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Financial Markets > Topic 3: Money Markets > Flashcards

Topic 3: Money Markets Flashcards

1
Q

What are the functions of the money market?

A
  • a way for the government to raise short term funds
  • a way of implementing monetary policy
  • a way the interest rate is determined (short term)
  • it is a market for sort term international trade finance
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2
Q

Money market operations comprise of:

A
  • not just a medium of exchange but it is also a traded commodity
  • the placing of deposits
  • short term borrowing
  • sale and purchase of money market securities
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3
Q

How does the interest rate determine the cost of borrowing?

A

As money becomes tight, interest rates rise.

When interest rates are high, borrowing declines as it becomes expensive

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4
Q

How do participants profit from me the money markets.

A

Borrowers of funds cannot expect to make a profit, they are more concerned with achieving objectives. but they can apply those funds in such a way that they can make profit.
Lenders of course will make a profit, but it must be weighed against the opportunity cost.

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5
Q

How do intermediaries (like the banks) make a profit?

A

They borrow funds cheaper than what they loan them out for. For example, the bank may borrow surplus funds (accepting deposits, buying money) at 4.5% and loan them out at 5%.

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6
Q

Major market participants include:

A
  • Central banks - RBA
  • commercial banks
  • investment (merchant banks)
  • finance companies
  • brokers
  • corporations
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7
Q

What are central banks role in money markets ?

A

They control the supply of money and /or the level of interest rates. Their objectives are:

  • economic growth
  • external balance
  • full employment
  • price stability
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8
Q

What are the commercial/trading banks role?

A

They accept deposits, and make loans to individuals and companies.
They assist individuals and companies to raise money through direct finance by acting as acceptor.
They provide financial services.

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9
Q

What role do investment (merchant) banks play?

A

They provide financial services in return for fees and commissions.
Accepting fixed deposits and short term loans.
Participate in the interbank money market, where banks manage their liquidity by lending amongst themselves.

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10
Q

Role of finance companies in the money market?

A

Hire/purchase or lease finance.
Manage investments and portfolios.
Some of these are longer term in nature and technically belong to the debt capital market, but they participate in the money market to manage their liquidity and obtain short term finance.

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11
Q

What role do Brokers play?

A

They provide many important services like:
Match borrowers with lenders,
Have particular expertise and access to info,
Provide anonymity (until transaction is finalised),
They are paid fees or commissions for their work.

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12
Q

Corporations role in money markets?

A

They play a major role as they need to lend and borrow short term funds. They do this by:
- borrowing and investing in overnight money markets
- taking advantage of overdraft facilities
- place fixed-term deposits and take out fixed term loans from banks.
(These are examples of intermediated/indirect finance)
- issue commercial bills and promissory notes (direct finance).

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13
Q

What is trade capital?

A

Sometimes used by corporations as an alternative source of finance.
It is inexpensive as no interest is charged.
Simply involves delaying payment to the company’s creditors for as long as possible (within the terms).
By the time it comes to pay, additional money will have been made meaning they have an ongoing source of funds (timing)

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14
Q

What are accruals?

A

Like trade credit, accruals are a spontaneous and interest free source of finance.
Things like wages and salaries, long service leave and taxes are accrued in an account and can be used in the money market to make money.

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15
Q

How does a finance company provide help a corporation make a profit from its accounts receivable and book debts?

A

This is called accounts receivable finance.
Underlying assets like accruals are used to raise money,
Or book debts can be used as security for loans or even be purchased.
This provides an immediate source of funds by giving up the right to claim the debts.
Price of these will reflect time value of money and risk associated with the debt.

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16
Q

Explain these products that are traded in the money market:

Instruments?

A

Both borrowing and lending

  • CASH PRODUCTS
  • DISCOUNT SECURITIES
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17
Q

What is the nature if the money market?

A
  • it is short term
  • not a physical market, it is connected via network of communications
  • becoming more integrated around the world due to financial deregulation, technological advances and more educated participants
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18
Q

Explain overnight(11am) cash?

A
  • quoted based on interest rates
  • usually $5 to 10 million parcels
  • these must be made overnight and settled by 11am the next day
  • can be rolled over to next day
  • the rate is reset daily
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19
Q

Explain 7 day cash (24hour cash)?

