Chapter 13: Money Markets

Question 1

Money market instruments can be issued by (4)

Answer 1

• Government (treasury bills)
• Regional government bodies (local authority bills)
• Companies (bills of exchange, commercial paper)
• Banks (different types of deposit)

Question 2

4 Types of bank deposits

Answer 2

• call deposits
• notice deposits
• term deposits
• certificates of deposit

Question 3

Call deposits

Answer 3

Depositor has “instant access” to withdraw funds

Question 4

Notice deposits

Answer 4

Depositor has to give a period of notice before withdrawal

Question 5

Term deposits

Answer 5

Depositor has no access to the capital sum earlier than the maturity of the deposit.

Question 6

Certificates of deposit

Answer 6

Tradable notes that state how much has been deposited

Question 7

10 Investment and risk characteristics of money market instruments

Answer 7

• normally good security as term is very short, depends on the borrower though
• Return is through income
• Level of income has a loose, indirect link with inflation
• Lower expected returns than equities or bonds over the long term
• Stable market values
• Short-term
• Low dealing expenses
• Liquid
• Normally highly marketable
• Returns normally taxed as income

Question 8

5 Participants in money markets

Answer 8

• Clearing banks
• Central banks
• Other financial institutions & non-financial companies
• Companies
• Individuals

Question 9

Clearing banks as a player in the money markets

Answer 9

Use money market instruments to lend excess liquid funds and to borrow when they need short-term funds

Question 10

Central banks as a player in the money markets

Answer 10

Act as lenders of last resort,
stand ready to provide liquidity to the banking system when required, and who buy and sell bills to establish the level of short-term interest rates

Question 11

Reasons for holding portion of their funds in market investments

Answer 11

• Meet expected liability outgoings
• High degree of uncertainty in liability outgo
• Possible investment opportunities
• Highly risk-averse (preserve capital value of assets)
• Short-term investment
• Rising interest rates
• Start of a recession
• Expected weakness in local currency
• General economic uncertainty

Question 12

Institutions hold money market instruments if they expect

Answer 12

• rising interest rates (might cause other asset values to fall)
• economic recession (a fear that equity and bond prices will fall)
• the domestic currency to weaken (makes overseas cash holdings attractive. And it may be followed by rising interest rates)
• general economic uncertainty.

Question 13

Circumstances under which money market instruments would be temporarily unattractive

Answer 13

• General economic uncertainty
• Expectations of falling interest rates
• The end of a recession / start of a boom
• Expectations of a strengthening domestic currency
• If the investor is not risk averse or not concerned with liquidity

Question 14

Main risks for an institutional investor with all their assets in domestic money market instruments

Answer 14

• Cash instruments are short-term investments and hence there is a mismatch by term with the investor’s liabilities
• Means that the investor’s assets will have to be reinvested many times at currently unknown future interest rates (high level of reinvestment risk)
• Holding all assets in one type of investment results in a lack of diversification. Al the investments will be positively correlated, resulting in a concentration of risk