Money Market Debt

Question 1

Which money market instrument is issued by corporations?

A. Treasury Bill
B. Repurchase Agreement
C. Commercial Paper
D. Prime Banker’s Acceptances

Answer 1

The best answer is C.

Commercial paper is corporate money market debt which is not eligible for Fed trading. Treasury bills are issued by the U.S. Government. Repurchase agreements are entered into between Government securities dealers; and banker’s acceptances are issued by commercial banks.

Question 2

All of the following statements are true about commercial paper EXCEPT commercial paper:

A. is a funded debt of the issuer
B. matures on a pre-set date and at a pre-set price
C. is quoted on a yield basis
D. is an unsecured promissory note

Answer 2

The best answer is A.

Corporate “funded debt” represents long term debt financing of a corporation with at least 5 years to maturity. Since commercial paper has a maximum maturity of 270 days, it is not a funded debt. Commercial paper is quoted on a yield basis; matures at a pre-set date and price; and is an unsecured promissory note of the issuer.

Question 3

Which statement is TRUE about commercial paper?

A. Commercial paper has a maximum maturity of 90 days
B. Commercial paper can only be issued by commercial banks
C. Commercial paper is quoted on a dollar price basis
D. Commercial paper is quoted on a yield basis

Answer 3

The best answer is D.

Commercial paper is a short term corporate IOU with a maximum maturity of 270 days (if it was longer, it would have to be registered with the SEC). Commercial paper is quoted on a yield basis (as is all money market debt).

Question 4

Which statement is FALSE about commercial paper?

A. Commercial paper has a maximum maturity of 270 days
B. Commercial paper matures on a pre-set date at a pre-set price
C. Commercial paper is quoted on a yield basis
D. Commercial paper is a secured promissory note

Answer 4

The best answer is D.

Commercial paper has a maximum maturity of 270 days. Commercial paper is quoted on a yield basis; matures at a pre-set date and price; and is an unsecured promissory note of the issuer.

Question 5

Commercial paper can be issued for all of the following maturities EXCEPT:

A. 14 days
B. 30 days
C. 90 days
D. 360 days

Answer 5

The best answer is D.

Commercial paper is issued by corporations with a duration of anywhere from over 1 to 270 days. The most common is 30 day commercial paper. No maturities longer than 270 days are issued, because then the issue would have to be registered with the SEC and sold with a prospectus. If the issue is 270 days or less, it is exempt from SEC registration and prospectus requirements.

Question 6

Which statement is TRUE about commercial paper?

A. The most common maturity is 10 days
B. The most common maturity is 30 days
C. The maximum maturity is 90 days
D. The maximum maturity is 365 days

Answer 6

The best answer is B.

The most common maturity for commercial paper is 30 days. The maximum maturity is 270 days.

Question 7

Commercial paper with a maturity of 270 days or less:

A. must be registered under the Securities Act of 1933
B. must be registered under the Securities Act of 1934
C. must have a trust indenture
D. is an exempt security

Answer 7

The best answer is D.

Commercial paper is an exempt security under the Securities Act of 1933. It does not have to be registered and sold with a prospectus if its maturity is 270 days or less. This makes it much less expensive for an issuer to market the securities, since the regulatory burden is much lower.

Question 8

Banker’s Acceptances are:

A. time drafts used to finance imports and exports
B. demand deposits used to finance imports and exports
C. time drafts used to finance the issuance of ADRs
D. demand deposits used to finance the issuance of ADRs

Answer 8

The best answer is A.

Banker’s Acceptances are time drafts on a bank used to finance imports and exports. BAs trade at a discount to their face amount until maturity, but the trading market is rather thin.

Question 9

A Prime Banker’s Acceptance is:

A. only sold through prime brokers
B. a security that pays the prevailing prime rate
C. eligible for trading by the Federal Reserve trading desk
D. a low quality issue tied to the prime rate plus a risk premium

Answer 9

The best answer is C.

