Financial Markets and Institutions 6Th Edition: Powerpoint Slides For

PowerPoint Slides for:
Financial Markets and Institutions 6th Edition

By Jeff Madura Prepared by David R. Durst The University of Akron
CHAPTER
Money Markets
Chapter Objectives
Provide a background on money market securities Explain how institutional investors use money markets Explain the globalization of money markets
Copyright 2002 Thomson Publishing. All rights reserved.
Money Market Securities

Maturity of a year or less Debt securities issued by corporations and governments that need short-term funds Large primary market focus Purchased by corporations and financial institutions Secondary market for securities

Treasury Bills Commercial paper Negotiable certificates of deposits Repurchase agreements Federal funds Bankers acceptances
Treasury bills
Issued to meet the short-term needs of the U.S. government Attractive to investors
default riskbacked by Federal Government Excellent liquidity for investors

Minimal
Short-term maturity Very good secondary market
Competitive Bidding
Treasury bill auction (fill bids in amount determined by Treasury borrowing needs)
Bid process used to sell T-bills Bids submitted to Federal Reserve banks by the deadline Bid process
Accepts
highest bids Accepts bids until Treasury needs generated


Noncompetitive Bidding
Treasury bill auctionnoncompetitive bids ($1 million limit)

May be used to make sure bid is accepted Price is the weighted average of the accepted competitive bids Investors do not know the price in advance so they submit check for full par value After the auction, investor receives check from the Treasury covering the difference between par and the actual price
Estimating T-bill yield

No coupon payments Par or face value received at maturity Yield at issue is the difference between the selling price and par or face value adjusted for time If sold prior to maturity in secondary market
Yield
based on the difference between price paid for T-bill and selling price adjusted for time
Calculating T-Bill Annualized Yield

SP PP PP
YT =
365 n
YT = The annualized yield from investing in a T-bill SP = Selling price
PP = Purchase price
n = number of days of the investment (holding period)
T-bill yield for a newly issued security

Par PP PP
T-bill discount =
360 n
T-bill discount = percent discount of the purchase price from par Par = Face value of the T-bills at maturity
PP = Purchase price
n = number of days to maturity

Commercial Paper
Short-term debt instrument Alternative to bank loan Dealer placed vs. directly placed Used only by well-known and creditworthy firms Unsecured Minimum denominations of $100,000 Not a large secondary market
Commercial paper backed by bank lines of credit

Bank line used if company loses credit rating Bank lends to pay off commercial paper Bank charges fees for guaranteed line of credit
Estimating commercial paper yields

Par PP PP
YCP =
360 n
YCP = Commercial paper yield Par = Face value at maturity
PP = Purchase price

Negotiable Certificates of Deposit (NCD)
Issued by large commercial banks Minimum denomination of $100,000 but $1 million more common Purchased by nonfinancial corporations or money market funds Secondary markets supported by dealers in security
NCD placement
Direct placement Use a correspondent institution specializing in placement Sell to securities dealers who resell Sell direct to investors at a higher price
NCD premiums
Rate above T-bill rate to compensate for lower liquidity and safety

Repurchase Agreements
Sell a security with the agreement to repurchase it at a specified date and price Borrower defaults, lender has security Reverse repo name for transaction from lender Negotiated over telecommunications network Dealers and brokers used or direct placement No secondary market
Estimating repurchase agreement yields

SP PP PP
Repo Rate =
360 n
Repo Rate = Yield on the repurchase agreement SP = Selling price
PP = Purchase price

Federal Funds
Interbank lending and borrowing Federal funds rate usually slightly higher than Tbill rate Fed district bank debits and credits accounts for purchase (borrowing) and sale (lending) Federal funds brokers may match up buyers and sellers using telecommunications network Usually $5 million or more
Exhibit 6.5
1 Purchase Order
Importer
Exporter
Shipment of Goods
L/C (Letter of Credit) Application
L/C
American Bank (Importers Bank)
7 Shipping Documents & Time Draft Draft Accepted (B/A Created)
Japanese Bank (Exporters Bank)
Shipping Documents & Time Draft 6
L/C Notification

