FNCE 3020 Financial Markets and Institutions


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FNCE 3020 Financial Markets and Institutions

  1. 1. FNCE 3020 Financial Markets and Institutions Lecture 8 The Money Markets
  2. 2. The Money Markets : Definitions and Characteristics <ul><li>The money market is the financial market for short-term borrowing and short term lending (1 year or less). </li></ul><ul><ul><li>Money market instruments can be as short as overnight. </li></ul></ul><ul><li>Includes short-term debt securities, such as banker's acceptances, commercial paper, repurchase agreements, negotiable certificates of deposit, and Treasury Bills. </li></ul><ul><li>Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for short-term time horizons. </li></ul><ul><ul><li>Many, but not all, have well developed secondary markets, and thus are regarded as highly liquid financial assets. </li></ul></ul><ul><li>Financial asset bid and ask spreads (i.e., the buying and selling spread) are relatively small due to the large size of the market. </li></ul><ul><li>Money market securities generally have (relatively) low default and price (i.e., interest rate) risk, but (relatively) high reinvestment risk. </li></ul>
  3. 3. Purpose of Money Markets <ul><li>Satisfying Needs of Investors: </li></ul><ul><ul><li>Provides investors a place for investing surplus funds for short periods of time. </li></ul></ul><ul><ul><ul><li>Can be as short as overnight (e.g., Fed funds market or the repurchase agreement market) or out to a year. </li></ul></ul></ul><ul><ul><ul><li>Offers highly liquid assets (as measured by relative price stability and good secondary markets). </li></ul></ul></ul><ul><li>Satisfying Needs Borrowers: </li></ul><ul><ul><li>Provides borrowers source of short-term funds. </li></ul></ul><ul><ul><li>For example, financing the working capital needs of businesses. </li></ul></ul><ul><ul><ul><li>Commercial paper market </li></ul></ul></ul><ul><li>Important to both investors and borrowers because the timing of their short term cash inflows and outflows may not be well synchronized. </li></ul><ul><ul><li>Money markets provide a way to manage cash-timing problems. </li></ul></ul>
  4. 4. Participants in U.S. Money Markets <ul><li>U.S. Treasury Department </li></ul><ul><ul><li>Financing its internal (“domestic”) deficit (when government expenditures exceed tax receipts), or </li></ul></ul><ul><ul><li>Refinancing operations as national debt maturities. </li></ul></ul><ul><li>Foreign Governments (and Central Banks) </li></ul><ul><ul><li>Recycling their U.S. dollar (“external”) trade surpluses back into U.S. financial markets. </li></ul></ul><ul><ul><ul><li>Involves many Asian countries today (China, Japan, South Korea). </li></ul></ul></ul><ul><li>Federal Reserve System (U.S. Central Bank) </li></ul><ul><ul><li>Federal Reserve Bank of New York conducts Open Market Operations in the money markets (buying and selling U.S. T-Bills) to meet the fed funds target. </li></ul></ul>
  5. 5. Participants in U.S. Money Markets <ul><li>Commercial Banks and Other Depository Institutions (e.g., savings banks) </li></ul><ul><ul><li>Source of funds to these institutions </li></ul></ul><ul><ul><li>Also hold their “secondary reserves” in the form of liquid U.S. Treasury bills (these are part of their investment portfolio). </li></ul></ul><ul><ul><ul><li>Essential for meeting unexpected deposit withdrawals and increases in loan demands. </li></ul></ul></ul><ul><li>Non Depository Financial Firms (e.g., finance companies, leasing companies) </li></ul><ul><ul><li>Securing funds in the money markets to lend to “potential” customers </li></ul></ul><ul><li>Non-financial Businesses Firms </li></ul><ul><ul><li>Financing short term working capital needs (cash shortfalls) </li></ul></ul><ul><ul><li>Important for financing foreign trade (financing export sales is done through bankers acceptances) </li></ul></ul><ul><ul><li>Investing their short term surplus funds </li></ul></ul>
