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F&B > (Topic 2) Money & Bond Markets > Flashcards

(Topic 2) Money & Bond Markets Flashcards

1
Q

The Money Market refers to the trading of short-term securities (maturity < 1 year). The instruments are held as part of bank reserves and can be used as collateral if banks need to raise funds from the CB. What are the instruments?

A
  • Treasure bills
  • Commercial paper
  • Bankers’ acceptances
  • Certificate of Deposit
  • Eurocurrency Deposits
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2
Q

What are some Domestic Money Market Instruments?

A
  • Treasury Bills (T-Bills)
  • Commercial papers
  • Banker’s acceptance
  • Repo agreements
  • Eurocurrency deposits
  • Certificates of deposit (CDs)
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3
Q

T-Bills are issued by the treasury of the country concerned to finance national debt.

What are the characteristics of a Treasury Bill?

A
  • Risk free (gov. guarantees to pay face value upon maturity)
  • Highly liquid
  • Discount securities (upon issue sold at discount to face value - size of discount a determinant of the yield on holding the T-Bill)
  • Sold at discount to face value and makes no coupon payment
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4
Q

Yield (y) = (F-P/P)(365/t)100

What is the relationship between a T-Bill’s price and yield?

A

Inverse.

When purchasing price increases, yield will face, and vice-versa.

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5
Q

What are the ways that a T-Bill can be sold? (5)

A
  • Public issue
  • Tender issue
  • Auction issue
  • Direct placement
  • Additional tranches of existing issues
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6
Q

What is Commercial Paper?

A

Unsecured promissory note issued by a company (with good credit ratings) into the money market - promising to pay to the purchases of the issue the face value of the paper which is sold at a discount on the market.
Usually less than 270 days of duration and typical maturity range is 30-60 days

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7
Q

What is the Interbank Money Market?

A

The market where commercial and investment banks as well as other non-bank financial intermediaries can lend and borrow money with each other.

It is predominantly a short-term market with most of the loans ranging from overnight to 14 days.

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8
Q

What is usually higher and more volatile, and why?

LIBOR or T-bills?

A

LIBOR is usually marginally higher and more volatile since all loans are unsecured.

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9
Q

What is a Banker’s Acceptance?

A

It facilitates a commercial trade transaction by having a bank’s guarantee for repaying the loan to the holder.

It can be traded on the secondary market at a discount of its face value.

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10
Q

What is a repo agreement?

A

The sale of a security with a commitment by the seller to repurchase the security at a specified price at a future date.

It is a collateralised loan with the seller handing over the security as collateral.

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11
Q

What is a certificate of deposit (CD)?

A

Usually issued by a bank to acknowledge that a specified sum of money has been deposited at the institution with a determined maturity and rate of interest.

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12
Q

What are some of the features of an international money market?

A
  • A market in which borrowers and lenders of funds from different countries are brought together to exchange funds
  • Consists of national currencies that are held on short-term deposit in countries other than the countries issue of the currency
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13
Q

What are Eurocurrency markets?

A

Banking markets which are conducted outside of the legal jurisdiction of the authorities of the currency that is used for banking transactions.

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14
Q

What is the Eurodollar?

A

A short term deposit or loan made in dollars outside the USA.
- Accounts for 65% of all Eurocurrency transactions

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15
Q

What are the features of the Eurodollar market?

A
  • Majority of activity in London, Paris, Luxembourg and Frankfurt
  • Lots of offshore banking centres
  • Euro banks normally free of government regulation
  • Pivotal rate of interest is LIBOR
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16
Q

What is the Dollar LIBOR ($LIBOR)?

A
  • Short term interest rate on the dollar in Euromarket

- London Interbank Offered Rate

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17
Q

What is normally higher:

3-month $LIBOR or 3-month US Treasury Bill?

A

3-month $LIBOR

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18
Q

What is the value of the TED Spread?

A

3-month $LIBOR - 3-month US Treasury Bill

Treasury bill - Eurodollar spread

19
Q

Why might the TED Spread increase?

A
  • Funding has become more difficult in the interbank market

- Banks are becoming more distrustful of each other

20
Q

What is the competitive advantage of Eurobanks? (Over US banks)

A

They have the ability to offer higher deposit rates and lower loan rates

21
Q

What factors contribute to the competitive advantage of Eurobanks?

A
  • They are free of regulation (+ have no minimum reserve requirements)
  • Benefit from economies of scale
  • Avoid much of the cost associated with domestic banking regulations (e.g. admin)
  • Competition is greater than
    In domestic banking, encouraging greater efficiency and competitive pricing
  • Do not have to pay deposit insurance
  • Lending is almost exclusively to high quality customers (with low default risk)
22
Q

What are the pros of Eurocurrency markets?

A
  • Increases the range of facilities available to borrowers and lenders (domestically & internationally)
  • Competitive interest rates
  • Facilitates financial transfers between private economic agents (+ between countries, financing current accounts deficits with ease)
23
Q

What are the drawbacks of Eurocurrency markets?

