Finance 300 Financial Markets Lecture 13 Professor J. Petry, Fall, 2002©

2 Housekeeping Midterm #2 on Tuesday, October 15 th multiple choice questions In class problems, TTD Chapter V. I will not ask you to do problems from this material. I will ask questions related to the basic characteristics of the money market instruments listed. Series VII style questions are indicative. Office hours: Thursday 4-5 Friday 12-2 Monday 12-2.

3 Duration & Convexity Calcs Volatility=Δ price/price =-[duration / (1 + yield)] * Δi = Corrected ΔP/P = -modified duration Δy + ½ Convexity Δy 2 = = = Check this against actual price change. Actual = =

4 Agenda of topics Financial Markets are traditionally segmented into Money Markets and Capital Markets. –The Money Market includes short-term, highly liquid, and relatively low-risk debt instruments. Their security and liquidity result in their sometimes being referred to as “Cash” or “Cash Equivalents”. (T- bills, CDs, CP, Repos, etc). This is covered in Ch. V. –Capital Markets include longer-term, relatively riskier securities than does the Money Market. Generally, the Capital Markets are divided into four segments: longer-term fixed income markets, equity markets, and the derivative markets for options and futures. Equities was Ch. 3, and derivates will come later. –The Fixed Income Market—our focus since Chapter IV—spans both areas of Financial Markets. Our first Chapter on Fixed Income discussed the bond market generically (Chapter IV--The Debt Market). Chapter V is the Money Market. Chapter VI is Government Debt and Chapter VII is Corporate Debt.

5 Money Market—Chapter V Money market instruments –Are debt instruments with an original term to maturity of one year or less. –Debt securities generally, can be in the form of: Interest bearing Interest bearing at maturity Discount notes –The short-term nature of money market instruments are either interest bearing at maturity, or discount notes.

6 Money Market—Chapter V Key Money Market Rates Prime Rate. Base rate on corporate loans posted by at least 75% of the nations 30 largest banks. Discount Rate. The charge on loans to depository institutions by the Federal reserve Banks. Established by the FOMC as an indicator of monetary policy direction. Federal Funds. Reserves traded among commercial banks for overnight use in amounts of $1mn or more. FOMC targets this rate as a indicator of monetary policy direction. Call Money – 3.5%. The charge on loans to brokers on stock exchange collateral. Commercial Paper (CP) – Short term debt of corporations. Overnight Repurchase Rate – 1.85%. Dealer financing rate for overnight sale and repurchase of Treasury Securities.

7 Money Market—Chapter V Key Money Market Rates Treasury Bills. Issued by the US Treasury and backed by the “full faith and credit” of the US Government. Certificates of Deposit. Money market CDs are debt instruments issued by banks.