Book 3 Pages 1-51 Flashcards
what are the different maturities of T-bills?
4, 8, 13, 26, 52
what is the minimum purchase amount in regards to T-bills?
$100
The Bank Discount rate is the rate at which a Bill is quoted in the secondary market and is based on the par value, amount of the discount and a 360-day year.
The Coupon Equivalent also called the Bond Equivalent, or the Investment Yield, is the bill’s yield based on the purchase price, discount, and a 365- or 366-day year. The Coupon Equivalent can be used to compare the yield on a discount bill to the yield on a nominal coupon bond that pays semiannual interest.
Example:
- 07/01/19
- 4 Weeks
- Bank Discount = 2.13
- Coupon Equivalent Yield = 2.17
do T-bills have default risk?
no
are T-bills subject to original issue discount rules?
no
when is interest income paid under T-bills?
at maturity
is interest income taxed at the federal level in regards to T-bills?
Yes
is interest income taxed at the state level in regards to T-bills?
no
publicly traded, short term, unsecured promissory notes issued by companies to raise cash to finance accounts receivable and inventories
commercial paper
However, investors need to be aware that these notes are not FDIC-insured. They are backed solely by the financial strength of the issuer in the same manner as any other type of corporate bond or debenture. Standard &Poor’s and Moody’s both rate commercial paper on a regular basis using the same rating system as for corporate bonds, with AAA and Aaa being their highest respective ratings. As with any other type of debt investment, commercial paper offerings with lower ratings pay correspondingly higher rates of interest. But there is no junk market available, as commercial paper can only be offered by investment-grade companies.
true or false? commercial paper is issued in denominations of $100k
true
what is the average maturity length of commercial paper?
Example 2 -
- Let us calculate the bond equivalent yield of the following commercial paper.
Face value=$600,000
- Maturity period=90 days
- Net amount realized=$595,000
30 days
Common measures of return on money market instruments such as bank discount yield and money market yield can’t be directly compared with capital market instruments such as bonds. This is because they are either calculated with reference to the face value i.e. the maturity value instead of the initial value and/or they are based on a 360-day year. The bond equivalent yield addresses both theses weaknesses and enables comparison.
Bond Equivalent Yield
- To compare the return on discounted securities with other investments in relative terms, analysts use the bond equivalent yield formula.
Example
- Bond Equivalent Yield = [($600,000 - $595,000)/$595,000] x (360/90)
- 3.3613%
Maturities on commercial paper rarely range longer than 270 days. Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates.
A major benefit of commercial paper is that it does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months, or 270 days, making it a very cost-effective means of financing. The proceeds from this type of financing can only be used on current assets, or inventories, and are not allowed to be used on fixed assets, such as a new plant, without SEC involvement.
Financial Crisis -
- The commercial paper market played a big role in the financial crisis that began in 2007. As investors began to doubt the financial health and liquidity of firms such as Lehman Brothers, the commercial paper market froze, and firms were no longer able to access easy and affordable funding. Another effect of the commercial paper market freezing was some money market funds - substantial investors in commercial paper - “breaking the buck.” This meant that the affected funds had net asset values under $1, reflecting the diminishing value of their outstanding commercial paper issued by firms of suspect financial health.
what is the maturity range for commercial paper?
1 to 270 days
true or false? commercial paper has a high default risk
false, it is low
true or false? commercial paper usually has higher yields than T-bills and CDs
true
true or false? commercial paper interest income is taxed at federal but not state levels
false, it is taxed at both
when is commercial paper interest income taxed?
in the year it is earned
deposits placed with commercial banks at a specified interest rate for specified time period
CDs
Do CDs have high or low default risk?
low
is interest income from CDs taxed at state, federal, or both levels?
both levels
are money market accounts subject to a limited amount of withdrawals per month?
yes
Because money market accounts fall under Federal Reserve Regulation D, banks may limit the number of withdrawals you can make in any one statement cycle – typically up to six withdrawals per month.
when is money market interest income taxed?
in the year earned
The IRS requires that you report the interest on your money market account in the year that you earn it, regardless of whether or not you take the money out of the account. If you have a money market deposit account, the income counts as interest income, even if you have the account at a credit union and the payments are called dividends. If you have a money market mutual fund, the payments count as dividend income, but are still reported as taxable income in the year you earn them.
When people discuss money market accounts, they often confuse money market deposit accounts, which are interest-bearing savings accounts, with money market mutual funds, which invest in short-term notes. Your interest payments are taxed in the same year regardless of whether you have a money market deposit account or a money market mutual fund.
true or false? interest income from a money market account is taxed at federal and state levels
true
used by securities dealers to finance large inventories of marketable securities
Example
repurchase agreements
Example
Who?
- Cash Providers
- Money Market Mutual Funds
- Insurance Companies
- Corporations
- Municipalities
- Central Banks
- Securities Lenders
- Commercial Banks
- Securities Providers
- Securities Lenders
- Hedge Funds
- Levered Accounts
- Central Banks
- Commercial Banks
- Insurance Companies
Why?
- secure, collateralized nature of the transaction, coupled with flexibility of liquidity and collateral, repos provide an efficient solution, pairing conservative short-term lenders (i.e. investors and money market funds) with borrowers in need of short-term financing (repo dealers)
Parties
- Investor = Money Market Fund
- The investor has funds that he is willing to lend
- Currency, size, collateral, and pricing must be negotiated
- Custodian =
- Provides two accounts = collateral account and cash account
- Securities Margin posted = Each transaction is secured with collateral that is worth more than the notional amount, acting as a buffer for the lender against short-term variations in the collateral’s value.
- Rep Dealer =
- Posts collateral with haircut
- Maturity Date
- The principal amount, plus interest, is transferred from the repo dealer’s cash account to the investor’s cash account
- Upon receipt of the cash, the custodian will release the collateral from the investor’s account back to the repo
- On instruction from the investor, the custodian will then send the cash and interest to the investor’s bank account
true or false? repurchase agreements have a short term to maturity
true
true or false? repurchase agreements have high risk
false