Quiz #2 Jargon

Question 1

Money Market Mutual Funds (MMMFs)

Answer 1

Securities offered by companies that invest in other money market instruments including commercial paper, certificates of deposit, treasury bills, and repos

Question 2

Why did financial institutions create MMMFs

Answer 2

To compete with banks. Gives investors a high-yield option to bank depositors.

Question 3

What do MMMFs invest in (type of investment)?

Answer 3

Low-risk returns on high-quality, short-term investments

Question 4

What is MMMF regulated under?

Answer 4

The SEC and the Investment Company Act of 1940

Question 5

What do MMMFs do?

Answer 5

Fund pool assets and provide investment returns to the capital of the pool

Question 6

NAV

Answer 6

Net Asset Value

Question 7

What can MMMFs do with their NAV?

Answer 7

Allowed to maintain $1 NAV if the value of the assets >$0.995/share

Question 8

Why is a MMMF safer than a Bank?

Answer 8

1. Low asset-liability mismatch (short-term vs. long-term loans)
2. MMMF assets are very high quality (T-bills, repo, commercial paper. Banks invest in risky mortgages, construction loans, etc.)

Question 9

Why is a Bank safer than a MMMF?

Answer 9

1. FDIC insurance
2. Access to the Federal Reserve discount window (can have pledged emergency loans from the Fed)
3. Banks have an equity buffer to shield depositors from asset losses

Question 10

4 Types of MMMFs

Answer 10

1. Treasury Only
2. Treasury (can be through repo)
3. Prime Money Market
4. Municipal (tax-exempt)

Question 11

Commercial Paper

Answer 11

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]

Question 12

How can MMMFs price their assets?

Answer 12

Through Rule 2a-7, they can price their assets at the amortized cost vs. market value (if they meet certain requirements)

Question 13

Benefits of Rule 2a-7

Answer 13

1. Increased Stability
2. Diversification (makes MMMFs diversify their portfolio)
3. Liquidity (encourages MMMFs to invest in short-term highly liquid assets)
4. Transparency

Question 14

Community Banks

Answer 14

Banks that hold <$10 billion in assets

Question 15

Community Bank Special Characteristics (according to FDIC)

Answer 15

1. Provides “traditional” banking services in local communities
2. Core deposits mainly local - make loans to small businesses
3. Operates by leveraging specialized knowledge of local communities/customers

Question 16

Why are Community Banks less efficient than other financial mechanisms?

Answer 16

1. Community Risk
2. Concentration Risk
3. Idiosyncratic Local Risk

Question 17

The 3 Rating Agencies

Answer 17

1. Standard & Poors (S&P)
2. Moody’s
3. Fitch

Question 18

Spot Interest Rate

Answer 18

Today’s Interest Rate for a discount bond

Question 19

If a bond price goes down, what happens to YTM

Answer 19

YTM goes up (investor can buy bond at a lower price)

Question 20

What do Rating Agencies do?

Answer 20

Help determine the composition of the capital structure

Question 21

AAA Liabilities

Answer 21

SPV (special purpose vehicle) Highest paid first 1st. Pay the lowest interest. Funding is lower overall.

Question 22

The ‘miracle’ of finance

Answer 22

Pooling small, illiquid, subordinate loans and making them AAA

Question 23

Conflict of Interest in the Rating Market

Answer 23

Bond issuers pays rating agency to rate their bonds. Want ‘investment grade rating’

Question 24

Investment grade bonds

Answer 24

Class of bonds considered to be clear and safe from default in the near term

Question 25

Subinvestment grade bonds

Answer 25

Bonds with higher default probability and higher yields to compensate investors

Question 26

Why are bond rating important?

Answer 26

1. Bond rating agencies signal information for investors
2. Investors use bond rating when purchasing bonds
3. Investors may be restricted from purchasing bonds with low ratings
4. Some pension funds mandate a minimum average ratings in its holdings

Question 27

Treasury Bonds

Answer 27

1. Maturity longer than 10 years
2. Bonds sold at PAR and pay coupons semi-annually

Question 28

Treasury Notes

Answer 28

1. Maturity 2-10 years
2. Sold at PAR and pay coupons semi-annually

Question 29

Treasury Bills

Answer 29

1. Maturity <1 year
2. Sold at a discount, pay no coupons, and mature to PAR

Question 30

Differences between Treasury Notes and Bills

Answer 30

1. Duration
2. Coupon Rate