  6. 6. Participants in U.S. Money Markets <ul><li>Contractual Financial Firms (e.g., property and casualty insurance companies) </li></ul><ul><ul><li>Holding liquid assets to meet unpredictable and unanticipated claims from policy holders. </li></ul></ul><ul><li>Investment firms (brokerage firms, asset managers; mutual funds; pension funds) </li></ul><ul><ul><li>They offer money market portfolios to investors. </li></ul></ul><ul><ul><ul><li>Encourages investors with limited funds (and limited investor knowledge) to participate in the money markets. </li></ul></ul></ul><ul><li>Individuals (Households) </li></ul><ul><ul><li>Are investors primarily through money market mutual funds. </li></ul></ul><ul><ul><ul><li>But individuals can invest directly (e.g., commercial paper). </li></ul></ul></ul>
  7. 7. Key Money Market Instruments <ul><li>Treasury Bills </li></ul><ul><li>Federal Funds </li></ul><ul><li>Repurchase Agreements (“repos”) </li></ul><ul><li>Negotiable Certificates of Deposit (CDs) </li></ul><ul><li>Commercial Paper </li></ul><ul><li>Prime Loans </li></ul><ul><li>Bankers’ Acceptance </li></ul><ul><li>Eurocurrencies Accounts (“Offshore Accounts”) </li></ul>
  8. 8. Money Market Instruments and Rates <ul><ul><ul><ul><li>Instrument Interest Rate (p.a.) </li></ul></ul></ul></ul><ul><li>Oct 25, 04 Nov 7, 06 Oct 29, 07 </li></ul><ul><li>Prime rate 4.75% 8.25% 7.75% </li></ul><ul><li>Fed funds (overnight) 1.75% 5.25% 4.75% </li></ul><ul><li>1 month T-bills* 1.57% 5.105% 3.915% </li></ul><ul><li>1 month Commercial paper** 1.78% 5.27% 4.78% </li></ul><ul><li>1 month CDs 1.90% 5.29% 4.81% </li></ul><ul><li>1 month bankers’ acceptances 1.90% 5.27% 4.68% </li></ul><ul><li>1 month London euro$s 1.92% 5.28% 4.70% </li></ul><ul><li>Repurchase Agreements*** n.a. 5.25% 4.73% </li></ul><ul><li>*Auction results </li></ul><ul><li>**Dealer placed </li></ul><ul><li>***Dealer financing rate for overnight sale and repurchase of Treasury securities. </li></ul><ul><li>Source: http://online.wsj.com/page/mdc/2_0500-rates-10.html?mod=2_0031 </li></ul>
  9. 9. Money Market Instruments and Rates <ul><ul><ul><ul><li>Instrument Interest Rate (p.a.) </li></ul></ul></ul></ul><ul><li>Oct 29, 07 Mar 19, 08 </li></ul><ul><li>Prime rate 7.75% 5.25% </li></ul><ul><li>Fed funds (overnight) 4.75% 2.25% </li></ul><ul><li>1 month T-bills* 3.915% 0.52% </li></ul><ul><li>1 month Commercial paper** 4.78% 2.53% </li></ul><ul><li>1 month CDs 4.81% 2.55% </li></ul><ul><li>1 month bankers’ acceptances 4.68% 2.55% </li></ul><ul><li>1 month London euro$s 4.70% 2.50% </li></ul><ul><li>Repurchase Agreements*** 4.73% 1.13% </li></ul><ul><li>*Auction results </li></ul><ul><li>**Dealer placed </li></ul><ul><li>***Dealer financing rate for overnight sale and repurchase of Treasury securities. </li></ul><ul><li>Source: http://online.wsj.com/page/mdc/2_0500-rates-10.html?mod=2_0031 </li></ul>
  10. 10. Money Market Rates Move Together
