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Finance > Lecture 6- The Money Market > Flashcards

Lecture 6- The Money Market Flashcards

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1
Q

What does the money market comprise of?

A
  • Bank’s exchange settlement funds
  • RBA using the market to maintain the cash rate
  • Money market securities (low risk- low return)
  • Banks raising funds from the issue of NCDs
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2
Q

What are the four key roles of the money market?

A

1) Enable direct financing through the issue of short- term securities
2) Provide the banking system with a low- risk market for their liquid reserves
3) Pice discovery function by enabling the calculation of reference rates for short- term funds
4) Enables the RBA to implement monetary policy and so influence the economy’s macroeconomic performance

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3
Q

How does the money market contribute to the flow of funds?

A
  • Enables direct financing, in wholesale amounts, by banks, non- financial companies and the government.
  • Offers an alternative to flow-of-fund processes present within ADIs
  • Provides a low risk and return investment opportunity for institutional investors
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4
Q

In what two ways does the money market contribute to the banking system?

A

1) Holds the banking system’s liquid reserves (loans to inter- bank overnight market and in short- term securities)
2) Enables banks to raise funds through the issue of NCDs, and through the sale of bills they accept on behalf of investors (BABs)

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5
Q

How does the money market aid with price discovery?

A

Market determines price of short- term interest rates (known as the BBSW) and is calculated by AFMA every day based on the yields of the securities of the prime banks trade (NCDs and BABs)

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6
Q

What are BBSW rates used to do?

A

Using in floating rate loan contacts as the basis for future interest rates

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7
Q

How does the money market assist the RBA?

A

Enables the RBA to buy or sell money market securities in the money market when implementing changes in its targets for the cash rate. In addition, the market holds the ES funds, for which the RBA is responsible for

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8
Q

What are the key and distinguishable features of money market securities?

A

1) Term is less than one year
2) Make a single payment (face value)
3) Promissory notes (NCDs) or bills of exchange (BABs)
4) Issued at a discount to their face value
5) Most have a low credit risk, even though they are mostly unsecured

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9
Q

What are the two main types of money market securities and what are their features?
Which overall securities in the money market are the most prevalent?

A 
Type 1: Bank accepted bills (BABs)- both the borrower and the acceptor promise to redeem the security 
Type 2: Promissory notes: 
     a) NCDs 
     b) Treasury notes 
     c) Commercial paper 
Most prevalent: BABs and NCDs
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10
Q

Who are NCDs and Treasury notes and commercial papers issued by?

A

1) NCDs- issued by banks
2) Treasury notes- issued by the Commonwealth Government through a competitive tender (risk free- so trade below the BBSW- 10% of the markets securities)
3) Commercial paper: Issued y low-risk borrowers through a dealer panel (state governments, public enterprises, companies)

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11
Q

What is a repurchase agreement?

A

Agreement to sell securities on the basis that they are repurchased at a later date at an agreed price

  • Provides short-term finance for the seller from the provider for the period of the agreement
  • Can be intra day of for a number of months
  • Also used by RBA
  • Round trip- sell and then buy back transactions within the same day
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12
Q

What type of market is the money market?
Who operates in the market and how do they trade?
How are bids and offers quoted?
- How do dealers make a profit in relation to bid a and quote yields?

A

Wholesale, OTC market
Dealers operate in this market, and quote their bid (buy) and offer (sell) yields.
The main dealers are major banks, foreign owned banks, investment banks and merchant banks
Bid (Buy) and offers (sell) are quoted in yields
- Bid high yield
- Sell low yield

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13
Q

Who operates the clearinghouse for the money market? What type of settlement are transactions within this particular market?

A

Austraclear- arranges RTGS settlement on the same day (T+0) basis
Morning trades- are settled in the afternoon, and afternoon trades and settled the next morning

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14
Q

How do dealers within the money market make money (four ‘factors’)

A

1) Hold an inventory of securities and earn interest and trading income
2) Buy low and sell high (will mean buying with high yield, selling with low yield)
3) Attract trades by setting competitive quotes and ‘shade’ quotes to stay competitive
4) Quotes are private and for that call only

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15
Q

What are the two formulas we use when determining the investment yield?