A

Period of deposit(loan) is fixed for 7 days

  • can be repaid or withdrawn but requires at least 24hours notice
  • interest rate is reset daily, AFTER the initial 7 days
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20
Q

Explain two way pricing?

A
  • buy and sell price
  • bank is usually the price maker and quotes two prices
  • the profit is the ‘spread’
  • the price taker has to accept the worst side of the quote
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21
Q

Example of quote rates:
You have $10 mill to invest overnight, you ask the bank for the price, the bank says 7.45-60.
What price can you invest your money at?

A

As the investor you want the highest possible rate. In this quote the bank is offering you 7.45% which is less than what they will lend it to you at 7.60%. The 15 point spread is the banks profits.you are the price taker and must accept (or try somewhere else) the lessor rate.

22
Q

What is a committed loan?

A

A short term loan that is available to draw down on at all times.
A commitment fee is payable.
For companies.

23
Q

What is an uncommitted loan?

A

The line is available at the discretion of the bank.
Fees are slightly lower than committed loans.
For companies.

24
Q

What is a bank overdraft?

A

A common source of short term finance.
One of the most expensive.
Allows the customer to overdraw.
Interest is charged daily.
They have to be repaid immediately if demanded.
Because banks have to make those funds available for you they cannot earn optimal profit on unused funds, so the interest rate charged is higher.

25
Q

What are discount securities?

A

A product traded in the market at a price less than their face value.
No interest is received, rather it is discounted and they get the face value when it matures.
There are many types.

26
Q

What are commercial bills (discount security)?

A

AKA: bill of exchange.
A drawer (borrower) instructs the acceptor (drawee) to pay a certain amount, at a certain time, to a certain party in the future.
It can be on sold to a Third party, who is the holder.
Can be held for 7-185 days.
$5-10million parcels.
Traded on interest rates.
Banks quote two way prices.
Extra fees can include line fee, acceptance fee, endorsement fee.

27
Q

What are the four types of bills?

A

Non-bank bill.
Bank accepted bill.BAB
Bank endorsed bill. BEB
Promissory notes.

28
Q

Describe a non- bank bill?

A

Created by a borrower.
Accepted by a non-bank party.
Then sold in the market.
No bank involvement.

29
Q

Describe a bank accepted bill?

A

Banks are better set up (bank acceptance facility) which is easy for companies to use for finance.
Bank acts as acceptor, charges fee for this.
Bank will pay the face holder at bill maturity.
Most popular type of bill.
Greater credit worthiness if using bank.
Which is based on the acceptor, not the borrower.
Acceptance fee reflects the credit risk.

30
Q

Describe a bank endorsed bill?

A

A non bank bill that is resold on the market by a bank becomes a bank endorsed bill.

31
Q

Describe promissory notes?

A

Available only to large corporations with excellent credit rating.
It is an IOU written by the borrower in favour of the holder of the note.
Sold at auction via tender or directly market approached.
No bank fees.
Riskier than bank accepted bills hence the interest rate (yields) are higher.
Usually 30-180 days.

32
Q

Describe treasury notes?

A

Issued by Central bank on behalf of government.
Issued weekly by tender.
Maturities are 5, 13, and 26 weeks.
Actively traded on secondary markets, based on yields.
Treasury notes are considered the most liquid (besides cash)
The bank is required to keep a proportion of their assets liquid, they use treasury notes for this.
RBA uses them to grow or reduce money supply, which is how they control interest rates, economic growth and inflation.

33
Q

What is a certificate of deposit?

A 
Issued by a bank to a bearer.
Bank agrees to pay sum of money on a certain date.
90-180 days.
Have high credit quality.
Can be traded on secondary market.
Minimum $50,000
34
Q

Describe re-purchase agreement?

A

An agreement to sell an asset (usually shares or bonds) and repurchased at a later date.
Buy repo: buy today and sell at a predetermined future rate.
Sell repo: sell securities today and buy back at later date.
The lending party receives the asset as security (actually passed to the party, not loaned).
Banks and RBA use repos to manage their liquidity and implement monetary policy.

