CHP 13

Question 1

Cash can be placed on deposit:

Answer 1

• Having instant access to withdraw – call deposit
• With a notice period for withdrawal
• Fixed term with no access before maturity

Question 2

Rate of interest paid by the borrower can be:

Answer 2

• Fixed for the term of the deposit
• Fixed for the initial period
• Variable from day one
The borrower may have to give notice of any changes in the interest rates.

Question 3

2.1. Clearing banks

Answer 3

Money markets are dominated by clearing banks who use them to lend and borrow short term funds.
These are usually very short term (over night). Interbank rates are usually taken as the benchmark for short term interest rates.

Question 4

2.2. Central banks

Answer 4

These are lenders of last resort and stand ready to provide liquidity to the banking system when needed.
They also use their operations in the money market to establish the level of short-term interest rates.
Central bank money market operations are done via REPO arrangements and the sale or purchase of Treasury and other bills.

Question 5

2.3. Other institutions

Answer 5

These also borrow and lend in the money markets.

Question 6

3. Attractions of money market investments

Answer 6

Long-term institutional investors such as life companies and pension funds generally hold cash only for:
• As liquidity to meet expected outgoings
• Temporarily, when taking a view that values of other assets are likely to fall

Question 7

3.2. Holding cash for liquidity

Answer 7

• Known short-term commitments
• Uncertain outgo
• Opportunities
• Recent cashflow
• Preservation of nominal value of capital and risk aversion

Question 8

3.3. Economic circumstances in which cash is attractive

Answer 8

Economic conditions that will make cash temporarily attractive to long-term institutional investors or others:
• Generally rising interest rates which depress both bond and equity markets
• The start of a recession – where it is believed equity markets will get lower growth and bonds might suffer from an increase in government deficit
• Weakness of the national currency making cash investments in other currencies attractive.

Question 9

General economic uncertainty re attractiveness of money market instruments

Answer 9

Stability of capital values will make cash attractive to risk-averse investors – this is enhanced in times of economic uncertainty.
Over the long term, cash is expected to give lower return than more risky assets or less liquid investments.