Chapter 4: Learning Objectives  Characteristics of Financial Market Instruments: Money Market Instruments Capital Market Instruments  Financial Innovations

The Money Market (most important)  Treasury Bills  Bank of Canada Advances  Mature days  issued by the Federal Govt  large secondary market  rate fluctuates according to overnight market band  useful indicator of monetary policy stance  “lender of last resort” loan  access by CPA members  Actively discouraged source of borrowing

The Operating Band for the Overnight Market Overnight Market Rates Bank Rate Rate on +ve balances = Bank rate less 0.50% OPERATING BAND BOC target rate = mid-point of range OverdraftSurplus ON * =(BR t +R t sb )/2

Bank of Canada Advances

The Money Market (cont’d)  Special Purchase and Resale Agreements(SPRA) FIG4.2  Bankers’ Acceptances FIG 4.3  Short-term loan used by BOC to affect liquidity in fin. Mkts.  Can be implemented at short notice and has been used more frequently of late.  Widely used as a method of high quality short-term finance  large and active secondary mkt.

The Money Market (cont’d)  Special Purchase and Resale Agreements (SPRA) FIG4.2 (cont’d)  If participant i’s LVTS is LVTS i while participant j’s LVTS balance are LVTS j then we would expect: LVTS i + LVTS j = 0

Financing Through an SPRA Investment DealerBank of Canada Bank Call Loan SPRA T-billGovt Dep. Call loan BOC Dep. AssetsLiabilities

Financing via a Banker’s Acceptance Importer Exporter BANKS Investment Dealers Investors Letter of credit issued Secondary Market Rediscounting “Stamped”

The Money Market (cont’d)  Interbank deposits  Eurocurrency instruments  Growth reflects globalization and importance of interbank transactions  useful as a cash management tool  offshore financial market in several centers (London UK most important)  highly liquid, low tax and transactions costs  useful guide for int’l int rate developments

The Money Market [cont’d]  The Large Value Transfer System (LVTS) Assists in the operations of the clearing system Attempting to reduce systemic risk Not, strictly speaking, an instrument Created by the CPA (Canadian payments Association]

The Capital Market & Derivatives (most important)  Govt of Canada bonds  Stocks  Derivatives  Large secondary market  principal source of debt finance across the term structure  newly issued and large secondary market  private source of debt  Large variety  can be a source of reduced or increased risk.

Main Groups Holding Government Debt

Net New Issues of Stocks and Bonds

Summary  Financial Markets can be subdivided into the Money and Capital Markets  Money Market instruments are short-term in nature  Capital Market instruments are long-term in nature  The principal Money market instruments are Tbills, Bank of Canada Advances, SPRAs, Banker’s Acceptances, interbank deposits and the Eurocurrency market  The principal capital market instruments are Govt bonds, stocks and derivative products