A prime banker’s acceptance is the highest quality banker’s acceptance and is one which is eligible for trading by the Federal Reserve trading desk in New York.

Question 10

All of the following statements regarding short term negotiable certificates of deposit are correct EXCEPT:

A. the minimum denomination is $100,000
B. short term negotiable CDs are callable
C. trading occurs in the secondary market
D. these securities are issued by banks

Answer 10

The best answer is B.

Short term negotiable CDs are issued by banks in minimum $100,000 denominations. They are non-callable and trade in the secondary market. Note, in contrast, that banks also issue long term negotiable CDs that can be callable.

Question 11

Which of the following money market instruments trades at par plus accrued interest?

A. Banker’s Acceptances
B. Jumbo Certificates of Deposit
C. Commercial Paper
D. Federal Funds

Answer 11

The best answer is B.

Negotiable certificates of deposit (over $100,000 face amount) are issued at par and mature at par plus accrued interest. If they are traded prior to maturity, they trade with the amount of accrued interest due. Banker’s Acceptances, Commercial Paper, and Federal Funds are all original issue discount obligations.

Question 12

Long-term negotiable certificates of deposit are subject to all of the following risks EXCEPT:

A. Interest rate risk
B. Call risk
C. Reinvestment risk
D. Prepayment risk

Answer 12

The best answer is D.

Long-term negotiable Certificates of Deposit (over 1 year maturity) are subject to interest rate risk, as is any fixed rate debt instrument. If market rates go up, the market value of the CD will decline.

Long-term CDs can be callable, so they are subject to call risk in a declining interest rate environment.

Interest is paid semi-annually and, again in a declining interest rate environment, if these payments are reinvested in new CDs, the rate of return on reinvested monies will decline - thus they have reinvestment risk.

Finally, the secondary market for these securities is limited - so they can have marketability risk.

Prepayment risk is typically associated with mortgaged-backed securities such as Ginnie-Mae pass-throughs.

Question 13

A customer buys a Brokered CD for $100,000. Upon receipt of his next account statement, the customer sees that the market value of the CD is shown as $99,800. This would occur because:

A. interest rates have risen
B. interest rates have fallen
C. the broker’s commission for selling the CD has been subtracted out
D. the bank that issued the CD has charged an up-front handling fee

Answer 13

The best answer is A.

If interest rates rise after issuance, the value of the CD in the secondary market will fall. Since the interest rate on the instrument is fixed at issuance, if market interest rates rise, then the price of this instrument must fall to bring its yield up to current market levels.

Question 14

Which statement is TRUE regarding a “step-down” certificate of deposit?

A. The interest payment is fixed
B. The principal payment may be reduced
C. The interest payment may be reduced
D. The security may be “stepped down” to another smaller bank at the issuer’s discretion

Answer 14

The best answer is C.

A “step-down” CD is one that starts with a high introductory “teaser” interest rate. Then the rate “steps down” to the market rate of interest at specified intervals. Regardless, at maturity, the CD is redeemed at par.

Question 15

Which statement is TRUE regarding a Step-Down Certificate of Deposit?

A. Initial payments are made at an interest rate that is above the prevailing prime rate but stepped down to the Treasury rate over time
B. At a predetermined time, the interest rate is decreased to a rate that is at, or below, the market
C. At a predetermined time, the maturity is decreased or “stepped down”
D. At the issuers’ discretion, the interest rate is decreased to a rate that is at, or below, the market

Answer 15

The best answer is B.

This question boils down to the fact that you don’t get something for nothing. With a step-down CD, you start with a higher-than-market “teaser” rate. This is used as an incentive to the client to buy the CD. Then, at a predetermined date, the rate steps down to a lower rate, and this rate is usually a bit lower than the market rate at that time, so that, on average, the investor will still earn the market rate over the life of the CD.

