Chapter 11 - The Money Market

Question 1

Securities with high liquidity and short terms (3)

Answer 1

1. Sold in large denominations
2. Low default risk
3. Original maturity of one year or less

Question 2

Purpose of money markets (2)

Answer 2

Lenders/buyers: warehouse surplus funds for short time
-don’t care about return, only liquidity
Borrowers/sellers: low-cost source of temporary funds
-cash management:the timing of cash inflows and outflows are not well synchronized

Question 3

Money market players

Answer 3

Borrowers: govts, finance companies, bank corporations
Lenders: money market mutual funds, insurance, pension funds, bank corporations

Question 4

Money market instruments (6)

Answer 4

1. Treasury bills
2. Federal funds
3. Eurodollar
4. Purchase agreements
5. Negotiable certificates of deposit (NCD)
6. Commercial paper

Question 5

T-Bills

Answer 5

Discount bonds - one of the most liquid financial markets. Discounting is common to short-term securities because there is little time to collect coupons.

Question 6

T-Bill Auction

Answer 6

Competitive bid: dealers put in quantity and price. The bids are accepted in ascending order of yield (descending price) until offering amount is reached. Treasury will then sell at the highest yield (lowest price) among accepted bids

Non competitive bid: bidders only provide amount not price. The treasury automatically accepts all. The bidders will pay the price determined by the competitive bidders, but are guaranteed the amount.

Question 7

FedFunds

Answer 7

Short-term funds loaned or borrowed between financial institutions, usually over night.

-monetary policy implemented on this market, the effective rate is determined by demand and supply between banks, but moves around the target, hence the name target/intended FedFunds.

Question 8

Repurchase Agreement (repo)

Answer 8

An agreement where a financial instrument is sold and bought back at a later date.
-short-term collateralized loan. Normally low risk-

Question 9

Negotiable Certificates of Deposit (NCD)

Answer 9

Bank-issued deposit that specifies the ROI and maturity date.

• term deposit - must reach maturity
• large - 100k - 10m
• buyers/lenders:wealthy people & institutional investors

Question 10

Commercial paper

Answer 10

Unsecured promissory notes issued by large corporations with maturity less than 270 days. Sold on discount basis. No secondary market.

Question 11

Asset-backed commercial paper

Answer 11

Commercial paper is secured by some asset. Mostly issued by banks. Assets are of low quality e.g. US mortgages.

Question 12

Eurodollars

Answer 12

Dollar denominated deposits healed in foreign banks, short-term interbank deposits often o/n.
Alternative source for short-term funding for banks