The debt market

Question 1

What is the relationship between price and YTM?

Answer 1

1. The value of a bond (price) and yield to maturity (YTM) are negatively related.
2. If the interest rate 𝑖 increases (YTM increases), the PV of any given cash flow is lower; hence, the price of the bond must be lower.

Question 2

What does current yield signify?

Answer 2

A change in the current yield always signals change in same direction as yield to maturity

Question 3

Who participates in the money market? (7)

Answer 3

1. US treasure department
2. Fed reserve system- monetary policy reasons
3. Commercial banks
4. Businesses
5. Investment/finance/insurance companies
6. pension funds
7. individuals

Question 4

What are the different money market instruments? (6)

Answer 4

• Treasury Bills
• Repurchase Agreements
• Commercial Paper
• Negotiable Certificates of Deposit
• Federal Funds
• Eurodollars

Question 5

What are treasury bills?

Answer 5

Debt securities issued by the US Treasury to cover government budget shortfalls: sold at face value.

• very liquid
• default, risk free
• maturities often
• don’t pay interest sold at a discount

Question 6

What are REPO? (5)

Answer 6

1. Essentially a form of collateralized short- term borrowing.
2. A firm sells securities, but agrees to buy them back at a certain date for a certain price.
3. Can be done by banks and nonbanks. Usually done by large dealers in government securities, bond trading desks etc.
4. The collateral is usually government securities with very high quality, but can be done with other securities as well.
5. Repos played an important role in the 2008 global financial crisis (we will return to this later).

Question 7

What is the haircut?

Answer 7

The difference between the amount loaned and the value of the collateral is called the haircut

Question 8

What is commercial paper? (3)

Answer 8

1. Issued by corporations.
2. Maturities: up to 270 days.
3. The use of commercial paper increased significantly in the early 1980s because of the rising cost of bank loans.

Question 9

What are negotiable certificates of deposit?

Answer 9

is a bank-issued security that documents a deposit and specifies the interest rate and the maturity date

Question 10

What are fed funds? (3)

Answer 10

1. short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day.
2. Used by banks to meet short-term needs to meet reserve requirements
3. Banks with excess reserves (i.e., whose reserves exceed their required reserves) will typically lend funds (generally overnight) to banks in need of reserves.
   - The name comes from the fact that the funds are held at the banks’ accounts with the Federal Reserve bank.
   - he rate of interest (or price) on these interbank transactions is a benchmark interest rate called the federal funds rate or simply fed funds (rate).

Question 11

What are eurodollars?

Answer 11

1. Eurodollars represent Dollar-denominated deposits held in foreign banks.
2. The market is essential since many foreign contracts call for payment is U.S. dollars due to the stability of the dollar, relative to other currencies.

Question 12

What is the London interbank market? (3)

Answer 12

1. Some large London banks act as brokers in the interbank Eurodollar market, quoting rates at which they are willing to lend.
2. This market is used by banks around the world as a source of overnight funding.
3. The rate paid by banks buying funds is the London interbank bid rate (LIBID); fund are offered for sale at the London interbank offer rate (LIBOR).