Question 16

A customer wishes to buy a $50,000 certificate of deposit offered by your firm. The customer wishes to know if the CD is FDIC insured. As the broker handling the account, you should tell the customer that:

A. the CD is insured because the amount is less than the $100,000 maximum permitted amount that qualifies for FDIC coverage
B. CDs sold through brokerage firms do not qualify for FDIC insurance regardless of the amount, but they are SIPC insured
C. as long as the CD is titled in the customer’s name and the customer does not have accounts at the issuing bank totaling more than $200,000, then the CD is FDIC insured
D. as long as the CD is held in the custody of an FDIC member bank and the amount is $100,000 or less, then FDIC insurance covers the CD

Answer 16

The best answer is C.

Brokered CDs are sold by brokerage firms that are representing issuing banks. FDIC insurance of $250,000 maximum covers bank deposits - but only if the deposit is titled in the customer’s name. If the CD is titled in the brokerage firm’s name, then the insurance coverage would not apply! This customer wishes to buy a $50,000 CD. As long as the customer does not have deposits at the issuing bank in excess of $200,000 (thus not exceeding the $250,000 maximum FDIC coverage) and the CD is titled in the customer’s name, then the CD would be FDIC insured.

Question 17

All of the following can initiate repurchase agreements with government and agency securities as collateral EXCEPT:

A. Government securities dealers
B. Federal Reserve Banks
C. Federal Home Loan Banks
D. Commercial banks

Answer 17

The best answer is C.

Government securities dealers, Commercial banks, and the Federal Reserve through its open market trading desk, all initiate repurchase agreements. Federal Home Loan Banks sell bonds to obtain funding. With the funds, it buys mortgages from Savings and Loans, making a secondary mortgage market and injecting fresh funds into the S&L’s.

Question 18

All of the following statements are true regarding overnight repurchase agreements EXCEPT:

A. the investment has no liquidity risk
B. the investment has no interest rate risk
C. interest rates charged are most similar to the Federal Funds rate
D. the issuer loses control of the underlying securities for the duration of the agreement

Answer 18

The best answer is B.

Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will “sell” some of its inventory overnight to another dealer, with an agreement to buy the position back the next day. The difference between the sale price and the repurchase price is the interest earned. There is virtually no liquidity risk, since the loan is of the shortest term and is secured by pledged government securities. The interest rate on such agreements generally parallels and is somewhat lower (since the loans are secured) than the Fed funds rate, since overnight loans using government securities are most similar to overnight loans of reserves (Fed Funds) from bank to bank. Since government securities are pledged as collateral, the dealer gives up custody of the securities overnight.

Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth! If the borrower of the funds defaults, the lender can sell the collateral - but it will still be worth less than the original loan amount!

Question 19

Which statement is TRUE regarding repurchase agreements?

A. Repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory
B. Repurchase agreements are initiated by the Federal Reserve to tighten the money supply
C. Reverse repurchase agreements enhance the liquidity of the dealer
D. If a repurchase agreement extends for longer than overnight, the agreement is known as a “Due Bill” repurchase agreement

Answer 19

The best answer is A.

Under a “repurchase agreement,” a government securities dealer sells some of its inventory to another dealer or to the Federal Reserve, with an agreement to buy back the securities at a later date for a pre-established price. In this manner, the dealer gets a temporary inflow of cash which loosens the money supply. Since government dealers finance their inventory, by reducing the amount of inventory on hand, they are reducing inventory finance charges when such an agreement is employed.

Under a “reverse repurchase agreement,” the dealer is buying securities from the Federal Reserve (instead of selling), draining the dealer of cash. Under any repurchase agreement, the underlying government securities are the collateral. The collateral that underlies the agreement must be transferred from seller to buyer to support the transaction. In the “good old days,” dealers could do repurchase agreements that were backed by a promise to deliver the underlying securities (a “due bill” for the securities) instead of making physical delivery. Due bill repurchase agreements are no longer permitted.

Question 20

Which statement is FALSE regarding repurchase agreements?

A. Repurchase agreements typically mature in 1 to 90 days
B. Repurchase agreements are used by the Federal Reserve to influence money supply levels
C. Investors in repurchase agreements have no interest rate risk
D. Investors in repurchase agreements have no price risk

Answer 20

The best answer is C.

