1. Financial Markets and Institutions 6th Edition
PowerPoint Slides for:
Financial Markets and Institutions 6th Edition
By Jeff Madura
Prepared by
David R. Durst
The University of Akron

2. Money
Markets 6

3. Chapter Objectives Provide a background on money market securities
Explain how institutional investors use money markets
Explain the globalization of money markets

4. Money Market Securities
Maturity of a year or less
Debt securities issued by corporations and governments that need short-term funds
Large primary market focus
Purchased by corporations and financial institutions
Secondary market for securities

5. Money Market Securities
Treasury Bills
Commercial paper
Negotiable certificates of deposits
Repurchase agreements
Federal funds
Banker’s acceptances

6. Money Market Securities
Treasury bills
Issued to meet the short-term needs of the U.S. government
Attractive to investors
Minimal default risk—backed by Federal Government
Excellent liquidity for investors
Short-term maturity
Very good secondary market

7. Money Market Securities
Treasury bill auction (fill bids in amount determined by Treasury borrowing needs)
Bid process used to sell T-bills
Bids submitted to Federal Reserve banks by the deadline
Bid process
Accepts highest bids
Accepts bids until Treasury needs generated
Competitive Bidding

8. Money Market Securities
Treasury bill auction—noncompetitive bids
($1 million limit)
May be used to make sure bid is accepted
Price is the weighted average of the accepted competitive bids
Investors do not know the price in advance so they submit check for full par value
After the auction, investor receives check from the Treasury covering the difference between par and the actual price
Noncompetitive Bidding

9. Money Market Securities
Estimating T-bill yield
No coupon payments
Par or face value received at maturity
Yield at issue is the difference between the selling price and par or face value adjusted for time
If sold prior to maturity in secondary market
Yield based on the difference between price paid for T-bill and selling price adjusted for time

10. Money Market Securities
Calculating T-Bill Annualized Yield
SP – PP
365 YT  = PP n
YT = The annualized yield from investing in a T-bill
SP = Selling price
PP = Purchase price
n = number of days of the investment (holding period)

11. Money Market Securities
T-bill yield for a newly issued security
Par – PP
360
T-bill discount =  PP n
T-bill discount = percent discount of the purchase price from par
Par = Face value of the T-bills at maturity
PP = Purchase price
n = number of days to maturity

12. Money Market Securities
Short-term debt instrument
Alternative to bank loan
Dealer placed vs. directly placed
Used only by well-known and creditworthy firms
Unsecured
Minimum denominations of $100,000
Not a large secondary market
Commercial Paper

13. Money Market Securities
Commercial paper backed by bank lines of credit
Bank line used if company loses credit rating
Bank lends to pay off commercial paper
Bank charges fees for guaranteed line of credit

14. Money Market Securities
Estimating commercial paper yields
Par – PP
360
YCP  = PP n
YCP = Commercial paper yield
Par = Face value at maturity
PP = Purchase price
n = number of days to maturity

15. Money Market Securities
Issued by large commercial banks
Minimum denomination of $100,000 but $1 million more common
Purchased by nonfinancial corporations or money market funds
Secondary markets supported by dealers in security
Negotiable Certificates of Deposit (NCD)

16. Money Market Securities
NCD placement
Direct placement
Use a correspondent institution specializing in placement
Sell to securities dealers who resell
Sell direct to investors at a higher price
NCD premiums
Rate above T-bill rate to compensate for lower liquidity and safety

17. Money Market Securities
Sell a security with the agreement to repurchase it at a specified date and price
Borrower defaults, lender has security
Reverse repo name for transaction from lender
Negotiated over telecommunications network
Dealers and brokers used or direct placement
No secondary market
Repurchase Agreements

18. Money Market Securities
Estimating repurchase agreement yields
SP – PP
360
Repo Rate =  PP n
Repo Rate = Yield on the repurchase agreement
SP = Selling price
PP = Purchase price
n = number of days to maturity

