a foreign jurisdiction, and
their claim may not be enforced by the foreign
government.
• Euronotes
– Participants
Borrowers
Underwritten or committed note issuance
facility (a syndicate formed by a group of
banks)
Investors
– Maturity
One month
Three months
Six months
IX. Euro-Commercial Paper
(Euro-CP)
• Participants
Borrowers
Dealers
Investors
• Maturity
Euro-commercial paper has longer maturity (
i.e., longer than 270 days) than that of U.S.
commercial paper, and therefore has a more
active secondary market.
• Placement
Euro-commercial paper is almost always
dealer-placed. The commission ranges between
5 and 10 basis points of the face value.
• Yield
Euro-commercial paper is typically between 50
and 100 basis points above LIBOR.
VIII. Valuation of Money Market
Instruments
• Market Value
P = Par / (1 + i)n,
where
P = price of the money market instrument,
Par = par value,
i = required annual rate of return, and
n = time to maturity (a fraction of one year).
Example:
Par = $10,000,
i = 7%, and
n = 1 year.
P = $10,000/ (1 + 0.07)1
= $9,345.79.
• Price Determinants
P = ƒ( i) = ƒ(Rf, DP, LP) ,
where
P = change in price,
i = change in required rate of return,
Rf = change in risk-free rate,
DP = change in default risk premium, and
LP = change in liquidity premium.
– Determinants of risk-free rate
* Economic growth
* Inflation
* Money supply
– Determinants of default risk premium
* Economic conditions
* Conditions in the firm’s industry (degree of
competition, etc.)
* Firm-specific conditions (debt level,
management, etc.)