Repurchase agreements are used by the Federal Reserve to inject funds into the money supply. The agreement stipulates that the Fed buy government securities from the dealer’s inventory, with an agreement to sell back those securities at a pre-agreed price (hence there is no price risk) at a pre-set future date. The dealer gets a temporary infusion of cash, which the dealer can use to buy other securities or (if the dealer is a bank) which may be loaned to someone else.

Most repos are “overnight,” though durations can extend for longer periods. Repos expose the dealer to interest rate risk because, even though the agreement stipulates that the securities will be repurchased at a pre-agreed price; if interest rates rise substantially, the actual value of those repurchased securities can fall dramatically. When the dealer attempts to resell the securities, it can incur a substantial loss.

Question 21

Which statement is TRUE regarding overnight repurchase agreements?

A. A dealer who needs cash will “sell” some of its inventory overnight to another dealer and is subject to interest rate risk
B. A dealer who needs cash will “sell” some of its inventory overnight to another dealer and is not subject to interest rate risk
C. A dealer who needs cash will “buy” some of its inventory overnight to another dealer and is subject to interest rate risk
D. A dealer who needs cash will “buy” some of its inventory overnight to another dealer and is not subject to interest rate risk

Answer 21

The best answer is A.

Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will “sell” some of its inventory overnight to another dealer, with an agreement to buy the position back the next day.

Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth!

Question 22

All of the following statements are correct regarding overnight repurchase agreements EXCEPT:

A. the seller loses control of the underlying securities for the duration of the agreement
B. the interest rate charged is most similar to the Federal Funds rate
C. the investment has interest rate risk
D. the investment has liquidity risk

Answer 22

The best answer is D.

Overnight repurchase agreements are typically effected between government securities dealers. A dealer who needs cash will “sell” some of its inventory overnight to another dealer, with an agreement to buy the position back the next day. The difference between the sale price and the repurchase price is the interest earned. There is virtually no liquidity risk, since the loan is of the shortest term and is secured by pledged government securities.

The interest rate on such agreements generally parallels and is somewhat lower (since the loans are secured) than the Fed funds rate, since overnight loans using government securities are most similar to overnight loans of reserves (Fed Funds) from bank to bank. Since government securities are pledged as collateral, the dealer gives up custody of the securities overnight.

Repos do have interest rate risk, relating to the underlying securities. If interest rates rise, the underlying securities can decline in value. Since the maturity of the underlying securities can be of any length, long maturity values may decline more than the accrued interest to be earned on the agreement. When the borrower of the funds buys back the securities the next day at the pre-agreed price, it buys back securities at more than they are worth!

Question 23

Which statement is TRUE regarding repurchase agreements effected between the public and government securities dealers?

A. The public customer is the seller of the government securities
B. The dealer is losing liquidity
C. The public customer is the lender of monies
D. The dealer is obligated to sell the securities back at a later date

Answer 23

The best answer is C.

When a government dealer enters into a repurchase agreement with the public, the dealer is “getting liquid” by selling government securities to the customer, with an agreement to buy them back at a later date. Thus, the customer is lender of cash to the government dealer.

Question 24

To loosen credit the Federal Reserve will:

A. sell U.S. Government securities to bank dealers with an agreement to buy them back at a later date
B. buy U.S. Government securities from bank dealers with an agreement to sell them back at a later date
C. sell Foreign Government securities to bank dealers with an agreement to buy them back at a later date
D. buy Foreign Government securities from bank dealers with an agreement to sell them back at a later date

Answer 24

The best answer is B.

To inject cash into the money supply, the Fed will enter into a repurchase agreement where the Fed buys the “paper” from the dealer backed by eligible securities, with an agreement to sell it back at a later date. The bank then gets cash which it can lend out.

Question 25

Which of the following actions by the Federal Reserve will tighten credit?

A. Repurchase Agreement
B. Buy securities from dealers
C. Matched Sale
D. Expand the money supply

Answer 25

The best answer is C.

