Lesson 2.7: Money Markets and Bank Accounts Flashcards
Money market investments consistently fulfill all these roles within a client’s portfolio:
A) serve as a short-term home for cash balances.
B) serve as an alternative to bonds and equities in a multi-asset class portfolio to lower the overall volatility.
C) earn higher returns than cash.
Money market investments can fulfill a number of roles within a client’s portfolio, including
short-term allocation for cash balances;
serving as an alternative to bonds and equities in a multi-asset class portfolio to lower the overall volatility of the portfolio; and
serving as part of the asset allocation strategy to get higher returns than they would receive on cash.
A bank is advertising a no-cost DDA. Your client asks you to describe what that is. You would respond that DDA stands for:
the most common definition of a DDA is demand deposit account, better known as a checking account.
Money market instruments are:
short-term debt.
Money market instruments are high-quality debt securities with maturities that do not exceed one year.
A client plans to purchase a home within the next three months and will require $100,000 for the down payment. The client has the money in her DDA and asks you for your recommendation as to the best place to put the money. Your recommendation would probably be for the client to:
keep the money where it is.
DDA stands for demand deposit account, usually a checking account at a bank. Because this client cannot afford any risk to principal, and the bank account is covered by FDIC insurance, this is the most attractive option. The 1-year CD would offer more income, but there would likely be a penalty for early withdrawal. Even though the GNMA is directly backed by the U.S. government, it is subject to market fluctuation, a risk this client cannot take.
Which of the following are not considered money market instruments?
I. American depositary receipts
II. Commercial paper
III. Corporate bonds
IV. Jumbo (negotiable) certificates of deposit
I and III
A money market instrument is a high-quality, short-term debt security with maturity of one year or less. American depositary receipts (ADRs) are equity, and corporate bonds are long-term debt instruments.
The following are true of negotiable, jumbo certificates of deposit:
A) they usually have maturities of one year or less.
B) they are readily marketable.
C) they are usually issued in denominations of $100,000 to $1 million or more.
Negotiable CDs are general obligations of the issuing bank; they are not secured by any specific asset. They qualify for FDIC insurance (up to $250,000), but that is not the same as stating that the bank has pledged specific assets as collateral for the loan.
Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are usually traded in blocks of $1 million or more.
The value of which of the following would be least likely to be impacted by changes in interest rates?
A) A bank CD maturing in 5 years
B) A U.S. Treasury bond issued 25 years ago with a 30-year maturity
C) A convertible preferred stock
D) A laddered bond portfolio
A) A bank CD maturing in 5 years]
This question is dealing with interest rate (or money-rate) risk. That risk refers to the inverse relationship between the price of fixed-income investments and interest rates. That is, when interest rates go up, the price of fixed-income securities falls (and vice versa). However, this risk only affects investments that are marketable (those with a fluctuating market price). Bank CDs are nonnegotiable (we’re not referring to the negotiable jumbo CDs with a maturity of one year or less) and, as a result, will not fluctuate in price, regardless of changes to interest rates. In this case, interest rate risk is eliminated. That is one of the reasons why the exam’s first choice for capital preservation is insured bank CDs. Will a laddered bond portfolio reduce interest rate risk? Yes, but it will not eliminate it. Is a convertible preferred (or bond) less subject to changes in interest rates than one without the conversion feature? Yes, but the risk is still there. Does a 30-year T-bond with 5 years remaining to maturity have a short duration and, therefore, a reduced interest rate risk? Yes, but the price of the bond will still be affected by changes in the market interest rates.
What rate of interest would a bank in England charge another British bank for a short-term loan?
——————————————————————————-A European corporation seeking a short-term loan would probably be most concerned about an increase to?
short-term borrowing rates. Also known as
Secured Overnight Financing Rate (SOFR)
For more than 40 years, the London Interbank Offered Rate—commonly known as LIBOR—was a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages, and corporate debt. Over the last decade, LIBOR has been burdened by scandals and crises. Effective January 2022, LIBOR is no longer being used to issue new short-term loans in the U.S. It was replaced by the Secured Overnight Financing Rate (SOFR) which many experts consider a more accurate and more secure pricing benchmark.
As is always the case with NASAA, we do not know when the exam questions will be updated. One thing we can promise you is that any question relating to this topic will not have both LIBOR and SOFR as choices, so you should choose whichever one appears.
Stock mutual funds:
The redemption period for mutual funds is seven days.
Life insurance cash values:
Life insurance cash values can take 30 days or longer to cash out.
Which of the following are characteristics of negotiable jumbo CDs?
I. Issued in amounts of $100,000 to $1 million or more
II. Typically pay interest on a monthly basis
III. Always mature in one to two years with a prepayment penalty for early withdrawal
IV. Trade in the secondary market
I & IV
Negotiable jumbo CDs are issued for $100,000 to $1 million or more and trade in the secondary market. Most jumbo CDs are issued with maturities of one year or less. Being negotiable, there is no prepayment penalty. These CDs generally pay interest on a semiannual basis, not monthly.
Which of the following is unlikely to be issued at a discount?
A) Commercial paper
B) Treasury bill
C) Zero-coupon bond
D) Jumbo CD
D) Jumbo CD
Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing.
An individual purchases a $10,000 CD with a 5-year maturity from her local bank branch. In doing so, she is eliminating:
Interest rate risk is the uncertainty that changes to market interest rates will cause the price of an investment to fluctuate in value. Because this type of bank CD is nonnegotiable (it doesn’t trade), changes to interest rates do not impact the principal value of the investment—she can always redeem the CD for $10,000 (although there could be a penalty for early withdrawal). As a fixed-income investment, though, it does suffer from purchasing power risk, also known as inflation risk, and the investor has the opportunity cost of settling for a lower rate of return than could potentially be obtained with equities.
Characteristics of commercial paper?
A) It represents a loan by the holder to the issuer.
B) It is commonly issued to raise working capital for a corporation.
C) Negotiated maturities and yields
D) NOT registered with the SEC
Commercial paper instruments are debt securities; they represent loans to the issuing corporation by the holder. They are commonly issued to raise working capital and, as debt obligation, are senior in preference to preferred stock in claims against an issuer.
Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Most commercial paper is sold to institutions, and the borrower and lender negotiate the terms. Those terms include the interest rate (the yield because they’re discounted) and whether these are overnight, 30-day, or longer maturities. Because commercial paper is issued with maturities of no more than 270 days, it is exempt from registration under the Securities Act of 1933.
A money market mutual fund would be least likely to invest in which assets?
Newly issued U.S. Treasury notes
A money market mutual fund typically invests in money market instruments—those with a maturity date not exceeding 397 days. Treasury notes are issued with maturity dates of 2–10 years.
