Quiz #2 Jargon Flashcards
Money Market Mutual Funds (MMMFs)
Securities offered by companies that invest in other money market instruments including commercial paper, certificates of deposit, treasury bills, and repos
Why did financial institutions create MMMFs
To compete with banks. Gives investors a high-yield option to bank depositors.
What do MMMFs invest in (type of investment)?
Low-risk returns on high-quality, short-term investments
What is MMMF regulated under?
The SEC and the Investment Company Act of 1940
What do MMMFs do?
Fund pool assets and provide investment returns to the capital of the pool
NAV
Net Asset Value
What can MMMFs do with their NAV?
Allowed to maintain $1 NAV if the value of the assets >$0.995/share
Why is a MMMF safer than a Bank?
- Low asset-liability mismatch (short-term vs. long-term loans)
- MMMF assets are very high quality (T-bills, repo, commercial paper. Banks invest in risky mortgages, construction loans, etc.)
Why is a Bank safer than a MMMF?
- FDIC insurance
- Access to the Federal Reserve discount window (can have pledged emergency loans from the Fed)
- Banks have an equity buffer to shield depositors from asset losses
4 Types of MMMFs
- Treasury Only
- Treasury (can be through repo)
- Prime Money Market
- Municipal (tax-exempt)
Commercial Paper
short-term, uncollateralized debt issued by (highly rated issuers) banks and corporations as a discount that matures at PAR. [cash-like + rolls over like a repo]
How can MMMFs price their assets?
Through Rule 2a-7, they can price their assets at the amortized cost vs. market value (if they meet certain requirements)
Benefits of Rule 2a-7
- Increased Stability
- Diversification (makes MMMFs diversify their portfolio)
- Liquidity (encourages MMMFs to invest in short-term highly liquid assets)
- Transparency
Community Banks
Banks that hold <$10 billion in assets
Community Bank Special Characteristics (according to FDIC)
- Provides “traditional” banking services in local communities
- Core deposits mainly local - make loans to small businesses
- Operates by leveraging specialized knowledge of local communities/customers
Why are Community Banks less efficient than other financial mechanisms?
- Community Risk
- Concentration Risk
- Idiosyncratic Local Risk
The 3 Rating Agencies
- Standard & Poors (S&P)
- Moody’s
- Fitch
Spot Interest Rate
Today’s Interest Rate for a discount bond
If a bond price goes down, what happens to YTM
YTM goes up (investor can buy bond at a lower price)
What do Rating Agencies do?
Help determine the composition of the capital structure
AAA Liabilities
SPV (special purpose vehicle) Highest paid first 1st. Pay the lowest interest. Funding is lower overall.
The ‘miracle’ of finance
Pooling small, illiquid, subordinate loans and making them AAA
Conflict of Interest in the Rating Market
Bond issuers pays rating agency to rate their bonds. Want ‘investment grade rating’
Investment grade bonds
Class of bonds considered to be clear and safe from default in the near term
Subinvestment grade bonds
Bonds with higher default probability and higher yields to compensate investors
Why are bond rating important?
- Bond rating agencies signal information for investors
- Investors use bond rating when purchasing bonds
- Investors may be restricted from purchasing bonds with low ratings
- Some pension funds mandate a minimum average ratings in its holdings
Treasury Bonds
- Maturity longer than 10 years
- Bonds sold at PAR and pay coupons semi-annually
Treasury Notes
- Maturity 2-10 years
- Sold at PAR and pay coupons semi-annually
Treasury Bills
- Maturity <1 year
- Sold at a discount, pay no coupons, and mature to PAR
Differences between Treasury Notes and Bills
- Duration
- Coupon Rate