  11. 11. T-Bills Importance to Investors <ul><li>Money Market Assets generally safe and highly liquid: </li></ul><ul><ul><li>Safe: Assume no (to very little) risk of default. </li></ul></ul><ul><ul><li>Liquidity: Good secondary market (can be sold quickly) and with (relative) principal value stability (little price risk). </li></ul></ul><ul><li>Purchased by commercial banks for: </li></ul><ul><ul><li>Secondary reserves. </li></ul></ul><ul><ul><li>Needed to meet cash withdrawals and loan demands. </li></ul></ul><ul><li>Purchased by investment firms: </li></ul><ul><ul><li>For their money market mutual fund offerings. </li></ul></ul><ul><li>Money market instruments are also importance because investors and borrowers can manage cash inflow and outflow imbalances. </li></ul>
  12. 12. Marketable U.S. Government Debt; December 2007 <ul><ul><li>Security Amount Percent of Total </li></ul></ul><ul><ul><li>T-Bills: $1,000 billion 22% </li></ul></ul><ul><ul><li>T-Notes: $2,487 billion 55% </li></ul></ul><ul><ul><li>T-Bonds: $559 billion 12% </li></ul></ul><ul><ul><li>Other (TIPs): $471 billion </li></ul></ul><ul><ul><li>Total: $4,517 billion </li></ul></ul><ul><ul><ul><li>Note: 10% of the marketable debt is held by the Federal Reserve. About half the marketable debt is held by foreigners (private and public holdings), with Japan the largest at $680 billion and China second at around $400 billion. </li></ul></ul></ul><ul><ul><li>Source: http:// www.fms.treas.gov/bulletin/index.html (federal debt link). </li></ul></ul>
  13. 13. The Real Rate of Interest Notice that the inflation rate exceeds the rate on T-bills in several of the years. This indicates a negative real return for T-bill investors during these periods.
  14. 14. Current U.S. Real T-Bill Rates <ul><li>3 month T-Bill rate = 0.88% (March 18, 2008) </li></ul><ul><li>CPI; core (annual rate)= 2.30% (February 2008) </li></ul><ul><li>Real rate = -1.42% </li></ul><ul><li>What does this current real rate tell you? </li></ul><ul><ul><li>What is the incentive to invest? </li></ul></ul><ul><ul><ul><li>Positive or negative? </li></ul></ul></ul><ul><ul><li>What is the incentive to borrow? </li></ul></ul><ul><ul><ul><li>Positive or negative? </li></ul></ul></ul><ul><ul><li>Is Fed policy easy or tight? </li></ul></ul><ul><li>In October 2007 the real rate was +1.18% </li></ul><ul><ul><li>How have the incentives and Fed policy changed? </li></ul></ul>
  15. 15. Federal Funds <ul><li>Short-term funds transferred (i.e., loaned or borrowed) between financial institutions through the Federal Reserve System, usually for a period of one day (overnight). </li></ul><ul><ul><li>These funds are the excess reserves of banks. </li></ul></ul><ul><ul><li>Federal funds rate is currently the key U.S. monetary policy operating target. </li></ul></ul><ul><ul><li>Open market operations affects this rate by varying the supply of financial institutions’ reserves. </li></ul></ul><ul><li>Important to commercial banks: </li></ul><ul><ul><li>Lending institutions: earn money on excess reserves. </li></ul></ul><ul><ul><li>Borrowing institutions: balance their reserve requirement account. </li></ul></ul><ul><li>Very important as a “base” (or benchmark) rate for other money market rates in the economy. </li></ul><ul><ul><li>Current rate is 2.25% </li></ul></ul>