A

1) Present value formula

2) Return formula

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16
Q

What are the two components in the ‘holding period yield’?

A

1) Capital gain/ loss component:
If sold at a higher yield= loss
If sold at a lower yield= profit
2) Interest component

17
Q

How do we calculate the capital gain and interest components of the holding period yield?

A

Capital Gain= Actual sales price less the price if INTEREST RATES STAYED THE SAME
Interest= The change in the value of the security over the same time period, if the yield remained at the same amount, over the time period the security was held for

18
Q

What is a bond?

A

Long term security that makes regular interest payments (coupons) and pays its face value at maturity

19
Q

What are the four types of bonds?

A

1) Debentures- issued as secured retail bonds
2) Convertible bonds- converted into issuer’s shares
3) Floating rate notes- medium-term bonds which coupon payment is based on the reference rate
4) Treasury bonds- issued by the Australian office of financial management (AOFM) on behalf of the Commonwealth Government

20
Q

What type of a market is the bond market?

A

Wholesale, OTC type of market

21
Q

Who are the main issuers of bonds in Australia (3 categories)

A

1) Commonwealth government
2) State government
3) Non- government borrowers

22
Q

How do bonds contribute to the flow of funds?

A

Enable wholesale borrowers to raise large sums for long terms
Enables wholesale investors with access to a defensive asset class:
- more risk than share, less risky than shares
- Low credit risk
- Market risk= changes in yields

23
Q

How does the bonds market contribute to price discovery? What are the two specific areas the bond market assets in?

A

Reveals long- term interest rates

1) Default free interest rates= 3 year and 10 year yields being bench market rates (treasury bond market is liquid and enhances the quality of price discovery)
2) Credit risk premium= Trading in semi-government and non- government bonds revels the size of the credit risk.

24
Q

What does credit spread show (in relation to credit risk premium)

A

The margin above the default free rate a borrower has to pay because of their credit rating

25
Q

What are the trading and settlement arrangements in the bonds market?

A
  • Dealers are market makers that operate according to AFMA protocols.
  • Trade with each other and wholesale clients
  • Standard parcel size= $10m
  • Dealers quote bid and offer yields on a semi annual compound basis
  • Settlement is arranged by Austraclear on a T+3 RTGS basis
26
Q

What are the three segments of Australian bond issues?

A

1) Treasury bonds (issued by AOFM on behalf of Comm. Government)
2) Semi- government bonds (issued by state borrowing authorities)
3) Non- government bonds (issued by finanicals- ADIs, kangaroo bonds (non- residents), non- financial companies)

27
Q

Do treasury bonds or semi- government bonds have a higher yield?

A

Semi- government

28
Q

What does a AAA rating and a CCC rating indicate?

A

AAA= Lowest degree of risk CCC, substancial risk

29
Q

How are bond investment yields calculated?

A
  • Semi- annual compound rate- coupons are paid 2 times per year on a date and months that align with the bond’s maturity date
  • Bonds are prices per $100 of face value, 6DP
30
Q

What is the difference between ex and cum interest dates?

A

One week before coupon paid, coupon is assigned to the then holder.

  • Bond trades as ex- interest until after coupon date (will not include next coupon payment)
  • All others are cum dividends
31
Q

When will bonds be traded at a premium?

A

Coupon rate exceeds the market yield

32
Q

When will bonds be at a discount ?

A

When the yield is higher than the bonds coupon rate

33
Q

What formula is used to determine the price when bonds are bought?

A

PVAF and PV formulas

34
Q

What formula is used to determine the reinvestment amount?

A

Future Value formula

35
Q

Which formula is used to determine the return?

A

Price sold + dividends reinvested/ price bought for

Finance (10 decks)

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