Chapter 5 - Money Markets Flashcards
Money Markets
refers to the global market place for short-term financial instruments that are highly liquid.
Have a maturity of one year or less
usually debt instruments
Broker Dealer
an entity that trades securities for its own account or on behalf of its customers
Broker: when executing trades on behalf of a customer
Dealer: when executing trades for its own account
Street Name (holding securities)
securities are held in the broker’s name on behalf of the broker’s account. Holding securities in the street name does not affect the rights of the actual owner. allows investors to stay anonymous
Ask price
the price at which the dealer will sell a security
bid price
the price at which the dealer with buy a security
spread
difference between the ask and bid prices
this is the dealers profit
Central Securities Depositories (CSDs)
companies that hold securities to enable book-entry transfer of securities
may provide trade matching along with clearing and settlement
E.g. Depository trust company
Book-entry Security
Book-entry securities are investments such as stocks and bonds whose ownership is recorded electronically. Book-entry securities eliminate the need to issue paper certificates of ownership. Ownership of securities is never physically transferred when they are bought or sold; accounting entries are merely changed in the books of the commercial financial institutions where investors maintain accounts. (INVESTOPEDIA)
Default/ Credit Risk
The likelihood that the payments owed to creditors will not be made under the original loan terms
higher yields are required on more risky instruments to compensate buyers for the risk
Default risk is asses by credit rating agencies Moody’s, S&P, Fitch
Liquidity Risk
the likelihood that a security cannot be sold quickly without incurring a substantial loss in value.
primary determinants of liquidity are marketability and maturity
Interest Rate Risk
involves the uncertainty associated with future interest rate levels
two components: reinvestment risk and price risk
Reinvestment Risk
results from the potential for lower interest rates in the future. After IR drop the proceeds from maturing investments will be reinvested at a lower rate
Price Risk
the potential for an increase in interest rates
refers to changes in interest rates having an adverse impact on the value of a security
Securities with longer maturities have increased price risk as their market values are more responsive to changes in IR
FX Risk
Arises when investors purchase securities in other currencies. There is a risk that the return on the securities will be lower once the investment is converted back sometime in the future
Commercial Paper (CP)
tradable promissory not that represents an unsecured obligation or debt to the issuer
maturity can be overnight to 270 days for publicly traded CP and 397 days for private placement
does not pay interest, instead it is issued at a discount and the facevalue is paid at maturity. thus yield is influenced by the difference between the purchase price and the face value
investment grade CP is highly liquid
Asset Backed Commercial Paper (ABCP)
Secured against specific assets, usually short-term trade receivables from a single company or range of companies
issued through a sponsoring financial institution refereed to as a conduit, rather than the actual company
can be single seller seller (backed by assets of a single institution) or multi seller (backed by assets purchased from a number of issuers
advantage: secured
disadvantage: complex and hard to value, market is smaller and less liquid
Bank Obligations
the way in which banks raise funds in the money markets
1) time deposits
2) banker’s acceptance
3) Repo Agreements
Time Deposits
Savings accounts, CDs, Negotiable CDS
Negotiable CD
large-value time deposits issued by banks and other financial institutions that are bought and sold on the open market.
usually traded in multiples of 100,000 or more
Certificate of Deposit Account Registry Service (CDARS)
a private service that makes it possible to receive full FDIC insurance coverage on amounts up to $50 m by distributing the funds among CDs issued by a network of banks
Eurodollars
US denominated deposits held in financial institutions outside the US
a way for non US banks and foreign branches of US banks to raise funds in the global money market
may be issued as negotiable eurodollar CDs or as time deposits
higher rate or returns than regular CDs due to limited regs
Yankee CDs
USD denominated CDs sold by US branches of non-US Banks
usually sold through the NY branches and carry a min invest of 100k
higher rates of return than reg CDs
Banker’s Acceptance (BA)
a time draft that is issued by a purchaser of goods to pay a supplier that has been accepted by the bank on which the draft is drawn. constitutes the bank’s unconditional promise to pay the draft at maturity
Government Paper
National, State, and Local government agencies raise funds in the money market by issuing short-term promissory notes,
Treasury Bills (T Bills)
money market instruments that are sold at a discount to their par value at maturity
auctions held and bids accepted starting with the highest bid (aka lowest yield) and going down to lowest price to sell entire issue. bidder is guaranteed the desired amount of T bills at the average price
Floating Rate Notes (FRNS)
way to raise short term funds
typically have maturities as one year or longer
pay a regular coupon along with the promised return of their face value at maturity
rate if interest resets periodically based on LIBOR or EURibor
min and max coupon rates
Repurchase Agreements (REPOs)
a bank or securities dealer sells government securities it owns to an investor and agrees to repurchase them at a later date at a slightly higher price
short term borrowing agreement
negotiated between two parties so maturity and yield can be tailored (however yield is generally determined by the market repo rates)
generally over collateralized
Reverse REPO
when you buy a security with the promise to sell it back at a later date (the buyer in the repor agreement)
short term investing agreement
Tri-Party Repo
when the collateral for a repo agreement is held by a broker dealer and funds are exchanged through that party
Money market funds (MMF)
Commingled pools of money market securities
MMFs are typically held by financial institutions and investors purchase an ownership interest in the fund
Usually contain a dollar weighted average portfolio maturity of 60 days or less
More stable in times of interest rate volatility
Net asset value (NAV)
A value the represents the price per share of a mutual fund or an exchange traded fund.
Calculated As The total value of all securities or assets in the fund less liabilities divided by the number of out standing shares
Commercial book-entry system (CBES)
A multi tiered automated system for purchasing, holding, and transferring marketable securities
Operated by the us treasury
Indirect holding
When an investor purchases securities through a broker, dealer or financial institution the securities are held on the book-entry system of that firm. This is called indirect holding
Depository trust and clearing corporation (DTCC)
Owned by member financial institutions, is is a corporation that works through its subsidiaries, to provide clearing, settlement and information services for equities, corporate and municipal bonds etc
Operates on an at-cost basis
