1. Financial and Real Estate Markets
Money Markets
Capital Markets
Mortgage Markets
Financial Derivative Markets

2. The Money Markets Money Markets Purpose
Money market securities are usually sold in large denominations
They have low default risk
They mature in one year or less from their issue date
Purpose
Investors in Money Market: Provides a place for warehousing surplus funds for short periods of time
Borrowers from money market provide low-cost source of temporary funds

3. Interest Rates of Money Market Instruments

4. Participants in Money Markets
U.S. Treasury Department
Federal Reserve System
Commercial Banks
Businesses
Investment and Securities Firms
Individuals (mostly through money market mutual funds)

5. Money Market Instruments
Treasury Bills
Federal Funds
Repurchase Agreements
Negotiable Certificates of Deposit
Commercial Paper
Banker’s Acceptance
Eurodollars

6. Treasury Bills
Short-term borrowings of the federal government (US Treasury Department)
Usually sold at discount

7. Discounting Example
You pay $9850 for a 91-day T-bill. It is worth $10,000 at maturity. What is its annualized yield?

8. Federal Funds
Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day
Having excess reserve -> loan (sell) federal funds
Fed can influence the rate by setting target

9. Federal Funds
Figure 8.2: Federal Funds and Treasury Bill Interest Rates, January 1990–January 2002

10. Negotiable Certificates of Deposit
A bank-issued security that documents a deposit and specifies the interest rate and the maturity date
Denominations range from $100,000 to $10 million

11. Negotiable Certificates of Deposit Comparing Interest on CDs and T-bills
Figure 8.3: Interest Rates on Negotiable Certificates of Deposit and on Treasury Bills, January 1990–January 2002

12. Commercial Paper
Unsecured promissory notes, issued by corporations, that mature in no more than 270 days
Banks also issue commercial paper, but have reserve requirement on bank-issued commercial paper

13. Commercial Paper Comparing Interest on Commercial Paper to Bank Prime Rate
Figure 8.4: Return on Commercial Paper and the Prime Rate, January 1990–January 2002

14. Banker’s Acceptances
An order to pay a specified amount to the bearer on a given date if specified conditions have been met, usually delivery of promised goods
Used in international trade
Have secondary markets

15. Repo (Repurchase agreement)
Buyer purchase securities with an agreement that the seller will repurchase them in short period of time, anywhere from 1 to 15 days from the original date of purchase.
Implicitly the buyer is a lender, seller is borrower
Buyer is compensated with the interest
This contract has secondary market

16. Eurodollars Dollar denominated deposits held in foreign banks
Used as alternative to fed fund for banks around the world
London interbank bid rate (LIBID)
The rate paid by banks buying funds
London interbank offer rate (LIBOR)
The rate offered for sale of the funds

17. Figure 8-6: Interest Rates on Money Market Securities, 1990–2002

18. Money Market Mutual Funds
Open-end investment funds that invest only in short-term securities
No fee for purchasing or redeeming shares
Minimum initial investment of $500 to $20,000
Check-writing privileges
No fee for writing checks
No minimum check amount
Earn 0.5% to 1% higher return than interest earned on money in the bank
Low risk of default, low rate of risk
Popular to small investors

19. Money Market Fund Assets
Figure 8.8: Average Distribution of Money Market Fund Assets, 2001

20. Capital Markets Original maturity is greater than one year
Best known capital market securities:
Stocks and bonds
Primary issuers of securities:
Federal and local governments
Corporations
Largest purchasers of securities:
You and me

21. Capital Market Trading
Primary market for initial sale (IPO)
Secondary market
Over-the-counter
Organized exchanges (i.e., NYSE)

22. Want to be listed on the NYSE?
You will need at least:
2000 stockholders, each owning at least 100 shares
A minimum of 1.1 million shares traded publicly
Pretax earnings of $2.5 million at the time of listing
$2 million in pretax earning in each of the two prior years
A total of $100 million in market value of publicly traded shares

