1 Chapter 6 Financial Markets, Instruments, and Participants ©2000 South-Western College Publishing

2 Money Market The market for financial assets with an original maturity of less than one year

3 Capital Market The market for financial assets with an original maturity of greater than one year

4 Term to Maturity The length of time from when a financial security is initially issued until it matures

5 Primary Market The market in which a security is initially sold for the first time

6 Secondary Market The market in which previously issued financial securities are sold

7 Spot Market Market in which the trading of financial securities takes place instantaneously

8 Financial Futures Markets Organized markets that trade financial futures agreements

9 Speculation The buying or selling of financial securities in the hopes of profiting from future price changes

10 U.S. Treasury bills (T-bills) Short-term debt instruments of the U.S. government with typical maturities of 3-12 months

11 The Principal Money Market Instruments Amount Outstanding, End of Year Billions of Dollars Type of Instrument Treasury Bills Negotiable CDs Commercial Paper Banker’s Acceptances Repurchase Agreements and Fed Funds Eurodollars 1960 $ Exhibit $ $ $482 N.A N.A $430 N.A

12 The Money Market Instrument Treasury Bills Negotiable CDs Commercial Paper Banker’s Acceptances Repurchase Agreements and Fed Funds Fed Funds Eurodollars Typical Maturities 3 to 12 months 1 to 6 months 1 to 270 days 90 days 1 day, and 2 day to 3 months typical; 6 months less typical Chiefly 1 business day Overnight, 1 week, 1 to 6 months and longer Exhibit 6-2a

13 Exhibit 6-2b The Money Market Instrument Treasury Bills Negotiable CDs Commercial Paper Banker’s Acceptances Repurchase Agreements and Fed Funds Fed Funds Eurodollars Principal Borrowers U.S. Government Depository Institutions Financial & Business Firms Banks, Securities, nonfinancial firms, governments Depository Institutions Banks

14 The Money Market Instrument Treasury Bills Negotiable CDs Commercial Paper Banker’s Acceptances Repurchase Agreements and Fed Funds Fed Funds Eurodollars Exhibit 6-2c Secondary Market Very Active Modest Activity Moderately Active Limited None, but very active primary market for short maturities Active broker’s market None

15 Treasury Bills Maturity Sept 24 ‘98 Oct 01 ‘98 Oct 08 ‘98 Oct 15 ‘98 Oct 22 ‘98 Oct 29 ‘98 Nov 5 ‘98 Nov 12 ‘98 Days to Maturity Asked Chg AskYld Bid

16 Negotiable Certificates of Deposit (CDs) Certificates of deposit with a minimum maturity of $100,000 that can be traded in a secondary market First introduced by Citibank in 1961

17 Commercial Paper Short-term debt instruments issued by corporations

18 Banker’s Acceptances Money market instruments created in the course of international trade to guarantee bank drafts due on a future date

19 Importer ExporterImporter Exporter bank Exhibit 6.3 Goods Now Cash Later Investor No Bankers’ Acceptance Cash Now Discounts Now Accepted Time Draft Now Cash Later Acceptance Now Transaction occurs with a bankers’ acceptance

20 Repurchase Agreements Short-term agreements in which the seller sells a government security to a buyer with the simultaneous agreement to buy it back on a later date at a higher price

21 Federal (Fed) Funds Loans of reserves (deposits at the Fed) between depository institutions typically overnight

22 Eurodollars Dollar-denominated deposits held abroad

23 The Capital Market Exhibit 6-5 U.S. Govt. Agency Securities U.S. Government Agency Some activity Instrument Typical Principal Secondary MaturitiesBorrowersMarket Corporate Stock ____ Corporations Mortgages 15 to 30 years Homeowners and other investors Moderately active Corporate Bonds 2 to 30 years Corporations U.S. Govt. Notes Bonds 2 to 10 yrs. U.S. Government Very active Municipals 2 to 30 years State & Local Governments 30 years Up to 30 years Active Very active for large corporations Active

24 Stocks are... Equity claims that represent ownership of the net assets and income of a corporation

25 Mortgages Loans made to purchase single or multiple family residential housing, land, or other real structures, with the structure or land serving as collateral for the loan

26 The Principal Capital Market Instruments Amount Outstanding, End of Year Billions of Dollars Type of Instrument Corporate Stock Mortgages Corporate & Foreign Bonds U.S. Government Securities U.S. Government Agency Securities Municipal Securities 1960 $ Exhibit $ $1, N.A $3,530 3,804 1,704 1, N.A $12,958 5,288 3,421 3, ,368

27 Corporate Bonds Long-term debt instruments issued by corporations

28 U.S. Government Securities Long-term debt instruments of the U.S. government with original maturities of 2-30 years

29 U.S. Government Agency Securities Long-term bonds issued by various government agencies including those that support commercial, residential and farm real estate lending, and student loans

30 State and Local Government Bonds (Municipals) Long-term instruments issued by state and local governments to finance expenditures on schools, roads, etc.

31 Revenue Bonds Bonds used to finance specific projects with proceeds of those projects used to pay off bondholders

32 General Obligation Bonds Bonds that are paid out of the general revenues and are backed by the full faith and credit of the issuer

33 Money Rates Prime Rate- The interest rate that serves as a basis for quoting rates to customers; an indicator of the cost of business borrowing from banks Federal Funds Rate- The interest rate charged on overnight loans in the federal funds market; a sensitive indicator of the cost to banks of borrowing funds Treasury Bill Rate - The interest rate on Treasury bills; an indicator of borrowing money Discount Rate - The rate charged by the Federal Reserve Banks for loaning reserve asset deposits to depository institutions

34 Money Rates Federal Home Loan Mortgage Rate (Freddie Mac)- The interest rate on “Fannie Mae” guaranteed mortgages; an indicator of the cost of financing conventional residential housing purchases Federal National Mortgage Association Rate (Fannie Mae)- The interest rate on “Fannie Mae” mortgages; an indicator of the cost of financing conventional housing purchases London Interbank Offered Rate (Libor)- The interbank rate for dollar-dominated deposits in the London market among international banks; the interest rate that serves as a basis for quoting other international rates

35 Market Maker A dealer who links up buyers and sellers of financial securities and sometimes takes positions in the securities

36 Broker Person who arranges trades between buyers and sellers

37 Dealer Person who arranges trades between buyers and sellers AND can be a principal in a transaction A market maker

38 Bid Price The price at which a market maker is willing to buy securities

39 Asked Price The price at which a market maker is willing to sell securities

40 Assist in raising funds to finance deficits by marketing a borrower’s new securities in the primary market Market Makers Stand ready to buy or sell outstanding securities in the secondary market Advise potential buyers and sellers of securities on the course of action likely to minimize costs and maximize returns Market Makers Exhibit 6.6

41 APEI wants to issue bonds to finance investment Merrill Lynch agrees (for a fee) to design a bond offering and to market (sell) the bonds The Marketing and Trading of a Corporate Bond Exhibit 6.7 Primary Market Activity SSUs and financial intermediaries buy APEI bonds that will mature in 20 years One year later SSUs (or financial intermediaries) decide to sell some of their APEI Secondary Market Activity Salomon sells “used” APEI bonds to another SSU Salomon Bros. Makes a market in APEI bonds by buying bonds from SSUs