  16. 16. Repurchase Agreement (Repos) <ul><li>In a repurchase agreement, or repo, a customer provides cash to a government securities dealer in exchange for a Treasury bill, note or bond. The exchange is reversed the next day, with the customer receiving interest on the overnight loan. </li></ul><ul><li>Essentially a short-term collateralized loan. </li></ul><ul><ul><li>Party selling securities receives immediate cash. </li></ul></ul><ul><ul><li>Party buying securities will receive interest. </li></ul></ul><ul><li>Under these agreements, one can invest or borrow money for periods ranging from 1 to 365 days. </li></ul><ul><ul><li>Major participants are “primary” government securities dealers. </li></ul></ul><ul><ul><ul><li>Banks and dealers authorized to participate in auctions of U.S. Treasury securities through the New York Federal Reserve Bank and the Federal Open Market Committee. </li></ul></ul></ul>
  17. 17. Use of Repurchase Agreements <ul><li>Financial institutions enter into repo transactions in order to cover cash short positions or to earn a return on idle cash. </li></ul><ul><ul><li>Borrow or lend funds for short periods of time. </li></ul></ul><ul><ul><li>Most typical time frame: 3 to 14 days. </li></ul></ul><ul><li>Central banks use repurchase agreements for “temporary” or “defensive” open market operations. </li></ul><ul><ul><li>Central bank buying securities from government securities dealers to temporarily increase funds in market (these are called repurchase agreements); seller agrees to buy back. </li></ul></ul><ul><ul><li>Central bank selling securities to government securities dealers to temporarily remove funds from market (these are called reverse repurchase agreements, or matched sale-purchase transactions); buyer agrees to sell back. </li></ul></ul><ul><li>The United States has the largest repo market in the world, followed by France. </li></ul>
  18. 18. Negotiable Certificates of Deposit <ul><li>A bank-issued security that documents a bank deposit and specifies an interest rate and a maturity date. </li></ul><ul><ul><li>Used by banks to raise funds. </li></ul></ul><ul><ul><li>Negotiable means holder can sell CD in secondary markets before maturity date. </li></ul></ul><ul><li>Denominations range from $100,000 to $10 million. </li></ul><ul><ul><li>Investors include individuals, asset managers. </li></ul></ul><ul><li>Negotiable important to investors because it provides “early” exit strategy if needed. </li></ul>
  19. 19. Commercial Paper <ul><li>Short term, promissory notes, issued by financial and non-financial corporations as a way of raising money: </li></ul><ul><ul><li>U.S. market: About $1.7 trillion outstanding commercial paper offered by approximately 2,000 companies. </li></ul></ul><ul><ul><ul><li>Non-financial companies (25%) and financial (75%) </li></ul></ul></ul><ul><ul><li>U.S. Commercial paper maturities are less than 270 days. </li></ul></ul><ul><ul><ul><li>This does not require SEC registration for a public placement. </li></ul></ul></ul><ul><ul><ul><li>In practice, most commercial paper has a maturity of between 5 and 45 days, with 30-35 days being the average maturity. Many issuers continuously roll over their commercial paper, financing a more-or-less constant amount of their assets using commercial paper. </li></ul></ul></ul><ul><ul><li>Small secondary market, thus generally held until maturity. </li></ul></ul><ul><ul><ul><li>Thus, not nearly as liquid as T-Bills. </li></ul></ul></ul><ul><li>Commercial paper is viewed as an alternative to short term borrowing from commercial banks (prime loans). </li></ul><ul><ul><li>Spread between the two usually produces a lower nominal return (or cost) on commercial paper than on prime loans. </li></ul></ul><ul><ul><ul><li>Difference is about 200 to 300 basis points ( See next slide) </li></ul></ul></ul>
  20. 20. Prime Rate and Commercial Paper Rate Notice that difference between the two ranges from 200 to 300 basis points.