Bankers Acceptance
A bank takes responsibility for a future payment of trade bill of exchange Used mostly in international transactions Exporters send goods to a foreign destination and want payment assurance before sending Bank stamps a time draft from the importer ACCEPTED and obligates the bank to make good on the payment at a specific time

Bankers Acceptance
Exporter can hold until the date or sell before maturity If sold to get the cash before maturity, price received is a discount from drafts total Return is based on calculations for other discount securities Similar to the commercial paper example
Major Participants in Money Market
Participants

Commercial banks Finance, industrial, and service companies Federal and state governments Money market mutual funds All other financial institutions (investing)
Short-term investing for income and liquidity Short-term financing for short and permanent needs Large transaction size and telecommunication network
Valuation of Money Market Securities

Present value of future cash flows at maturity (zero coupon) Value (price) inversely related to discount rate or yield Money market security prices more stable than longer term bonds Yields = risk-free rate + default risk premium
Exhibit 6.7
International Economic Conditions U.S. Fiscal Policy U.S. Monetary Policy U.S. Economic Conditions Issuers Industry Conditions Issuers Unique Conditions
Short-T erm Risk-Free Interest Rate (T -bill Rate)
Risk Premium of Issuer
Required Return on the Money Market Security
Price of the Money Market Security
Interaction Among Money Market Yields

Securities are close investment substitutes Investors trade to maintain yield differentials T-Bill is the benchmark yield in money market Yield changes in T-bills quickly impacts other securities via dealer trading Yield differentials determined by risk differences between securities Default risk premiums vary inversely with economic conditions
Globalization of Money Markets
Money market rates vary by country

Segmented markets Tax differences Estimated exchange rates Government barriers to capital flows
Deregulation Improves Financial Integration Capital Flows To Highest Rate of Return
Eurodollar deposits and Euronotes

Dollar deposits in banks outside the U.S. Increased because of international trade growth and U.S. trade deficits over time No reserve requirements at banks outside U.S.
Eurodollar Loans
Channel funds to other multinationals that need short-term financing
Euro-commercial paper
Issued without the backing of a banking syndicate Maturity tailored to investors Dealers that place paper create a secondary market Rates range between 50 and 100 basis points above the LIBOR rate

Performance of international securities Effective yield for international securities has two components
The yield earned on the investment denominated in the currency of the investment The exchange rate effect

Performance of international securities Yield for an international investment
Yf = SPf PPf
PPf Yf = Foreign investments yield

SPf = Investments foreign currency selling price
PPf = Investments foreign currency purchase
The exchange rate effect (%S) measures the percentage change in the spot during the investment period
Ye (1 Yf ) (1 %S ) 1
% S measures the expected percent change in the currency

Currency
appreciated, % S is positive and adds to net
yield Currency depreciated, % S is negative and reduces net yield

Chapter Concepts Summary

Surplus units channel investments to securities issued by deficit units Debt securities markets
Money Market Capital Market
Money market securities

Short-term High quality Very good liquidity

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PowerPoint Slides for:

Financial Markets and Institutions 6th Edition

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

default riskbacked by Federal Government Excellent liquidity for investors

Short-term maturity Very good secondary market

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

highest bids Accepts bids until Treasury needs generated

Money Market Securities

Treasury bill auctionnoncompetitive bids ($1 million limit)

Money Market Securities

Estimating T-bill yield

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Calculating T-Bill Annualized Yield

YT = The annualized yield from investing in a T-bill SP = Selling price

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

T-bill yield for a newly issued security

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Commercial paper backed by bank lines of credit

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Estimating commercial paper yields

YCP = Commercial paper yield Par = Face value at maturity

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Estimating repurchase agreement yields

Repo Rate = Yield on the repurchase agreement SP = Selling price

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

L/C (Letter of Credit) Application

American Bank (Importers Bank)

7 Shipping Documents & Time Draft Draft Accepted (B/A Created)

Japanese Bank (Exporters Bank)

Copyright 2002 Thomson Publishing. All rights reserved.

Shipping Documents & Time Draft 6

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Major Participants in Money Market

Valuation of Money Market Securities

Copyright 2002 Thomson Publishing. All rights reserved.

Short-T erm Risk-Free Interest Rate (T -bill Rate)