1. CHAPTER 6
MONEY MARKETS
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Dr David P Echevarria

2. 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
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Dr David P Echevarria

3. 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
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Dr David P Echevarria

4. 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
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Dr David P Echevarria

5. 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
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Dr David P Echevarria

6. 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
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Dr David P Echevarria

7. 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
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Dr David P Echevarria

8. Eurodollar 1-Month Deposit Rate
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Dr David P Echevarria

9. 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?
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Dr David P Echevarria