CHAPTER 6 MONEY MARKETS All Rights Reserved Dr David P Echevarria

MONEY MARKET SECURITIES Treasury Bills Weekly auctions by sealed bid Competitive, Noncompetitive Sold at Discount Very large and liquid secondary market Computing Annualized Yield (365 day year): YT = [ (SP – PP) / PP ] * 365 / n Where: SP = sell price, PP = Purchase price, n = number of days held Computing the Discount: TBD = [ (Par – PP) / Par ] * 360 / n Interest exempt from state and local taxes All Rights Reserved Dr David P Echevarria

MONEY MARKET SECURITIES Commercial Paper For most creditworthy companies 100 to 150 basis points less than the prime No secondary market (mostly direct placement) Yield computed the same way as T-Bills Max maturity 270 days All Rights Reserved Dr David P Echevarria

MONEY MARKET SECURITIES C. Negotiable Certificates of Deposit (NCD) Large dollar amount certificates designed to be negotiable Specialized secondary market YNCD = (SP – PP + Interest) / PP. Banker's Acceptances Finance import activity Products form the collateral for the BA Rates quoted in WSJ and elsewhere All Rights Reserved Dr David P Echevarria

MONEY MARKET SECURITIES E. Repurchase Agreements (repo) Underlying instrument is a treasury bill or bond Contracts designed for very short periods of investment F. Federal Funds The market for lending excess reserves, frequently over-night Some funds lent by the Federal Reserve on an over-night basis All Rights Reserved Dr David P Echevarria

MONEY MARKET SECURITIES G. Comparison of Money Market Securities Most liquid are T-Bills Best yields are from BA's Money Market funds will have all in their portfolio NO MAS! H. Institutional Use of Money Market Securities Provide method for investors to keep excess cash balances working Provide a method for limiting interest rate risk Provide an additional investment vehicle for portfolios All Rights Reserved Dr David P Echevarria

FOREIGN FINANCIAL MARKETS Eurodollar Deposits and Euro notes Foreign deposits denominated in dollars Notes issued in European financial markets but denominated in dollars Euro-commercial Paper Potential hedge vehicle Dealers provide a secondary market Lack of Regulatory Oversight Increased risks Source of competitive edge for foreign banks All Rights Reserved Dr David P Echevarria

Eurodollar 1-Month Deposit Rate All Rights Reserved Dr David P Echevarria

HOMEWORK QUESTIONS What are the 4 main types of money market instruments? What premiums do investors extract for reduced liquidity? Increases in default risk? Who issues commercial paper? Why is c-paper preferred to borrowing at prime? How does the Repurchase (repo) agreement work? Why are Fed Funds important to financial institutions? What are Eurodollar deposits and why are they important? All Rights Reserved Dr David P Echevarria