1.5 Asset classes - Money Markets

Question 0

What are the benefits of issuing T-Bills?

Answer 0

ISSUER - manage liquidity needs of gov

INVESTOR - secure, stable, low risk
- tax advantages

Question 1

Name 3 characteristics of Treasury bills (T-bills)

Answer 1

• Short-term loan instruments, guaranteed by the government, with a maturity date that is generally between one and 12 months later.
• They pay no coupon, i.e. no regular payments, one-off payment at the end
• Issued at a discount to their nominal value, with the discount representing the return available to the investor.

Question 2

How were T-Bills issued?

Answer 2

• Issued at weekly auctions, known as tenders, held by the DMO on the last business day of the week (usually a Friday).
• These tenders are open to bids from a group of eligible bidders which include all of the major banks. The bids are tendered competitively – only those bidding a high enough price will be allocated any T-bills and they will pay the price that they bid.
• The bids must be for a minimum of £500,000 nominal of the T-bills, and above this level bids must be made in multiples of £50,000.
• In subsequent trading, the minimum denomination of T-bills is £25,000.

For example, if a purchaser paid £990,000 for £1,000,000 nominal of a three-month T-bill, the return will be the gain made of £10,000. As a percentage of invested funds the return is: £10,000/£990,000 x 100 = 1.01% over three months.

Question 3

What is a repo?

Answer 3

A repo is a sale and repurchase agreement.

It is legally binding for both buyer and seller. For example, a gilt repo is a contract in which the seller of gilts agrees to buy them back at a future specified time and price.

Question 4

How do you calculate the repo rate?

Answer 4

The amount of cash paid over by Participant B at the start of the repo will be less than the amount paid over to Participant B at the end of the repo period. The difference between the two amounts, expressed as a percentage, is the effective interest rate on the repo transaction. It is usually referred to as the repo rate.

Question 5

Name the benefit of entering into a repo?

Answer 5

• The obvious benefit to Participant A is that they are able to raise finance against the security of the gilts that they hold

– potentially a relatively cheap source of short-term finance.

If Participant B is considered a conventional bank simply providing finance, then the benefit of using the repo is the security gained by holding the gilts. However, Participant B may be a gilt-edged market maker (GEMM) that has sold gilts that it does not hold. The repo transaction enables the GEMM to access the gilts that it requires to meet its settlement obligations. In this way, gilt repo facilitates the smooth running of the secondary market in gilts.

Question 6

Explain the purpose of a Standing Repo Facility

Answer 6

• The smooth running of the gilts market
• This enables any GEMM, or other DMO counterparty, to enter into a reverse repo arrangement with the DMO, perhaps to cover a short position in gilts.
• They must first sign the relevant documentation provided by the DMO and then are able to request any amount of a gilt above £5 million nominal.
• This facility is for next-day settlement, and the facility can be rolled forwards for up to two weeks. The DMO does charge a slightly higher than normal repo rate for firms accessing the standing repo facility.

Although the gilts market has been used as an example, it should be noted that the use of repos is an important liquidity provider for the debt markets as a whole.

Question 7

Inter-bank Rates

Answer 7

LIBOR

• the average price offered in London by banks
• calculated @ 11am by British Banks Association