To tighten credit, the Federal Reserve will sell government securities to bank dealers (draining the dealers of cash that could be lent out) with an agreement to buy them back at a later date. The sale is being “matched” to a future purchase and is used to temporarily drain cash from the credit markets. This is called a reverse repo or matched sale. Any expansion of the money supply would loosen credit and push down interest rates.

Question 26

Which statement is TRUE when the Federal Reserve enters into a reverse repurchase agreement with a U.S. Government securities dealer?

A. The Fed buys U.S. Government securities from the dealer and is loosening credit in the banking system
B. The Fed buys U.S. Government securities from the dealer and is tightening credit in the banking system
C. The Fed sells U.S. Government securities to the dealer and is loosening credit in the banking system
D. The Fed sells U.S. Government securities to the dealer and is tightening credit in the banking system

Answer 26

The best answer is D.

In a reverse repurchase agreement, the Fed sells government securities to a dealer (taking cash from the dealer) and will buy them back at a later date. This withdraws cash from the banking system, tightening credit.

Question 27

Which statement is TRUE regarding reverse repurchase agreements between the Federal Reserve and a primary bank dealer?

A. The primary bank dealer is the buyer of the underlying securities
B. The primary bank dealer is gaining reserves
C. The Federal Reserve is the buyer of the underlying securities
D. The Federal Reserve is adding liquidity to the system

Answer 27

The best answer is A.

OkIn a reverse repurchase agreement, the Federal Reserve drains reserves from dealer banks, tightening credit. It does this by selling eligible securities to the banks, who buy them for cash. Thus the banks are drained of excess cash and credit levels are reduced.

Question 28

Federal Funds are overnight loans of reserves from:

A. Federal Reserve to broker-dealers
B. broker-dealers to Federal Reserve
C. commercial bank to broker-dealer
D. commercial bank to commercial bank

Answer 28

The best answer is D.

Federal Funds are overnight loans of reserves from commercial bank to commercial bank. The “effective” rate is an average rate for selected banks across the United States. Thrifts cannot loan Federal Funds, nor can all primary dealers, since many of these firms are broker-dealers, not commercial banks.

Question 29

Eurodollar deposits are:

A. denominated in foreign currency and held in banks in foreign countries
B. denominated in U.S. currency and held in banks in foreign countries
C. denominated in U.S. currency and held in banks in the U.S.
D. denominated in foreign currency held in banks in the U.S.

Answer 29

The best answer is B.

Eurodollar deposits are U.S. currency held in banks in foreign countries, mainly in Europe. The Eurodollar market is centered in London - and the interest rate paid on these deposits is “LIBOR” = London Interbank Offered Rate.

Question 30

All of the following securities are eligible for trading by the Federal Reserve EXCEPT:

A. Treasury Bills
B. Bond Anticipation Notes
C. U.S. Government Bonds
D. Federal Home Loan Bank Bonds

Answer 30

The best answer is B.

The Federal Reserve trading desk can trade securities issued by the U.S. Government, Government Agencies, and prime Banker’s Acceptances. Bond Anticipation Notes are municipal issues. They are not eligible for Fed trading.

Question 31

All of the following securities can be purchased on margin EXCEPT:

A. Treasury bills
B. Structured products
C. Bankers’ acceptances
D. Commercial paper

Answer 31

The best answer is C.

Because money market instruments are “safe,” they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds, and listed stocks are the marginable securities.

As a general rule, structured products cannot be margined because they are not readily transferable.

Question 32

Commercial paper is a(n):

A. money market instrument that is considered funded debt
B. money market instrument that is considered unfunded debt
C. capital market instrument that is considered funded debt
D. capital market instrument that is considered unfunded debt

Answer 32

The best answer is B.

Commercial paper is a short term money market instrument. Short term debts are said to be “unfunded” debts. Long term debts are said to be “funded” (as in a “long term funding”).

