The Money Market Flashcards
What is the money market?
The money market consists of short-term securities under one year to maturity, normally issued in large denominations (over $100,000).
What are Treasury bills?
(money market)
Short-term loans to the government that are zero coupon payments, meaning you receive the face value at maturity.
so you don’t get periodic payments, you get what you gave at the end
The way bond buyers make money is because the government issues them at discount.
How do you earn money from T-Bills?
By paying at a discount to par (less than face value) and receiving the face value at maturity.
They are considered very safe as they are issued by the government.
What is the tax implication of earning from T-Bills?
You have to pay ** taxes on that profit** to the federal government. However, you** don’t have to pay state or local taxes**, which makes T-Bills more tax-efficient than many other investments.
What is the bank discount method?
An older method to calculate the price of T-Bills that only considers the difference between the purchase price and the face value.
it does not reflect the true YTM
What is a Certificate of Deposit (CD)?
A bank time deposit where you agree to let banks KEEP your money for a fixed period in exchange for interest. You cannot withdraw before maturity without paying a penalty.
What is the FDIC’s role in CDs?
reason why CDs are very safe
CDs are insured up to $250,000 by the Federal Deposit Insurance Corporation, protecting your money in case the bank fails.
What are the two types of CDs?
- Coupon-bearing CDs
- Zero-coupon CDs
What is Commercial Paper?
A short-term debt instrument issued by large corporations to manage short-term liabilities.
Very liquid (easily bought and sold), unsecured
Is commercial paper more suitable for institutional investors or individual? Why?
Institutional investors
Commercial paper is** issued in multiples of $100,000**
How is Commercial Paper similar to T-Bills?
Both are sold at a discount and repaid at full face value at maturity.
CP is like a corporate version of a T-Bill, but it’s riskier because it depends on the company’s creditworthiness, not the government’s backing.
What is a Bankers Acceptance?
A short-term financial instrument where a bank guarantees payment for its customer at a future date (usually within 6 months). If the customer can’t pay, the bank steps in and pays the holder.
It’s like a postdated check backed by the bank.
How does a Bankers Acceptance work?
The bank guarantees payment to the seller if the buyer fails to pay on a specific future date.
The bank gains the fees and interests (if the buyer doesn’t pay)
What happens if the buyer fails to pay on a Bankers Acceptance?
The bank pays the seller and then collects the money from the buyer later.
What are the forms of Bankers Acceptance?
- Very short guaranteed checks
- Documentary Credit
- Letters of Credit
widely used in foreign trade to guarantee payment
What is the liquidity status of CDs?
They are less flexible than regular savings accounts as you cannot withdraw before maturity without a penalty.
CDs over $100,000 are called ———– . What does this mean?
Negotiable CDs
They can be sold to other investors.
However, they are not very liquid
What is commercial paper backed by?
Only the corporation’s promise to pay
it is not backed by any collateral or company assets
What are eurodollars?
U.S. dollar-denominated deposits held in banks outside the United States, regardless of whether those banks are foreign or branches of U.S. banks
the Eurodollar market is HUGE averade $140bn daily
They are normally for large sums (5mn+) and mostly used by banks lending to and borrowing from each other.
What are Money Market Funds?
Mutual funds that invest money in money market instruments
(many people pool their money together to invest in a wide variety of assets)
What are the 3 types of investments in money market funds?
Government (most T Bills and agency securities), prime (corporate) or a combination
What are Broker’s Calls?
not really a money market instrument though
Loans that banks give to brokerage firms. These loans help brokers lend money to their clients who are buying stocks or other securities on margin (which means trading with borrowed money).
These loans can be terminated at any time by the bank. That’s why they’re called “at call” loans, the bank can “call” the loan back whenever it needs to. (bank can demand repayment at any time)
How does the interest of Broker’s calls work?
The broker pays interest on these loans, usually based on the interest rate of short-term Treasury Bills (1 week to 3 months) plus an extra 1%.
What are Repos?
(Repurchase Agreements)
a market participant sells securities to another with an agreement to buy them back at a higher price. They are collateralised loans (using securities as collateral)
point of view of the borrower
A loan between two parties, but instead of using cash as collateral, they use securities (like government bonds). If you don’t pay back the loan or repurchase the bond, the lender can keep the bond to cover their losses.This makes the loan less risky for the lender.
How long do repos usually last? are there other alternatives to this?
- Most repos are very short-term and last just one day. This is why they’re called Overnight Repos (ON repo)—you sell the bond today and buy it back tomorrow.
- Term Repos- Some repos last longer, for up to 6 months. These are called term repos, as they have a fixed period longer than overnight.
- Specialized Long-Term Repos- For specific needs, long-term repos (more than 6 months) can be arranged., These are done Over the Counter (OTC), meaning the terms are customized between the two parties.
Most of the liquidity of repos is concentrated in terms of —
up to one week
Most of the trading and demand for repos happens in short terms (up to 1 week) because they provide quick cash and flexibility.
What is a reverse repo?
the other point of view of the transaction. The participant buys bonds (borrows the securities) from another party. Has a specified interest rate (the cost of borrowing the bond) and a term (duration, often very short-term like overnight).
the opposite of a repo, point of view of the lender
Which is the largest and most efficient source of funding in the fixed income markets?
The Repo market
with $13-15 trillion outstanding and $3-4 trillion traded daily.
What do Central Banks use repos for?
as a monetary policy tool to set policy rates
3 primary uses of a repo
- Short-term funding and investment.
- Financing for leveraged investors like hedge funds.
- Enhancing liquidity in secondary debt markets.
What type of securities are typically used in repo transactions, and why?
High Quality Liquid Assets (HQLA), usually U.S. Treasury bonds, are used in repo transactions due to their high liquidity and safety.
They are considered the safest and most efficient collateral in money markets.
Who are the main participants in the repo market?
Main participants include hedge funds, pension funds, dealers, and other financial institutions. The market is dealer-driven, often coordinated via Interdealer Brokers (IDBs).
with Interdealer broker (IDBs) screens where dealers can post and see
the best quotes.
What can a repo be quoted as?
two types of repo pricing
- GC (general collateral)
- special repos
- GC are securities that are not in high demand and are easily available in the market, so as they don’t have any special demand pressures, they charge a standard rate of interest
- more demanded, so have higher interest rates, so as they are rare more people want them (often for short-selling)
What is a plain vanilla repo ticket?
just means a regular, short-term loan using bonds as collateral, with nothing complicated added to it.
What are Federal Funds?
How banks in the U.S. lend money to each other overnight (it makes them one of the most liquid and flexible forms of short-term borrowing) to maintain the required reserves at the Federal Reserve
To balance reserves, banks lend and borrow from each other overnight in the Federal Funds Market.
The interest rate they charge each other is the Fed Funds Rate—this rate is one of the most important in the financial system.
What was LIBOR?
LIBOR (London Interbank Offered Rate) was a premier short-term interest rate in the Eurodollar market. It served as the reference rate for thousands of loans, bonds, and derivatives (e.g., interest rate swaps, mortgages)
What was the problem with LIBOR?
Since LIBOR was based on banks’ self-reported estimates, it was vulnerable to manipulation (e.g., banks misreported rates for profit).
This led to a major financial scandal, and regulators decided to phase it out
so it was replaced by SOFR in the US in June 2023 (SONIA in UK, STR in Eurozone, TONA in Japan)
How is SOFR determined?
It is based on actual repo transactions backed by US Treasuries
Money market rates arent risk free
How do we measure this risk?
With the TED Spread
TED Spread = LIBOR or SOFR - TBill rate
