(Finmar) - Q2
(Finmar) - Q2
(Finmar) - Q2
Money Markets
● Bond equivalent yield, 𝑖𝑏𝑒, is the quoted
● S hort-term debt instruments thatisissuedby nominal, or stated, yield on a security.
economicagentsthatrequireshort-termfunds ● U sed to calculate the present value of an
and are purchased by economic agents. investment.
● Money market instruments are traded in ● It is the product of the periodic rate and the
secondary markets. They serve to reallocate number of periods in a year.
the (relatively) fixed amounts of liquid funds
available in the market at any particular time. 𝑃 −𝑃
𝑖𝑏𝑒 = ⎡⎢ 𝑓𝑃 0 ⎤⎥ ×
365
● Efficient in performing service in that they
𝑛
enable large amounts of money to be ⎣ 0 ⎦
transferred from supplier of funds tousersof
funds for short periods of time both quickly here
W
and at low cost to the transacting parties. 𝑃𝑓 = 𝐹
𝑎𝑐𝑒𝑉𝑎𝑙𝑢𝑒
● Money Market Instruments
- Provides an opportunity that 𝑃0 = 𝑃
𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑃
𝑟𝑖𝑐𝑒𝑜
𝑓𝑡ℎ𝑒𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑦
generates a higher rate of interest 𝑛 = 𝑁𝑜. 𝑜
𝑓𝑑
𝑎𝑦𝑠𝑢𝑛𝑡𝑖𝑙𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
(return) than holding cash (which
yields zero interest), but is also very
liquid and has relatively low default NOTE
risk.
ond equivalent yield does not consider the effects
B
of compounding of interest during a less than one
hy are money markets needed?
W year investment horizon.
The immediate cash needs of individuals,
corporations, and government do not necessarily
coincide with their receipts of cash.
Effective Annual Return (EAR)
● D iscount yield uses the terminalprice,onthe Negotiable ank-issued time deposits that
B
other hand, bond equivalent yields are based certificates of specify an interest rate and
on the purchase price of a security. deposits maturity date and are
● Anappropriatecomparisonofinterestrateson negotiable (saleable on
discount securities versus nondiscount secondary market)
securities,requiresconvertingadiscountyield
into a bond equivalent yield: Banker’s ime drafts payable to a seller
T
Acceptance of goods, with payment
guaranteed by a bank.
𝑃𝑓 65
3
𝑖𝑏𝑒 = 𝑖𝑑 × 𝑃𝑜
× 360
TREASURY BILLS
Single Payment Yields (spy) ● I ssued to refinance maturing government
debt.
● Special cases of the pure discount securities ● Virtually default risk free, referred to as the
that only pay the face value on maturity. risk free asset.
● Q uoted nominal interest rates on ● Have little interest rate risk and liquidity risk.
single-payment securities assume a 360-day ● Treasury Bill Asked Discount Yield
year. Example:
● In order to compare interest rates on these Suppose that you purchase the T-bill
securities with others that pay interest based maturing on October 24, 2013, for
on a 365-day year, the nominal interest rate $9,998.599.TheT-billmatures123daysafter
must be converted to bond equivalent yield: the settlement date,June23,2013,andhasa
face value of $10,000. The T-bill’s asked
discount yield is reported as:
65
3
𝑖𝑏𝑒 = 𝑖𝑠𝑝𝑦 × 360
● E ssentiallyacollateralizedfedfundsloan,with
the collateral (held by the repo seller) taking And te bond equivalent yield (bey) is:
the form of securities.
● Reverse repurchase agreement (reverse repo)
isthelender’spositionintherepotransaction.
Finally, the EAR on the commercial paper is:
It is an agreement involving the purchase
(buying) of securities by one party from
anotherwiththepromisetosellthembackata
given date in the future.
● Generallymaturesfrom1to14days.Butthere
is a growing market for longer-term, 1 to 3 EGOTIABLE CERTIFICATES OF
N
months. DEPOSITS
● Repurchase agreements are less liquid than ● b ank-issued time deposit that specifies an
fed funds. interest rate and maturity date and is
● Nonbanks are more frequent users of negotiable (i.e., salable) in the secondary
repurchase agreements. market.
● Repurchase Agreement Yield ● Can be traded any number of times in
Example: secondary markets; therefore, the original
Suppose a bank enters a reverse repurchase buyer is not necessarily the owner at maturity.
agreement in whichitagreestobuyfedfunds ● Maturities range from two weekstooneyear,
fromoneofitscorrespondentbanksataprice with most having a maturity of one to four
of$10,000,000,withthepromisetosellthese months.
funds back at a price of $10,000,291.67 ● Negotiated between the bank and the CD
($10,000,000 plus interest of $291.67) after buyer.
fivedays.Theyieldonthisrepotothebankis ● Negotiable CDs aresingle-paymentsecurities.
calculated as follows: Thus, interest rates on negotiable CDs are
generally quoted using a 360-day year.