  21. 21. Explaining the “Cost” Difference: Commercial Paper Backup Requirements <ul><li>What accounts for the interest rate differential? </li></ul><ul><ul><li>In 1970, Penn Central Transportation Co. defaulted on $82 million worth of commercial paper. </li></ul></ul><ul><ul><li>Since that time, investors have required that almost all commercial paper be rated by a rating service. </li></ul></ul><ul><ul><li>Rating services require evidence of short-term liquidity (a backup) and will not issue a commercial paper rating without it. </li></ul></ul><ul><li>Thus, commercial paper issuers need to have access to funds that can be used to pay off all or some of their maturing commercial paper. </li></ul><ul><ul><li>These back up funds are either in the form of their own cash reserves or bank lines of credit, with most commercial paper issuers maintain backup liquidity through bank lines of credit. </li></ul></ul><ul><li>Banks charge a fee for these lines of credit (a percentage of the credit line) whether or not the line is activated. </li></ul>
  22. 22. Placement of Commercial Paper <ul><li>Commercial paper can be placed either through commercial paper dealers or directly by the issuer. </li></ul><ul><li>Dealer placed paper: </li></ul><ul><ul><li>Most issuing firms place their paper through dealers (as opposed to directly). </li></ul></ul><ul><ul><li>Dealers include investment banks, such as Merrill Lynch, Goldman Sachs, and Shearson Lehman and commercial banks such as Citigroup, and Bank of America. </li></ul></ul><ul><ul><li>These dealers purchase commercial paper from issuers and resell it to the investing public. </li></ul></ul><ul><ul><li>The difference between what a dealer pays the issuer for commercial paper and what the dealer sells it for (called the &quot;dealer spread“) is around 10 basis points. </li></ul></ul>
  23. 23. Direct Placement of Commercial Paper <ul><li>A few companies (approximately 125) use their own organization to sell their commercial paper. </li></ul><ul><li>Most of these direct issuers are finance companies or bank holding companies. </li></ul><ul><ul><li>General Motors Acceptance Corporation (GMAC) offers its commercial paper directly to institutional and commercial investors in the United States. </li></ul></ul><ul><ul><ul><li>GMAC paper can be purchased directly by calling their trading floor line at 1-800-338-4622. Orders may also be placed electronically via the company’s issuer website. </li></ul></ul></ul><ul><ul><ul><li>http://www.gmacfs.com/us/en/business/investing/commercial_paper/index.html </li></ul></ul></ul>
  24. 24. Investors in Commercial Paper <ul><li>Major investors in the commercial paper market are institutions, and include: </li></ul><ul><ul><li>Money market mutual funds and commercial bank trust (private banking) departments </li></ul></ul><ul><ul><ul><li>Money market mutual funds hold about 33% of outstanding commercial paper, while bank trust departments hold up to 25 percent. </li></ul></ul></ul><ul><ul><li>Other important investors include non-financial corporations, life insurance companies, and pension funds. </li></ul></ul><ul><ul><li>Individuals hold little commercial paper directly. </li></ul></ul><ul><ul><ul><li>However, individuals are large indirect investors in commercial paper through their investment in money market mutual funds. </li></ul></ul></ul>
  25. 25. Foreign Commercial Paper Markets <ul><li>While the U.S. market is by far the largest, a variety of foreign commercial paper markets began operating in the 1980s and early 1990s. These other major (foreign) markets include: </li></ul><ul><ul><li>Japan (denominated in yen) </li></ul></ul><ul><ul><li>Canada (in Canadian dollars) </li></ul></ul><ul><ul><li>Eurodollar market (in U.S. dollars) </li></ul></ul><ul><ul><ul><li>U.S. dollar-denominated commercial paper issued in other than the U.S. financial market (offshore). </li></ul></ul></ul><ul><ul><ul><li>Market located primarily in Europe (London). </li></ul></ul></ul>
