Ch.5 Money Markets

Money markets: Original maturity of one year or less. The point is to borrow short term for short term uses. Typically wont lend short term to someone who is risky. Need to be a high quality borrower.

Cant compare a money market yield to a capital market yield.

Discount Yields (Treasury Bills & Commercial Paper)

(calculations in notebook)

  • Treasury Bills

    • Issued by US Gov.

    • Default Free, Highly Liquid, Short Term (4, 13, 26, 52 week)

    • New issues go through Treasury Auctions

      • Competitive Bid (Establish Quantity and Price)

      • Non-Competitive Bid (Establish Quantity, no price)

    • T-Bill Secondary Market:

      • On-The-Run (newly issued security, more liquid) vs Off-The Run (anything previously is Illiquid)

  • Fed Funds

    • Fed Funds Rate - Target rate in the conduct of monetary policy

    • Short term (overnight)

    • Banks with excess reserves lend fed funds (banks with low reserves borrow fed funds)

    • Uncollateralized loans, usually huge amounts

    • Arranged quickly

    • single payment loans (360 day year)

  • Repurchase Agreements (Repo)

    • Where seller of security agrees to repurchase securities at an agreed upon price

    • Collateral = securities (usually us treasury)

    • low credit risk

    • Risky = “haircut”

    • a real sale - ownership is transferred

    • single payment loans (360)

    • Seller (reverse repo) Buyer (repo)

  • Commercial Paper

    • Short term unsecured note (raise short term funds by corporations)

    • Not liquid (not active secondary market), one of largest money markets

    • max maturity (270 days) (debt is rolled over)

    • Primary market: sold to investors indirectly through brokers and dealers

    • secondary market: held by investors until maturity, has no active secondary market

    • discount instrument

    • financial crisis and asset backed commercial paper

  • Negotiable Certificate of Deposits

    • Time deposit issued by a bank (cant use for that amount of time)

    • Bearer certificate (can be sold in secondary market)

    • Substantial interest penalties for early withdrawals

    • Low liquidity

    • Denominations: 100k-10mil (1 mil most common)

    • Often purchased by MMMFs

    • Single Payment Loan (360 day)

  • Bankers Acceptances (international trade)

    • A time draft payable to a seller of goods with payment guaranteed by a bank

    • Foreign exporters prefer that banks act as guarantors before sending goods to importers

Money Market Participants:

  • US Treasury Dept: Sells US Treasury Securities to fund national debt when income tax isnt recieved

  • Federal Reserve System: Buy and sell US Treasury Securities to control money supply & open market operations

  • Commercial Banks: Buy & Sell CDs, Fef Funds, BAs, and Repos to manage and/or minimize excess reserves

  • MMMF (Money Market Mutual Funds)/Individuals: allows small investors to participate and earn slightly larger rates on bank accounts

  • Brokers and Dealers: Link buyers and sellers to make a market

Eurodollars: evolved as a source of overnight funding for international banks (like fed funds) via LIBOR (does not exist anymore) now is SOFR (secured overnight funding rate)