Question 33

The purchase price of each of the following can be negotiated EXCEPT:

A. Treasury Bill
B. Certificate of Deposit
C. Banker’s Acceptance
D. U.S. Savings Bonds

Answer 33

The best answer is D.

U.S. Savings Bonds are not negotiable. All of the other securities listed trade and thus, are all “negotiable.”

Question 34

Which securities will trade with accrued interest?

A. Negotiable Certificates of Deposit
B. Treasury Bills
C. Banker’s Acceptances
D. Treasury Receipts

Answer 34

The best answer is A.

Negotiable CDs that mature in 1 year or less are issued at par and mature with accrued interest. Those issued for longer periods pay interest semi-annually and trade with accrued interest. The other choices are all original issue discount obligations, which trade flat.

Question 35

Trades of all of the following will settle in Fed Funds EXCEPT:

A. Prime Banker’s Acceptances
B. Treasury Bills
C. Treasury Bonds
D. Prime Commercial Paper

Answer 35

The best answer is D.

Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations, and Prime Banker’s Acceptances. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in “Fed Funds.” Corporate securities such as commercial paper are not eligible for trading and settling through the Federal Reserve system; trades of these securities settle in “clearing house” funds.

Question 36

Trades of all of the following securities will settle in Fed Funds EXCEPT:

A. Treasury Bills
B. Treasury Notes
C. Municipal Bonds
D. Agency Bonds

Answer 36

The best answer is C.

Securities that are eligible to be traded by the Federal Reserve are those backed by the guarantee of the U.S. Government as well as certain agency obligations. Both Treasury Bills and Treasury Notes are eligible securities. Trades in eligible securities settle through the Federal Reserve system, and therefore settle in “Fed Funds.” Municipal bond trades and trades in corporate securities are not eligible for trading and settling through the Federal Reserve system; these securities settle in “clearing house” funds.

Question 37

All of the following statements are true regarding the Federal Funds rate EXCEPT:

A. The rate is computed every business day
B. The rate is lower than the discount rate
C. The rate is set by the Federal Reserve
D. The rate is charged from one Federal Reserve member bank to another member bank

Answer 37

The best answer is C.

The Federal Funds rate is the interest rate charged by Federal Reserve member banks for overnight loans to each other and is set by market forces. It is computed every day and can change throughout the day. It is lower than the discount rate since the Fed usually pegs the discount rate at 50 basis points over the Fed Funds rate.

The discount rate is charged by the Federal Reserve itself to member banks that wish to borrow reserves directly from the Fed.

Federal Reserve actions such as Open Market Operations strongly influence the Federal Funds rate, but the Fed itself does not set this rate.

Question 38

“LIBOR” is the commonly used term for the:

A. Long Term Bond Offered Rate
B. London Interbank Offered Rate
C. Last-In, Best Offered Rate
D. Lowest Interest Borrowing Offered Rate

Answer 38

The best answer is B.

“LIBOR” stands for the London Interbank Offered Rate which is the rate on which most Eurodollar loans are based. Also, Eurodollar bond offering interest rates are typically based on LIBOR plus a spread. (e.g., - the rate charged on the loan might be LIBOR plus 1 point; or LIBOR + 2 points). Essentially, LIBOR is the European equivalent of the U.S. “Fed Funds” rate.

Question 39

Money market discount instruments are quoted on a:

A. yield basis
B. percentage of par basis in 1/8ths
C. percentage of par basis in 32nds
D. percentage of par basis in 64ths

Answer 39

The best answer is A.

Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned.

Question 40

Which of the following securities would be assigned a “P” (Prime) rating?

A. Commercial Paper
B. Tax Anticipation Note
C. Common Stock
D. Corporate Bond

Answer 40

The best answer is A.

Commercial paper is rated by Moody’s on a P-1,2,3, and NP (“Not Prime”) scale. Municipal short-term notes are rated by Moody’s on an MIG-1,2,3, and SG (“Speculative Grade”) scale. Long-term bonds are rated by Moody’s on an “ABC” scale.