Money Market Securities
n Maturity of a year or less
n Debt securities issued by corporations and governments that need short-term funds
n Large primary market focus
n Purchased by corporations and financial institutions
Money Market Securities
n Treasury Bills
n Commercial paper
n Negotiable certificates of deposits
n Repurchase agreements
n Federal funds
n Banker’s acceptances
Money Market Securities
n Treasury bills
l Issued to meet the short-term needs of the U.S. government
l Attractive to investors
u Minimal default risk—backed by Federal Government
u Very good secondary market, hence excellent liquidity for investors
Money Market Securities
n Treasury bill auction (fill bids in amount determined by Treasury borrowing needs)
l Bid process used to sell T-bills
l Bids submitted to Federal Reserve banks by the deadline
l Bid process
u Accepts highest bids
u Accepts bids until Treasury needs generated
Money Market Securities
n Treasury bill auction—noncompetitive bids
($5 million limit)
l May be used to make sure bid is accepted
l Price is the weighted average of the accepted competitive bids
l Investors do not know the price in advance so they submit check for full par value
l After the auction, investor receives check from the Treasury covering the difference between par and the actual price
Money Market Securities
n Estimating T-bill yield
l No coupon payments
l Par or face value received at maturity
l Yield at issue is the difference between the selling price and par or face value adjusted for time
l If sold prior to maturity in secondary market
u Yield based on the difference between price paid for T-bill and selling price adjusted for time
Money Market Securities
n No coupon payments
n Calculating T-Bill Annualized Yield:
Money Market Securities
l Short-term debt instrument
l Major issuers are financial institutions
l Unsecured
u Used only by well-known and creditworthy firms
l Minimum denominations of $100,000
l Maturities vary from 1 day to 270 days
l Not a large secondary market
Money Market Securities
l Issued by large commercial banks
l Purchased by nonfinancial corporations or money market funds
l Pays interest to holder
l Minimum denomination of $100,000 but $1 million more common
l Maturities range from two weeks to 1 year
l Not a large secondary market
Money Market Securities
l Sell a security with the agreement to repurchase it at a specified date and price
l Borrower defaults, lender has security
l Reverse repo from lender’s perspective
l Negotiated over telecommunications network
l Dealers and brokers used or direct placement
l No secondary market
Money Market Securities
l Interbank lending and borrowing
l Federal funds rate usually slightly higher than T-bill rate
l The Fed debits reserve accounts for borrowing, and credits for lending
Money Market Securities
l A bank takes responsibility for a future payment of trade bill of exchange
l Used mostly in international transactions
l Exporters send goods to a foreign destination and want payment assurance before sending
Money Market Securities
l Exporter can hold until the date or sell before maturity
l If sold to get the cash before maturity, price received is a discount from draft’s total
l Return is based on calculations for other discount securities
Major Participants in Money Market
n Participants
l Commercial banks
l Finance, industrial, and service companies
l Federal and state governments
l Money market mutual funds
l All other financial institutions (investing)
n Short-term investing for income and liquidity
n Short-term financing for short and permanent needs
n Large transaction size and telecommunication network
Valuation of Money Market Securities
n Present value of future cash flows at maturity (zero coupon)
n Value (price) inversely related to discount rate or yield
n Money market security prices more stable than longer term bonds
n Yields = risk-free rate + default risk premium
l Yield differentials determined by risk differences between securities
Interaction Among Money Market Yields
n Securities are close investment substitutes
n Investors trade to maintain yield differentials
n T-Bill is the benchmark yield in money market
Globalization of Money Markets
n Money market rates vary by country
l Segmented markets
l Tax differences
l Estimated exchange rates
l Government barriers to capital flows
n Deregulation Improves Financial Integration
n Capital Flows To Highest Rate of Return
Globalization of Money Markets
n Effective yield for international securities has two components
l The yield earned on the investment denominated in the currency of the investment
l The exchange rate effect