  26. 26. Banker’s Acceptances: Background <ul><li>Assume an exporter and importer agree on the terms of a particular sale </li></ul><ul><li>What are the issues that remain for both? </li></ul><ul><ul><li>The exporter usually wants to maintain legal title to the goods until they are paid for (or at least until payment is assured), </li></ul></ul><ul><ul><li>While the importer typically is reluctant to pay for the goods before they are shipped (additionally, the importer wants to make sure that the goods ordered are indeed the goods shipped). </li></ul></ul><ul><li>Commercial banks have developed procedures to bridge this gap between the concerns of exporters and importers. </li></ul><ul><ul><li>In the process, banks provide external financing needed by the trading partners (specifically the importing firm). </li></ul></ul><ul><ul><li>Critical to this process is a letter of credit. </li></ul></ul>
  27. 27. Letter of Credit <ul><li>Defined: A Letter of Credit is a document which acknowledges a bank’s promise to pay a beneficiary (exporter) for merchandise sold to a buyer (importer) if specified conditions are met . </li></ul><ul><ul><li>Thus, a letter of credit substitutes the bank's credit for the credit of another party (i.e., the buyer of the goods). </li></ul></ul><ul><li>Letters of credit are used to ensure that payment will be received and that the goods ordered will be shipped. </li></ul><ul><ul><li>The use of letters of credit has become a very important aspect of international trade due to the nature of international dealings including factors such as distance, differing laws in each country and the potential difficulty in knowing each party personally, </li></ul></ul><ul><li>The bank acts on behalf of the buyer (i.e., importer) by ensuring that the supplier (i.e., exporter) will not be paid until the bank receives a confirmation that the goods which have been ordered have been shipped. </li></ul><ul><li>A letter of credit is a tool to reduce payment risk. </li></ul>
  28. 28. Letter of Credit and Bankers’ Acceptances <ul><li>Letter of credit arrangement will be requested by the exporter (seller) and will required the importer (buyer) to initiate a formal letter of credit with his/her bank. </li></ul><ul><li>The letter of credit will detail the conditions surrounding the transaction between an exporter and importer. </li></ul><ul><ul><li>What is being purchased, how shipped, when shipped, etc. </li></ul></ul><ul><li>When these conditions have been met, the bank will issue a draft (i.e., promise to pay or promissory note) which is presented to the exporter. </li></ul><ul><ul><ul><li>Draft can either be a sight draft (on demand) or a time draft. </li></ul></ul></ul><ul><li>When this draft is guaranteed by the importer’s bank it becomes a banker’s acceptance. </li></ul><ul><ul><li>Through the letter of credit, the exporter has the promise of a bank to pay, rather than a promise of the importer. </li></ul></ul><ul><li>The banker’s acceptance can be sold by the exporter before its maturity date in secondary markets. </li></ul><ul><ul><ul><li>It is sold at a discount at the existing banker’s acceptance rate. </li></ul></ul></ul><ul><li>Banker’s acceptances are a popular investment for money market funds. </li></ul>
  29. 29. 14 Steps in Trade Transaction Boulder Inc (exporter) Canadian Inc (importer) 1. Canadian Inc orders goods 2. Boulder Inc. agrees to sell, but requires letter of credit Northland Bank (in Canada) 3. Canadian buyer arranges Letter of Credit with its bank Southland Bank (in U.S.) 4. Northland Bank sends Letter of Credit L/C to Southland Bank 5. Southland advises Boulder Inc. of the L/C 6. Boulder Inc ships goods to Canadian buyer 7. Boulder presents draft for payment & documents to its bank. 8. Southland presents draft & documents to Northland. 9. Northland accepts draft, promising to pay in 60 days and returns acceptance to Southland Public Investor 10. Boulder Inc wishing to receive funds now tells Southland to sell acceptance (in secondary market) 11. Southland pays Boulder Inc. discounted amount on acceptance 12. Northland obtains Canadian buyer’s note (agreeing to pay) and releases shipment. 13. Canadian buyer pays its bank 14. Investor presents acceptance for payment at the end of 60 days; receives face value
