12. Financial markets and the treasury function

Question 1

What is a money market?

Answer 1

Market in which short-term assets and liabilities are traded.

Question 2

What is the stock market? What do the securities sold in this market split into?

Answer 2

Market in which long term debt and equity is traded.

Splits into primary and secondary (resale securities)

Question 3

What is a deficit unit?

What is a surplus unit?

Answer 3

Deficit unit: requires funds

Surplus unit: supplies funds

Question 4

There are two types of securities sold on a money market.

What are they and what does this mean?

Give examples of both.

Answer 4

Coupon bearing securities: have a fixed maturity and specified rate of interest.
I.e. certificates of interest or repos

Discount securities: sold at a discount to redemption reward.
I.e. treasury bills

Question 5

What are the benefits of money markets? (3)

Answer 5

Inter-bank trading: banks trade with each other to make most of own cash surpluses and shortages.

Liquidity: allow companies to obtain short-term cash where needed.

Government: allow government to raise cash where tax receipts ran out.

Question 6

What is eurocurrency?

Answer 6

Money deposited with a bank outside of it’s country of origin.

Question 7

What is the difference between the Euromarket and Eurobond market?

Answer 7

Euromarket: short-term

Eurobond market: long-term

Question 8

What are the roles of financial institutions?

Answer 8

Risk reduction: lending to a variety reduces pooled risk.

Aggregation: can reap larger benefits

Maturity transformation: can meet short and long term needs of savers and borrowers

Intermediation: bring together borrowers and lenders

Question 9

What is a certificate of deposit?

Answer 9

Certificate to show you have provided bank with deposit for fixed perioe with fixed interest.

Question 10

What is a repo?

Answer 10

X sells Y securities and simultaneously agrees to buy them back at later date. Difference in transactions is effective interest.

Question 11

How do you calculate interest on repos?

Answer 11

((Price bought back - price sold for) / price sold for) x days between transactions / 365

Question 12

Give examples of discount securities (3)

Answer 12

Treasury bill
Commercial bill
Commercial paper

Question 13

What is a derivative?

Answer 13

An asset whose value is primarily derived from the value of an underlying asset i.e. commodities, shares, interest rates

Question 14

How do you calculate the issue price of commercial paper?

Answer 14

Amount x 1 / (1 + 0.interest rate x days / 365)

Question 15

What is the difference between a cash generator and cash consumer?

Answer 15

Generator: lay off cash on short-term markets or return surplus funds to investors.

Consumers: look to borrow short-term.

Question 16

What are the main functions of the treasury? (3)

Answer 16

Short term management of resources (lending/borrowing funds)

Long term maximization of shareholder wealth (raise long-term finance, management of debt, dividend policy.)

Risk management (assessing risk exposure, interest rate risk management and foreign exchange risk)