Money Markets Flashcards
What does the yield curve show?
Bonds with low maturities have low yields.
Upwards sloping curve, concave and plateaus.
When can a yield curve invert?
Short term interest rates are above long term interest rates- tends to happen with recessions
What are money markets?
Markets in which short-term instruments (MMIs) are traded.
What is meant by short-term instruments?
Less than 1 year of original maturity
What type of markets are these sold on?
Primary and secondary market
Are money market instruments high risk, why?
Low risk because of the short-term nature
Do short term instruments pay coupons? How is interest paid?
No
Interest is paid when the instruments matures
What happens to the market price of a short-term bond over time?
The market price converges on the maturity value of the instrument as maturity approaches
Why does the rate of return and price calculation of bonds differ between countries?
How do we compare these rates?
UK year is 365 compared to US and Europe assume a 360-day year.
i(UK) = i(US) x (365/360)
What two ways do MMIs get their rate of return quoted?
As an interest yield
As a discount rate
Add flashcards for calculation
What are treasury bills?
Securities issued by the governent with initial maturities of 3 months, 6 months and a year.
What are treasury bills issued at?
A discount
What are commercial bills?
Same as TBs but issued by large firms
What are certificates of deposit?
Certificates of ownership of large time deposits. Can be traded.
What are interbank deposits?
Large deposits owned by banks made at other banks for short periods. often over night or a 7 day period
What is a repo?
Repurchase agreement- Sale of a security with a promise to repurchase it in the future at a specified price
Who are the issuers of MMIs?
Banks
Eurobanks and Eurocurrency markets
Corporations
Government
Who are the main holders of MMIs?
Banks
Corporations
Households
Pension funds
How are households holders of MMIs?
Mutual funds/unit trusts that are funds with lots of different assets and you can buy a few shares in them. Diversification is already done for you.
In the event of a general liquidity shortage amongst commercial banks, what does the central bank do?
CB becomes a monopoly supplier of liquidity. Sets price or quantity.
May offer to buy TBs from banks, but as a monopoly buyer, it can set the price that it will pay.
Repos.
What does the CB setting the price of TB do?
Sets the rate of interest at which the CB is providing liquidity
What is the corridor system of interest rate setting?
The Bank sets an official rate in the gilt repo market.
Commercial banks are expected to hold a target level of reserves with the Central Bank, remunerated at the mpc rate.
The corridor created by the standing facilities was intended to limit fluctuations in LIBOR by arbitrage.
The corridor is in effect LIBOR plus or minus 1%.
How do assets differ?
Term, interest, quotation, currency, registration and negotiability.
What is meant by the registration of an asset?
whether ownership is registered or whether possession is sufficient evidence (‘bearer security’)
What is meant by the negotiability of an asset?
Whether it can be traded on a secondary market
What are discount assets?
Include Treasury and commercial bills and commercial paper, whose return is quoted on a discount basis. They are traded on the discount market
Look at formula on asset pricing on money markets
What are certificates of deposit (CDs)?
A certificate, where a deposit has been made with a bank for a fixed period of time at the end of which it will be repaid with interest
What does a buyer of a CD acquire?
A claim on a sum which becomes available on a specified future date
What does the current price of a CD depend partly on?
Its maturity
What does a repurchase agreement require?
The borrower to sell an asset to a lender for a specified period with the promise to repurchase at the end of the period for a price which exceeds the selling price.
What asset do repos most commonly occur in?
Government bonds
What is Eurocurrency?
Any currency other than the domestic currency
What are the majority of eurocurrency instruments?
Bank deposits
What is the major traded instrument in eurocurrency markets?
CD
What do eurocurrency markets provide?
Another means of short-term lending/borrowing
What are the reasons for the creation of eurocurrency markets?
- In the 1960s, the communist bloc was reluctant to hold US$ in the United States.
- In 1963, ‘Regulation Q’ and interest equalisation tax in the United States limited interest rate payable on US deposits and increased the costs of borrowing.
- In 1973, oil price rise gave OPEC large $ earnings which they kept outside the United States.
- In the 1980s, there was rapid growth of world trade. Euromarkets used to finance growth in world trade.
- In 1981, International banking facilities set up to allow US banks to have own Eurobanks in US.
What are the potential problems with eurocurrency markets?
- The lack of regulation makes them more risky.
- Their lack of regulation has meant that countries have felt the need to deregulate own financial markets, some times too far. i.e. Sweden
- Could lead to loss of control over domestic money supply, causing inflation.
- Used to provide short-term capital requirements, short-term capital movements across countries often felt to cause currency volatility.
What requirement do Eurobanks not have?
Reserve requirements
What type of insurance do Eurobanks not require?
Deposit insurance
How do Eurobanks differ to domestic banks in terms of staff?
Fewer staff involved in compliance
What does the no reserve requirements and no deposit insurance result in for Eurobanks?
Smaller loan-deposit spreads in eurobanks
Because of the size of the depsoits and loans in Eurobanks, what can they benefit from?
Economies of scale
Who do Eurobanks tend to lend to?
Most lending is to high quality customers, which do not require high levels of research into their creditworthiness.
Do domestic authorities have any control over the Eurobond market? How?
Domestic authorities do have some control over the Eurobond markets, as can change terms of banking license.
Who are Northern Rock?
Originally a building society formed in 1965 to provide mortgage finance to the North East, following the merger of two smaller building societies.
What act was established in 1986?
The Building Societies Act
What was the Building Society’s Act of 1986?
They were allowed
to demutualise and turn themselves into banks
What was the Building Society’s Act of 1986 followed by and what did the overall act result in?
This was followed in 1994 with more legislation deregulating them. In the 1990s many of them demutualised and became banks in 1997
What did the removal of regulations and the building society’s act do for Northern Rock?
This enabled it to gain access to the money markets. In
particular the interbank markets.
What happened in 2007 to the interbank markets? What happened to Northern rock because of this?
They seized up.
NR became nationalised
What were Northern Rock doing wrong in terms of how it funded its loans?
Moved from funding its loans by deposits from
the retail sector to increasingly using the interbank markets.
Why was funding loans using interbank markets a bad move from Northern Rock?
Its loans were for long-term mortgages, but its funding was very short-term. In 2007 the interbank markets seized up and these short-term
funds could no longer be rolled over.
In September of 2007, what did the Bank of England do?
Injected 10 billion pounds
into the banking system.