  30. 30. Eurodollars (aka: Offshore Market) <ul><li>U.S. Dollar denominated time-deposits deposited in banks located outside of the United States. </li></ul><ul><ul><li>These banks can be either foreign banks or U.S. banks. </li></ul></ul><ul><ul><li>What is important is “location” – banks must be offshore from the U.S. </li></ul></ul><ul><ul><li>Largest euro-dollar market by location is in London, England. </li></ul></ul><ul><li>Today, other major currencies can also be deposited in these offshore markets. </li></ul><ul><ul><li>Yen, pounds, Swiss francs, European euros. </li></ul></ul><ul><ul><ul><li>These deposits are also offshore from their “legal” tender countries and are designed by the prefix “Euro” (e.g., euro-yen, euro-pounds, etc.) </li></ul></ul></ul><ul><li>Large global banks attract these deposits by offering interest rates on offshore time deposits (with maturities ranging from overnight deposits out to one year. </li></ul><ul><ul><li>These banks then lend these offshore deposits to global business who are in need of foreign currencies (e.g., needing dollars to pay for trade related activities). </li></ul></ul>
  31. 31. Understanding the Euro-Currency Market: An Example <ul><li>Assume a German company sells a product to a U.S. company and charges $1,000,000 for the sale. </li></ul><ul><li>The U.S. company pays by instructing its bank in New York to transfer $1,000,000 into the account of the German company (assume the German company has an account at a New York bank). </li></ul><ul><li>The German company then instructs its U.S. bank to transfer the dollar deposit to a U.S. dollar time deposit account at its bank in London. </li></ul><ul><li>The London bank can now lend out these dollars to its corporate clients and/or can lend out these deposits to other banks in the London Interbank Market. </li></ul>
  32. 32. Brief History of the Eurocurrency Market <ul><li>Market originated in 1956, at the time of the Hungarian revolt when communist governments (mainly the Soviet Union) concerned about the potential freeze of their dollar accounts in U.S. banks and needing dollars for international trade and, shifted their deposits to London. </li></ul><ul><li>The first bank in the London which accepting these U.S. dollar deposits was the Soviet-owned Banque Commerciale pour I'Europe du Nord. </li></ul><ul><ul><li>This bank was known by its cable code, EURBANK . </li></ul></ul><ul><ul><li>From this cable code the term euromarket originated. </li></ul></ul><ul><li>By the 1960s, the practice of euro-deposits was extended to regular business customers. </li></ul><ul><li>As the economies of Europe and Asia grew, the market was extended to additional currencies other than the US dollar. </li></ul>
  33. 33. Money Market Mutual Funds <ul><li>Investment funds that invest only in short-term securities. </li></ul><ul><ul><li>Money market fund investments can include U.S. Treasury securities, federal agency notes, certificates of deposit, repurchase agreements, bankers acceptances, and commercial paper (see next slide). </li></ul></ul><ul><ul><li>Open end funds (also called mutual funds): unlimited capitalization (number of shares) offered to the public. </li></ul></ul><ul><ul><ul><li>Purchase and sale of mutual fund share is through the investment funds themselves (e.g., Vanguard and T. Rowe Price money market funds) </li></ul></ul></ul><ul><ul><li>Closed end funds: fixed (limited) number of shares offered to the public </li></ul></ul><ul><ul><ul><li>Purchase and sale of shares is done through financial markets such as OTC or organized exchanges like the NYSE (e.g., John Hancock, Money Market Fund; JHMXX on NASDAQ) </li></ul></ul></ul><ul><ul><li>Combined these funds totaled $3.1 trillion at the end of 2007 (up from $2.4 trillion at the end of 2006). </li></ul></ul><ul><ul><ul><li>Market consists of retail market (sold to individuals) and Institutional market (sold to pension funds and businesses) </li></ul></ul></ul>
  34. 34. Assets of Money Market Mutual Funds <ul><li>Corporate notes = Debt instruments with maturities of 9 month out to a few years. </li></ul>
  35. 35. <ul><li>Tax-exempt refer to tax deferred accounts. </li></ul>Retail and Institutional Funds
  36. 36. Household Money Market Mutual Fund Holdings
  37. 37. Returns and Retail Money Market Mutual Fund Cash Flows <ul><li>Cash Flow = 6 month moving average </li></ul><ul><li>Interest Rate Spread = Money market mutual fund return minus commercial bank deposit rate </li></ul>
  38. 38. Comparing Major Money Market Securities