3. It is a market where money or its equivalent
can be traded.
Money is synonym of liquidity.
It consists of financial institutions and
dealers in money or credit who wish to
generate liquidity.
large institutions and government manage
their short term cash needs.
short-term borrowing and lending is done by
these financial institutions and dealers.
instruments with high liquidity and very short
term maturities are traded.
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Money&CapitalMarket
4. The more popular money market securities
are
Treasury bills
Commercial paper
Negotiable certificates of deposit
Repurchase agreements
Federal funds
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Money&CapitalMarket
5. Securities Issued by Investors Maturities Secondary market
activities
Treasury bills Government Household, firms
and financial
institution
Up to 1 years High
Retail CDS Bank & saving
institution
Household 7 days to 1
year or longer
Moderate
NCDS Large bank or
saving institution
Firms 2 week to 1
year
Moderate
Commercial
Paper
Bank, financing &
others companies
Firms 1 to 270 days Low
Banker
acceptances
Bank Firms 30 to 270
days
High
Government
funds
Depositors
institution
Depositors
institutions
1 to 7 days Nonexistent
Repurchase
agreement
Financial &
nonfinancial firm
Financial &
nonfinancial firm
1 to 15 days Nonexistent
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Money&CapitalMarket
7. When the government needs to borrow fund the
treasury frequently issues short term securities
which are known as Treasury bill (T-Bill). This are
issued weekly through auction. One year T-Bill is
issued on a monthly basis.
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Money&CapitalMarket
8. • Are issued by the Treasury
• Are sold weekly through an auction
• Have a par value of $1,000
• Are attractive to investors because they are
backed by the federal government and are
free of default risk
• Are liquid
• Can be sold in the secondary market
through government security dealers
• a promise to pay a said sum after a
specified period.
• issued with three-month, six-month and
one-year maturity periods.
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Money&CapitalMarket
9. at a price less than their face value.
on maturity, the government pays the holder its
face value.
interest income earned by the purchaser of the
instrument.
issued through a bidding process at auctions.
bid can be prepared either competitively or non
competitively.
T-bills auctions are held on the Negotiated Dealing
System (NDS) and the members electronically
submit their bids on the system.
NDS is an electronic platform for facilitating dealing
in Government Securities and Money Market
Instruments.
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Money&CapitalMarket
11. Investors in Treasury bills
Depository institutions because T-bills can be easily
liquidated
Other financial institutions in case cash outflows exceed
cash inflows
Individuals with substantial savings for liquidity purposes
Corporations to have easy access to funding for
unanticipated expenses
Pricing Treasury bills
The price is dependent on the investor’s required rate of
return:
Treasury bills do not pay interest
To price a T-bill with a maturity less than one year, the
annualized return can be reduced by the fraction of the
year in which funds would be invested
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Money&CapitalMarket
12. T-bills are sold at a discount from par value
The yield is influenced by the difference between
the selling price and the purchase price
If a newly-issued T-bill is purchased and held until
maturity, the yield is based on the difference
between par value and the purchase price
Formula for estimating yield-
𝐘𝐭 =
𝑺𝑷 − 𝑷𝑷
𝑷𝑷
×
𝟑𝟔𝟓
𝒏
Where,
Yt = yield from T-bill
n = number of days of the investment (holding period)
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Money&CapitalMarket
13. Estimating the T-bill discount
T-bill discount represent the percent of
discount of the purchase price from par value
for newly issued T-bill and is computed
below.
𝐓 − 𝐛𝐢𝐥𝐥 𝐝𝐢𝐬𝐜𝐨𝐮𝐧𝐭 =
𝑺𝑷 − 𝑷𝑷
𝑷𝑷
×
𝟑𝟔𝟓
𝒏
In addition 360 days used instead of 365 days
for the discount calculation.
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Money&CapitalMarket
15. The U.S. department of the Treasury issued for the first time
Treasury securities that adjust for inflation. These securities
are popularly referred to as Treasury inflation protection
securities (TIPS). This treasury refers to these securities as
treasury inflation index securities. The Treasury has issued TIPS
that are notes and bonds.
TIPS work as follows
The coupon rate is set as a fixed rate and it is determine by
auction process. That rate is determined via the auction
process described later in the section. The coupon rate is
called the real rate because the investors ultimately earned
over the inflation rate.
The adjustment for inflation is as follows
The principal on which the treasury will based both the dollar
(BDT) amount of the coupon payment & maturity value is
adjusted semi-annually. This is called inflation-adjusted
principal.
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Money&CapitalMarket
16. The convention for quoting bids and offers is different for
Treasury bills and Treasury coupon securities. The quoting on bids
& offers is different for Treasury bills and Treasury coupon
securities. Treasury bills values are quoted on a bank discount
basis not a price basis. The yield on a bank discount basis is
computed as follows:
𝐘 =
𝑫
𝑭
×
𝟑𝟔𝟎
𝒕
Where,
Y=Annualized yield on a bank discount basis.
D= Discount (Face Value - Price)
F = Face Value, t= Number of days maturity period.
t= number of days remaining to maturities (maturity period)
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Money&CapitalMarket
18. A certificate of deposit with a minimum face value of $100,000.
These are guaranteed by the bank and can usually be sold in a
highly liquid secondary market, but they cannot be cashed-in
before maturity.
Due to their large denominations, NCDs are bought most often by
large institutional investors. Institutions often use these as a way
to invest in a low-risk, low-interest security.
Are issued by large commercial banks and other depository
institutions as a short-term source of funds
Have a minimum denomination of $100,000
Are often purchased by nonfinancial corporations
Are sometimes purchased by money market funds
Have a typical maturity between two weeks and one year
Have a secondary market
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Money&CapitalMarket
19. Placement
Some issuers place their directly; others use a correspondent
institution that specializes in placing NCDs. Another alternative
is to sell NCDs to securities dealers, who in turn resell them. A
portion of unusually large issues is commonly sold to NCDs
dealers. Normally, however, NCDs can be sold to investors
directly at a higher price.