23. Treasury Bonds
No default risk
Very low interest rates

24. Compare 20-Year Treasury Bonds to 90-Day Treasury Bills
Figure 9-4: Interest Rates on Treasury Bills and Treasury Bonds, 1973–2002 (January of each year)

25. Municipal Bonds Issued by local, county, and state governments
Used to finance public interest projects
Tax-free municipal interest rate = taxable interest rate  (1  marginal tax rate)
Two types
General obligation bonds
Revenue bonds
NOT default-free

26. Comparing Revenue and General Obligation Bonds
Figure 9-5: Issuance of Revenue and General Obligation Bonds, 1984–2000 (End of year)

27. Corporate Bonds Face value of $1,000 Pay interest semi-annually
Can be redeemed anytime the issuer wishes
Degree of risk varies with each bond
Interest rate varies with level of risk

28. Characteristics of Corporate Bonds
Registered Bonds
Restrictive Covenants
Call Provisions
Higher yield
Sinking fund
Interest of the stockholders
Alternative opportunities
Conversion and Convertible Bonds

29. Convertible Bonds
The bond that can be converted into certain shares of common stocks at the discretion of the bondholder.
Conversion ratio

30. Types of Corporate Bonds
Secured Bonds
Mortgage bonds
Equipment trust certificates
Unsecured Bonds
Debentures
Subordinated debentures
Variable-rate bonds
Junk Bonds

31. Stock Represents ownership in a firm Earn a return in two ways
Price of the stock rises over time
Dividends are paid to the stockholder
Stockholders have claim on all assets
Right to vote for directors and on certain issues
Two types
Common stock
Right to vote
Receive dividends
Preferred stock
Receive a fixed dividend
Do not usually vote

32. Stock Prices

33. 30 Stocks in the Dow Jones Industrial Average

34. Stocks ADR – American Depository Receipts
A US bank buys the shares of a foreign company and places them in its vault. The bank then issue receipts against these shares, and these receipts can be traded domestically, usually on the NASDAQ.
In US dollars
No need to meet disclosure rules required by SEC

35. Mortgage Market Definition
Mortgage is a long-term loan secured by real estate by developer and family
Commercial mortgage and residential mortgage
A mortgage is amortized
The borrower pays it off over time in some combination of principal and interest payment that result in full payment of the debt by maturity

36. Types of Mortgage loans
Insured mortgage: Guaranteed by Federal Housing Administration or Veterans Administration, applicants need meet certain qualifications
Serve in the military
Low incomer
Conventional mortgage: insured by private mortgage insurance (PMI): loan-to-value exceeding 80%
Fixed or adjustable rate mortgages (ARM)
Innovative mortgage contracts, e.g.,
Graduated-payment mortgage
Second mortgage

37. Mortgage Market Primary Mortgage Market (see page 302)
Constituted by commercial banks, S&Ls, commercial banks, life insurance companies, and mortgage pools
Sell loans after they lend money
Diversify their risk in the secondary market
Secondary Mortgage Market
buy mortgage from the primary market
Bundle mortgages and offer securitized mortgage-backed assets

38. Mortgage Market Major participants in the secondary market
Fannie Mae (Federal National Mortgage Association)
Ginnie Mae (Government National Mortgage Association)
Freddie Mac (Federal Home Loan Mortgage Corp)
Securitization of Mortgages
Mortgages are too small to be wholesale instruments
Sell mortgage backed security
Mortgage pool
Mortgage pass-through – is a kind of special debt

39. Types of securitized mortgage/Debt
Mortgage Pool
Mortgage pass through: a security created when one or more holders of mortgages from a collection of mortgages and sell shares in a pool
Mortgage-backed security (MBS): make mortgage a security, similar ideas: asset-backed security (ABS)
Collateralized mortgage obligations (CMO)
Collateralized bond obligations (CBO)
Collateralized debt obligations (CDO)
The largest market dealer for securitized asset is Bear Sterns

40. Derivative Market See definitions in chapter 23 Option
Call
put
Futures and forward
Long
short
Swap
Financial contracts that obligate each party to the contract to exchange a set of payments it owns for another set of payments owned by another party