Chapter 19

Money Markets

Investments

Learning Objectives

   Relationship between quoted rates of return and prices Discount rate, dollar discount and yield to maturity Main types of money market instruments-T-bills, banker’s acceptance, bank deposits and loans, commercial bills, CD and repos

© K. Cuthbertson and D. Nitzsche



Money market instruments

© K. Cuthbertson and D. Nitzsche



Pricing of pure discount instruments

© K. Cuthbertson and D. Nitzsche



Dollar discount and yield

© K. Cuthbertson and D. Nitzsche

Figure 1 : Discount instruments : 1-year bills T-bill, maturity of 1 year Par (face or maturity) value, FV = 100 Trading at a discount d(%) Has a current market price of P P = 100(1-(d/100)) FV = 100 Discount, D 1 Time 0 © K. Cuthbertson and D. Nitzsche

Figure 2 : Discount instruments : bills < 1 year T-bill, maturity of

days Par (face or maturity) value, FV = 100 Trading at a discount d(%) Has a current market price of P (1 year =

= 365 days) P = 100[1 - (m/365)(d/100)] FV = 100 Discount, D 0 D = FV - P = FV[(d/100) (m/a)] © K. Cuthbertson and D. Nitzsche m/365 1 Time in years

Figure 3 : Yield instrument : 1-year CDs FV = 100 deposited, maturity of 1 year Quoted yield = y(% p.a.) TV = 100(1 + y/100) TV = 100(1 + y/100) FV = 100 0 © K. Cuthbertson and D. Nitzsche 1 Time

Figure 4 : Yield instruments : deposits < 1 year FV = 100 deposited, maturity of

days Quoted yield = y(% p.a.) TV = 100 (1 + (

/365)(y/100)) (1 year =

= 365 days) TV = 100[1 + (m/365)(y/100)] FV = 100 0 © K. Cuthbertson and D. Nitzsche m/365 1 Time in years

Case Study 1 : CD Market Conventions The UK CD market is very liquid and the market conventions are broadly similar to those in other banking centres such as New York, the euro area and the Far East. Key features of the UK market are :       Units of at least £ 500,000 Minimum/maximum redemption period is 7 days/5 years Interest on 1 year (or less) CDs is paid on maturity Interest on CDs with maturity graeter than 1 year is paid annually Quotations (‘on the street’) are on a yield basis Day-count basis is actual/actual © K. Cuthbertson and D. Nitzsche

Table 6 : US Treasury auction, T-bills Total issue $ 10bn Less non-competitive bids $ 0.5bn

Less Federal Reserve $2.5bn

Amount ($bn) 0.5

0.7

0.8

1 1.1

1.2

1.3

1.5

bids 0.5

1.2

2 3 4.1

5.3

6.6

8.1

Amount for competitive bidders $ 7bn Cumulative Bid (yield) 5.55

5.56

5.57

5.58

5.59

6 6.01

6.02