2. Money Market Instruments

Question 1

What are money markets geared towards?

Answer 1

Short-term liquidity and providing a temporary safe haven for investment funds.

Question 2

Money markets generally cover which instruments, and which maturities?

Answer 2

Cash and other instruments - that mature within one year of the point of issue.

Question 3

Why does an interbank market exist?

Answer 3

Because as Banks balances with their central bank rise & fall - there is a need to borrow and lend from each other.

Question 4

What are inter-bank rates?

Answer 4

Average rates at which banks borrow from each other.

Question 5

What is SONIA?

Answer 5

Sterling Overnight Index Average Rate - based on unsecured overnight borrowing published by the Bank of England (BOE)

Question 6

What is the US SOFR?

Answer 6

US Secured Overnight Financing Rate - based on overnight repo rate.

Question 7

What is the Eurozone €STR?

Answer 7

Euro Short-Term Rate - based on previous days unsecured overnight borrowing settled through Target2.

Question 8

What is SARON?

Answer 8

Swiss Average Rate Overnight - secured short term interest rate based on quotes in CHF repo market.

Question 9

Name the two interbank rates, which are a secured overnight rate?

Answer 9

1. US SOFR
2. SARON

Question 10

Name the two interbank rates, which are an unsecured overnight rate?

Answer 10

1. SONIA
2. €STR

Question 11

US SOFR is a secured overnight financing rate based on what?

Answer 11

Borrowing collateralised by US Treasury Securities.

Question 12

What is the US Fed Funds Rate?

Answer 12

The overnight rate at which US Banks lend money to each other

Question 13

Simple short term interest rates , such as SONIA, US SOFR etc could be the basis of which kind of contract?

Answer 13

STIRs (Short Term Interest Rate contracts)

Question 14

What is a key aspect that allows the interbank money market to operate efficiently?

Answer 14

Confidence

Question 15

Explain why confidence is so important?

Answer 15

Because banks & other investors who lend funds in the short term market do so often using internal guidelines or credit limits, and therefore not a strong guarantee the borrower is creditworthy.

Question 16

When there is a loss of confidence, those in need of short term funding will be impacted how?

Answer 16

They will need to pay a higher rate of interest, or seek funding from their respective central bank.

Question 17

Explain what happened with Northern Rock?

Answer 17

75% of its funding was obtained by rolling over short term financing in money markets. Confidence was lost, and Northern Rock were unable to obtain funding (even when willing to pay higher rates) and it led to being nationalised by the UK government.

Question 18

What is the main risk for a depositor in the money markets?

Answer 18

Counter-party risk - that the borrower cannot repay on maturity.

Question 19

In addition to internal guidelines, and credit rating, what else is a signal of financial stability?

Answer 19

CDS spreads (Credit Default Swap) spreads.
Seen as a real-time, market driven estimate of the likeliness for a company, country or organisation to default.

Question 20

What are Treasury Bills (T-Bills)?

Answer 20

Treasury Bills are the name given to short-term debt issued by governments.

Question 21

In the UK , who issues T-Bills and at what frequency?

Answer 21

The DMO (Debt Management Office) issued weekly on behalf of the UK government.

Question 22

T-Bills are generally issued with what maturities in the UK, and US?

Answer 22

UK - 3 & 6 months
US - 1, 3 & 6 months

Question 23

T-Bills are often referred to as what?

Answer 23

Promissory Notes

Question 24

Since they are backed by their respective governments, T-Bills are said to be a benchmark of what?

Answer 24

Risk-free returns, compared to other short-term money market instruments.

Question 25

Do T-Bills pay a coupon?

Answer 25

No. They are issued at a discount to their nominal value, and redeemed at par. The discount provides the return to the investor.

Question 26

Concerning T-Bills, what are the minimum denominations in £ & $?

Answer 26

£ - £5000
$ - $100

Question 27

What is a Certificate of Deposit, and who are they usually issued by?

Answer 27

A time deposit offered by Banks, and other financial institutions.

Question 28

What are the most common maturities for CDs?

Answer 28

3 & 6 months

Question 29

How are CDs purchased?

Answer 29

They’re purchased at their par value. At maturity the investor receives the full face value and the specified interest rate.

Question 30

Is it possible to sell a CD before its maturity?

Answer 30

Yes, although a penalty will be incurred, linked to a pre agreed interest rate.

Question 31

How does the yield on a CD compare to a T-Bill?

Answer 31

CDs usually pay a higher yield, reflecting their slightly higher credit risk.

Question 32

Can CDs be issued in any denomination?

Answer 32

Yes

Question 33

Who issues Commercial Paper?

Answer 33

Large financial, and non-financial institutions

Question 34

What are the usual maturities of Commercial Paper?

Answer 34

Usually range up to nine months.

Question 35

Commercial paper is usually denominated in minimums of what?

Answer 35

$500,000 (or currency equivalent)

Question 36

What is the largest CP market globally?

Answer 36

The US Market

Question 37

Explain the interest paid on CP, and how is it determined?

Answer 37

Interest depends on market conditions, and the issuing companies credit rating.