A
  • Lack of regulation
  • No access to lender of last resort
  • High degree of interbank activity can lead to illegal activity
  • Ticking time bomb underneath financial system
24
Q

Within the bond market, fundamental forces determine the price of bonds issued by governments. Government bonds have ____ liquidity and ___ transaction costs relative to equities and corporate bonds.

A

High liquidity, low transaction costs

25
Q

Government bonds provide a stream of regular income. ____ ____ and the ____ __ ____ equal to their face value.

A

Coupon payments and the payment upon maturity equal to their face value.

26
Q

Pb = (CF1/1+r1)+(CF2/(1+r1)(1+r2))+…+(CFT/(1+r1)(1+r2)…(1+rT))

Government bonds are ___ risk assets.

The price of a financial asset should be determined by the ____ value of the asset’s expected cash flow.

A

Low risk

Present value

27
Q

If the coupon (c) and yield (r) are constant,

Pb= Σ (c/(1+r)^t) + (M/(1+r)^T)

What does M, c, T, and t all stand for?

A 
M = the value of the bond upon maturity
c = the coupon
T = the time to maturity
t = interest rate
28
Q

What observations can be made from the formula determining the price of a bond (Pb = f(c, M, r))?

A
  • The bond price will be higher the greater the coupon (c) payment
  • The bond price will be higher the greater the maturity value (M) of the bond
  • The bond price will be higher the lower the interest rate (r)
  • The bond price will be more volatile with IR change as maturity (T) of the bond increases
29
Q

What is the simple yield (to maturity)?

A

It takes into account capital gains and losses on a bond. It assumes that the capital gain or loss on a bond occurs evenly over the remaining life of the bond.

30
Q

What is the yield to maturity?

A

The rate of return on a bond expressed as a percentage per annum if its held until maturity. The completely yield measure since it takes into account the cash flows, the term to maturity, capital gain/loss and the fact that the received coupon can be reinvested to earn extra interest.

31
Q

What is the par value relation?

A

Ratio of the current bond price to its maturity value (k=PB/M)
If:
- the ratio = 1, the bond is selling at “par”
- k>1 = “premium”
- k<1 = “discount”

32
Q

Uncertainty contributes to bond price volatility, for example, interest rate uncertainty can lead to future bond price uncertainty. Bond prices (Pb) and interest rates (r) are ______ related.
However, the amount the Pb is affected by a change in r is affected by the ____ ___ ____ of the bond.

A

Inversely related, affected by the time to maturity of the bond.

33
Q

What 2 factors deterring the price volatility of a bond?

A
  • The coupon payments (-) [the lower the coupon, the greater volatility of price]
  • Term to maturity (+) [the greater term to maturity, the greater the volatility]
34
Q

There is a ______ _____ relationship between bond price and yield to maturity.

A

Negative convex relationship.

[the change in r has a more significant effect on prices of bonds with longer term to maturity]

35
Q

The Macaulay Duration measures bond price volatility. Why do investors use it?

A

To calculate the risk of their investments and come up with appropriate investment strategies.

36
Q

What are 2 important features of the Macaulay Duration?

A
  • The duration is less than its term to maturity (D
37
Q

What is the equation for the modified duration, and what does it measure?

A

Dmod = (D/1+y)

It measures the sensitivity of the price of a bond to changes in the rate of interest, measuring the slope of the price-yield curve.

38
Q

The modified duration increases with 3 factors:

A
  • The higher the term to maturity of the bond
  • The lower the coupon payment
  • The lower the initial yield
39
Q

What risks are associated with corporate bonds?

A
  • Common risk with treasury bonds (IR risk, reinvestment risk, inflation risk)
  • Credit risk (default risk)
  • Call risk (may exercise call provision - clause giving issuer of security right to redeem security prior to maturity)
  • Event risk (unexpected event harms ability to repay debt)
40
Q

What is a domestic bond?

A

A bond issued in the domestic currency by a domestic entity.

41
Q

What is a foreign bond?

A

A bond issued in the domestic currency of a country by a foreign entity.

42
Q

What is a Eurobond?

A

A bond that is sold by a domestic or foreign entity in a currency that is different from the country where the bond is issued, e.g. a dollar bond issued in London is a dollar denominated Eurobond.

43
Q

What are the motivations behind International Capital Flows? (5)

A
  • Trade financing motive (through borrowing)
  • Borrowing or lending motive
  • Speculative motive (profiting from changes)
  • Hedging motive (avoid losses)
  • Capital flight motive (protecting investor funds from tax, seizure by government, restrictions, or political risk)
44
Q

What are the main incentives within the Eurobond market?

A
  • Interest equalisation tax
  • Withholding tax on foreign citizens that held US bonds
  • Lower cost finance for well known companies
  • Less stringent regulation/disclose requirements
  • Financial innovation is crucial, enabling issuers to raise finance

F&B (6 decks)

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