● Secondary market Yield on Negotiable
CD
COMMERCIAL PAPER Example:
A bank has issued a six-month, $1 million
● O
ne of the largest ( in terms of dollar value negotiable CD with a 0.72 percent quoted
outstanding) of t he money market annualinterestrate.Thebondequivalentyield
instruments. on the CD is:
1. Collateral
f brokers and dealers who acts
o - As part of the mortgage agreement,
as intermediaries in the money the financial institution will place a
markets by linking buyers and lienagainstapropertythatremainsin
sellers. place until the loan is fully paid off.
- Lienisapublicrecordattachedtothe
Corporations T
he ones who raise large title of the property tha givesFIsthe
amounts of funds in the money right to sell the property if the
markets, mortgage borrower defaults or falls
primarily in the form of into arrears on his/her payments.
commercial paper. 2. Down Payment
- As part of anymortgageagreement,a
Other FIs ecause their liability payments
B financial institution requires the
are relatively unpredictable, mortgageborrowertopayaportionof
property-casualty (PC) the purchase price of the property (a
insurance companies, and to a downpayment)attheclosing(theday
lesser extent life insurance the mortgage is issued).
companies, must maintain large - Decreases the probability that the
balances of liquid assets. borrower will default on the mortgage.
- Generally,a20percentdownpayment
Individuals hey participate in the money
T is required.
markets through direct 3. Insured versus Conventional Mortgages
investments in these securities or - Mortgages are classified as either
through investments in money federally insured or conventional.
market mutual funds, which - Federally insured mortgages
contain a mix of all types of originated by FIs, but repayment is
money market securities. guaranteed by either the Federal
Housing Administration or the
Veterans Administration.
Chapter 7: Mortgage Markets - Conventional mortgages
mortgages held by FIs and are not
federally insured, but they generally
Primary Mortgage Markets arerequiredtobeprivatelyinsuredif
the borrower’s down payment is less
● Mortgage than 20 percent of the property’s
- Loans to individuals or business to value.
purchase a home, land, or other real 4. Mortgage Maturities
property. - A mortgage generally has an original
- The property purchased with the loan maturity of either 15 or 30 years.
serves as collateral backing the loan. - FIs find the 15-year mortgage
attractive because of thelowerdegree
4 Basic Categories of Mortgages of interest rate risk on a 15-year
relative to a 30-year mortgage.
1 . ome
H - Mostmortgagesallowtheborrowerto
2. Multifamily dwelling prepay all or part of the mortgage
3. Commercial principal early without penalty.
4. farm - Ingeneral,themonthlypaymentisset
at a fixed level to repay interest and
principal on the mortgage by the
Mortgage Characteristics maturity date.
- Balloon payment mortgages
● U
niqueascapitalmarketinstrumentsbecause requires a fixed monthly interest
the characteristics of each mortgage held by payment (and, sometimes, principal
FIs can differ.
● M
ortgage contracts generally require the Mortgage Amortization
borrowertopayanassortmentoffeestocover
the mortgage issuer’s costs of processing the ● T he fixed monthly payment made by a
mortgage. mortgageborrowergenerallyconsistspartlyof
repayment of the principal borrowed and
Application Fee C
overs the issuer’s initial costs partly of the interest on the outstanding
of processing the mortgage balance of the mortgage.
application and obtaining a ● Amortization Schedule shows how the
credit report. fixed monthly payments are split between
principal and interest.
Title Search onfirms the borrower’s legal
C
ownership of the mortgaged 𝑡
1 𝑗
property and ensures there
are no outstanding claims
𝑃𝑉 = 𝑃𝑀𝑇 ∑
𝑗=
1
( )
1+
𝑟
𝑡
against the property. 𝑃𝑀𝑇 = ({ [
1 − 1/(1 + 𝑟) ]}/𝑟 )
Title Insurance rotects the lender against an
P
here
W
error in the title search.
PV = Principal amount borrowed throughthe mortgage
xample:
E
You plan to purchase a house for $150,000
using a 30-year mortgage obtained from
your local bank. The mortgage rateofferedto
you is 8% with zero points. In ordertoforgo
the purchase of private mortgage insurance,
you will make a down payment of 20% of
the purchase price ($30,000 = 0.20 ×
$150,000) at closing and borrow $120,000
through the mortgage.