19. Money Market Securities
Interbank lending and borrowing
Federal funds rate usually slightly higher than T-bill rate
Fed district bank debits and credits accounts for purchase (borrowing) and sale (lending)
Federal funds brokers may match up buyers and sellers using telecommunications network
Usually $5 million or more
Federal Funds

20. Exhibit 6.5 a Importer Exporter American Bank (Importer’s Bank)1
Purchase Order
Exporter
Shipment of Goods 5 2
L/C (Letter of Credit) Application 6
Shipping Documents & Time Draft 4
L/C Notification
American Bank
(Importer’s Bank)
Japanese Bank
(Exporter’s Bank)
L/C 3
Shipping Documents & T
ime Draft
Draft
Accepted (B/A
Created) 7

21. Money Market Securities
A bank takes responsibility for a future payment of trade bill of exchange
Used mostly in international transactions
Exporters send goods to a foreign destination and want payment assurance before sending
Bank stamps a time draft from the importer ACCEPTED and obligates the bank to make good on the payment at a specific time
Bankers Acceptance

22. Money Market Securities
Exporter can hold until the date or sell before maturity
If sold to get the cash before maturity, price received is a discount from draft’s total
Return is based on calculations for other discount securities
Similar to the commercial paper example
Bankers Acceptance

23. Major Participants in Money Market
Commercial banks
Finance, industrial, and service companies
Federal and state governments
Money market mutual funds
All other financial institutions (investing)
Short-term investing for income and liquidity
Short-term financing for short and permanent needs
Large transaction size and telecommunication network

24. Valuation of Money Market Securities
Present value of future cash flows at maturity (zero coupon)
Value (price) inversely related to discount rate or yield
Money market security prices more stable than longer term bonds
Yields = risk-free rate + default risk premium

25. Exhibit 6.7 a International Economic Conditions U.S. Fiscal Policy
Monetary
Policy
U.S.
Economic
Conditions
Issuer’s
Industry
Conditions
Issuer’s
Unique
Conditions
Short-T
erm
Risk-Free
Interest
Rate (T
-bill Rate)
Risk
Premium
of Issuer
Required Return
on the Money
Market Security
Price of the
Money Market
Security

26. Interaction Among Money Market Yields
Securities are close investment substitutes
Investors trade to maintain yield differentials
T-Bill is the benchmark yield in money market
Yield changes in T-bills quickly impacts other securities via dealer trading
Yield differentials determined by risk differences between securities
Default risk premiums vary inversely with economic conditions

27. Globalization of Money Markets
Money market rates vary by country
Segmented markets
Tax differences
Estimated exchange rates
Government barriers to capital flows
Deregulation Improves Financial Integration
Capital Flows To Highest Rate of Return

28. Globalization of Money Markets
Eurodollar deposits and Euronotes
Dollar deposits in banks outside the U.S.
Increased because of international trade growth and U.S. trade deficits over time
No reserve requirements at banks outside U.S.
Eurodollar Loans
Channel funds to other multinationals that need short-term financing

29. Globalization of Money Markets
Euro-commercial paper
Issued without the backing of a banking syndicate
Maturity tailored to investors
Dealers that place paper create a secondary market
Rates range between 50 and 100 basis points above the LIBOR rate

30. Globalization of Money Markets
Performance of international securities
Effective yield for international securities has two components
The yield earned on the investment denominated in the currency of the investment
The exchange rate effect

31. Globalization of Money Markets
Performance of international securities
Yield for an international investment
SPf – PPf Yf =
PPf
Yf = Foreign investment’s yield
SPf = Investment’s foreign currency selling price
PPf = Investment’s foreign currency purchase

32. Globalization of Money Markets
The exchange rate effect (%S) measures the percentage change in the spot during the investment period
% S measures the expected percent change in the currency
Currency appreciated, % S is positive and adds to net yield
Currency depreciated, % S is negative and reduces net yield

33. Chapter Concepts Summary
Surplus units channel investments to securities issued by deficit units
Debt securities markets
Money Market
Capital Market
Money market securities
Short-term
High quality
Very good liquidity