Directly
Through a correspondent institution securities dealers
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Money&CapitalMarket
20. Premium
NCDs offer a premium above the T-bill yield to
compensate for less liquidity and safety
Premiums are generally higher during recessionary periods
Yield of NCDs
NCDs provide a return in the form of interest and the
difference between the price at which the NCD was
redeemed or sold and the purchase price
If investors purchase a NCD and hold it until maturity, their
annualized yield is the interest rate
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Money&CapitalMarket
22. • Like treasury bills, yields on
commercial paper are quoted
on a discount basis—the
discount return to commercial
paper holders is the
annualized percentage
difference between the price
paid for the paper and the face
value using a 360-day year.
Specifically, where is the
discount yield, is the face
value, is the price paid,
and is the term length of the
paper in days:
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Money&CapitalMarket
23. And when converted to a bond equivalent yield
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Money&CapitalMarket
24. Some firms place commercial paper directly with
investors
Most firms rely on commercial paper dealers to sell
it
Some firms (such as finance companies) create in-
house departments to place commercial paper
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Money&CapitalMarket
25. Commercial paper outstanding by issuer and placement
Financial Nonfinancial Asset-backed All types
Dealer Directly Total Dealer Directly Total Dealer Directly Total Total
Total (average), $ billions
2001 336.5 280.6 617.0 205.9 38.5 244.4 500.8 127.6 628.4 1489.8
2008 552.2 231.5 783.7 174.6 17.1 191.7 663.1 100.4 763.6 1739.3
Share (percent)
2006 22.6 18.8 41.4 13.8 2.6 16.4 33.6 8.6 42.2 100.0
2008 31.7 13.3 45.1 10.0 1.0 11.0 38.1 5.8 43.9 100.0
SOURCE: Federal Reserve Board, Volume Statistics for Commercial Paper Issuance.
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Money&CapitalMarket
26. Issuers typically maintain a backup line of credit
Allows the company the right to borrow a specified
maximum amount of funds over a specified period
of time
Involves a fee in the form of a direct percentage or
in the form of required compensating balances
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Money&CapitalMarket
29. A banker acceptance indicates that a bank accepts responsibility for
a future payment, normally it used for internationally transection.
The banks facilitate international trade by stamping accepted. An
exporter that is sending goods to an importer whose credit rating is
not known action by stamping ACCEPTED on a draft, which obligates
payment at a specific point of time.
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Money&CapitalMarket
30. term for these instruments may vary from 30
days to 180 days.
For corporations, it acts as a negotiable time
draft for financing imports, exports and other
transactions in goods.
It is highly useful when the credit worthiness of
the foreign trade party is unknown.
The seller need not hold it until maturity and
can sell off the same in secondary market at
discount from the face value to liquidate its
receivables.
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Money&CapitalMarket
31. It is a short term credit investment created
by a non financial firm and guaranteed by a
bank to make payment.
It is simply a bill of exchange drawn by a
person and accepted by a bank.
It is a buyer’s promise to pay to the seller a
certain specified amount at certain date.
The same is guaranteed by the banker of
the buyer in exchange for a claim on the
goods as collateral.
The person drawing the bill must have a
good credit rating otherwise the Banker’s
Acceptance will not be tradable.
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Money&CapitalMarket
35. One party sells securities to another with an
agreement to repurchase them at a specified date
and price
Essentially a loan backed by securities
A reverse repo refers to the purchase of securities by
one party from another with an agreement to sell
them
Transactions amounts are usually for $10 million or
more
Common maturities are from 1 day to 15 days and
for one, three, and six months
There is no secondary market for repos
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Money&CapitalMarket
36. It is as called Repo or Reverse Repo are
transactions or short term loans.
two parties agree to sell and repurchase the
same security.
the seller sells specified securities with an
agreement to repurchase the same at a
mutually decided future date and price.
seller of the security borrows money for a
period of time called Repo period.
rate of interest agreed upon is called the
Repo rate.
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Money&CapitalMarket
37. The advantage of the repo market is that the rate
is less than the cost of bank financing. From the
customers view point the repo market offers
attractive yield/ return on a short term second
transaction to which is highly liquid. The repo
rates vary from transaction to transaction
depending upon the two factors:
1. Term of Repo
2. Availability of security.
The more difficult is to obtain collateral the
lower is the repo rate and vice versa.
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Money&CapitalMarket
38. Placement
Repo transactions are negotiated through a
telecommunications network with dealers and repo
brokers
When a borrowing firm can find a counterparty to a repo
transaction, it avoids the transaction fee
Some companies use in-house departments
Estimation of the yield
Repo rate is determined by the difference between
initial selling price and the agreed upon repurchase
price, annualized with 360 days year.
Formula for estimating the yield
Repo rate =
𝑆𝑃 − 𝑃𝑃
𝑃𝑃
×
360
𝑛
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Money&CapitalMarket
40. For money market securities making no interest payments, the
value reflects the present value of a future lump-sum payment
The discount rate is the required rate of return by investors
Impact of September 11
The weak economy combined with this event caused investors to
transfer funds into money market securities
The additional demand placed upward pressure on their price and
downward pressure on their yields
The Fed added liquidity to the banking system and reduced the federal
funds rate
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Money&CapitalMarket
41. Indicators of future money market security
prices
Economic growth is monitored since it signals changes
in short-term interest rates and the required return from
investing in money market securities
Employment
GDP
Retail sales
Industrial production
Consumer confidence
Indicators of inflation
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Money&CapitalMarket