35
Q

Convention, how does this relate to interest rates?

A

365 days in Australia/UK/Canada/Singapore

360 days in USA/ Europe and Japan.

36
Q

Describe two-way pricing for commercial bills:

A

Same concept as pricing of securities except:
Opposite way around,
A bank may quote 7.65/60
This means they buy at 7.65%
And sell at 7.60%
A price taker must do the opposite - sell at 7.65% and buy at 7.60%
If the bank is buying the bill they are LENDING money, if they sell they are BORROWING, and the price taker must borrow at a higher rate at which they will lend.

37
Q

Why are dealing rooms important for communication?

A

Up to date Information is vital for dealers, dealing rooms contain equipment and systems to base decisions on.
The dealing room will have newspapers, journals, internet, economic news bulletins, telephones, access info for such places as Reuters, Bloomberg etc, television (BBC, CNN etc)

38
Q

Where do dealers transact most of their deals?

A

Telephone.

39
Q

What do information-systems like Reuters provide?

A

Latest market prices
Volume of deals and their price levels
Financial market news
Political and economic news
Some graphics & data manipulation services
Banks may deal directly with one another over coded phone lines. More used inFX markets.

40
Q

Why does the “australian financial markets association” exist?

A

As most transactions occurs via phone
Generally they are bound to their word.
But this is sometimes not the case.
Many countries have their own bodies to deal with this problem (like AFMA) and telephone calls are recorded

41
Q

Describe the global financial system?

A

Transactions are conducted in large number of countries.
With different currencies and different interest rates and exchange rates.
Technology has advanced globalisation.
So has deregulation (ie floating exchange rates).
These are determined by global market forces.

42
Q

What is the Eurocurrency market?

A

Large money and capital markets located I international financial centres.
Refers to money held in banks outside of the country’s legal tender.
Borrowed and lent by banks in Europe.
Ie: USD being held in a bank outside of the US

43
Q

Why is it called Eurocurrency market?

A

To distinguish it from the USD domestic market.

Because USD are being traded within in these markets.

44
Q

What did the Eurocurrency market expand/include now?

A

Started inLondon but now involves many currencies and locations.
Securitised international debt, like discount securities and bonds.
Less regulated meaning they are sometimes easier and cheaper to source funds from.

45
Q

What products are traded I the Eurocurrency markets?

A

Intermediated products: short term bank advance and standby facilities.
direct products: euro note issuance facilities, euro commercial paper,Medium term notes.

46
Q

Describe short term bank advance?

A

Intermediated.
Min $1-5 million.
Less than 1 year (can be extended to medium) by including revolving facility.
Lump sum payment at a specified time.
Interest rates set to LIBOR or SIBOR (360 days or 365 for Au)

47
Q

Describe standby facilities?

A

Intermediated.
Line of short term credit.
Can be called up if needed, especially in tight liquidity periods.
12-24 months but can be shorter.
Two charges:
A fee for the funds being made available,
An interest fee on funds drawn, like to be higher than a standard Eurocurrency loan as usually drawn on in times of high liquidity pressure (risk)

48
Q

Describe euro note facilities (NIF)?

A

Direct product.
Promissory note drawn by borrower in their name.
$100,000-500,000 USD
30-180 days, but continue over years.
Underwritten by banks.
Sold at a discount by tender with interest determined by LIBOR.
Unsold notes are agreed to be purchased by banks.

49
Q

Describe Eurocommercial paper?

A 
Alternative to notes.
Not underwritten
Hedged
Not sold by tender
A Select panel of dealers decide to take the paper or place it I somewhere profitable.
50
Q

Describe medium term notes ( MTN)?

A

Debt obligations, do not have uniform maturity.
Do not have to be fully drawn when when issued.
Maturities of 9 months to 5 years.
Belong more to capital markets rather the money markets.
Similar to bonds as they issue coupon payments.

51
Q

Summary of money markets:

A

Short term instruments in debt market.
Relatively unregulated with many players interacting daily.
Volumes and transactions are large,specialised skills needed.
Short term debt is liquid, priced according to risk, return, liquidity and duration.
They are traded on domestic and global and Eurocurrency markets.

Financial Markets (14 decks)

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