part iv financial markets chapter eight the money markets

Part IV

Financial Markets

Chapter Eight

The Money Markets

Slide 8–4

The Money Markets

• Money Markets Defined1. Money market securities are usually sold in large

denominations

2. They have low default risk

3. They mature in one year or less from their issue date

Slide 8–5

Purpose of Money Markets

• 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

Slide 8–6

Interest Rates Available on Several Money Market Instruments

Slide 8–7

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)

Slide 8–8

Money Market Instruments

• Treasury Bills

• Federal Funds

• Repurchase Agreements

• Negotiable Certificates of Deposit

• Commercial Paper

• Banker’s Acceptance

• Eurodollars

Slide 8–9

Treasury Bills

1. Short-term borrowings of the federal government

2. Usually sold at discount

Slide 8–10

Discounting Example

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

iyt F PP

365

n

iyt $10,000 $9,850

$9,850

365

910.0611 6.11%

(1)

Slide 8–11

Results of a Treasury Auction

Slide 8–12

Figure 8-1: Treasury Bill Interest Rate and the Inflation Rate, January 1973–January 2002

Current inflation statisticsftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Slide 8–13

Federal Funds

• Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day

Slide 8–14

Federal Funds

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

Slide 8–15

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

Slide 8–16

Negotiable Certificates of DepositComparing Interest on CDs and T-bills

Figure 8.3: Interest Rates on Negotiable Certificates of Deposit and on Treasury Bills, January 1990–January 2002

Slide 8–17

Commercial Paper

• Unsecured promissory notes, issued by corporations, that mature in no more than 270 days

Slide 8–18

Figure 8.4: Return on Commercial Paper and the Prime Rate, January 1990–January 2002

Commercial PaperComparing Interest on Commercial Paper to Bank Prime Rate

Slide 8–19

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

Slide 8–20

Advantages to Banker’s Acceptances

1. Exporter paid immediately

2. Exporter shielded from foreign exchange risk

3. Exporter does not have to assess the financial security of the importer

4. Importer’s bank guarantees payment

5. Crucial to international trade

Slide 8–21

Eurodollars

• Dollar denominated deposits held in foreign banks

Slide 8–22

Eurodollars

• 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

• Time deposits with fixed maturities– Largest short term security in the world

Slide 8–23

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

Interest rates on money market instrumentshttp://www.federalreserve.gov/releases

Slide 8–24

Money Market Securities and Their Depth

Slide 8–25

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

Slide 8–26

Growth in Money Market Mutual Funds

Figure 8.7: Net Assets of Money Market Mutual Funds, 1975–2000

Slide 8–27

Money Market Fund Assets

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