Short term Lending and borrowing instruments Flashcards
Money market is
not a physical location; it is a virtual market place made up of electronic communications between banks, dealers and major corporations.
Basis upon which Money market operates:
a “wholesale” level,
with individual transactions of tens or hundreds of million pounds sterling.
mostly discounted quotes
also collective investment vehicles (“money market funds”)
offering access to the money market for individuals and small companies.
three basic ways for investors to access the money markets:
- directly on their own account –
⁃ most suitable for large financial firms - hire a professional investment management firm –
⁃ suitable for investors who will make transactions of large amounts
⁃ but who don’t have the expertise to deal in the market themselves - via a money market fund –
⁃ these provide a diversified holding
⁃ of money market instruments
⁃ and are most suitable for smaller investors.
Distinction is often made between domestic and international money markets.
The latter consists of funds
in a particular currency deposited in banks that are located outside that currency’s domestic market
(and are therefore not subject to the regulation and taxation that governs the domestic market).
Quoting MM instruments:
In the UK, money market interest rates are often quoted relative to LIBOR (the London Inter Bank Offered Rate).
is true of currencies other than just sterling,
eg a US bank may be prepared to lend to a US company at “1.5% over LIBOR”.
List the money market instruments introduced in Subjects A201 and A103.
1 Treasury bills 2 local authority bills 3 bills of exchange 4 certificates of deposit (CDs) 5 commercial paper 6 term deposits 7 call deposits.
Factors influencing the spreads of money market rates will include :
- default risk and
2. market liquidity.
Most money market securities operate on a
discount basis; do not pay explicit interest but rather generate returns by the difference between the purchase price and the maturity proceeds.
return is in the form of
a capital gain and
there is no explicit income payment.
taxation authorities
will generally
regard the returns as income,
and tax it accordingly.
Give 2 reasons why the risk of default is generally less for money market instruments issued by a company than for corporate bonds issued by the same company.
Reasons are:
1 The short-term future is more certain than the long-term future.
Investors can be more confident that a particular company
will survive a few weeks than they can
that it will survive the next twenty years.
2 Only the more reliable companies
⁃ can borrow using short-term instruments
⁃ such as commercial paper.
Example of MM instrument
A 3-month Treasury bill is being issued at an annual (simple) discount rate of 4%. Therefore, an investor would pay $99 at issue for each $100 nominal.
Lending in money markets
money markets provide a means for institutions (or individuals)
with excess short- term cash to
make a return on that cash.
The institutions involved in short term lending include :
banks, companies and national and local governments and government agencies.
The available investments for short term lending are:
1 Treasury bills
2 commercial paper
3 repos
4 government agency securities
5 bank time deposits and certificates of deposit
6 bankers’ acceptances and eligible bills.
major forms of money market investment in most markets are:
1 Treasury bills,
2 commercial paper and
3 repo agreements
Treasury bills
most economies major issuer of money market instruments is national government. Bills issued by the government are usually known as Treasury bills and are typically issued in 3-month (91-day), 6-month (182-day) and one-year forms.
