1. 1 Money Market (MM) MM is where organizations go to adjust their liquidity. Market is a collection of dealers that specialize in one or more MM instruments. Liquidity is stored in the MM by investing in MM securities (lending). Liquidity is purchased in the MM by selling MM securities (borrowing). Ideal place for temporary investments.

2. 2 Properties of a Good MM Instrument low default risk. short maturity (to have low price risk). high marketability (typically facilitated by standardized features). Sold in large denominations ($1 million is a tiny trade), per-dollar transaction costs thus kept low.

3. 3 Typical MM Instruments U.S. Treasury Bills 13 and 26 weeks Repurchase agreements 1 to 14 days Commercial paper 30 to 180 days Negotiable CDs 12 to 180 days Fed Funds 1 to 7 days Banker’s acceptances 30 to 180 days typical maturities

4. 4 Auctioning New T-Bills Weekly auction by U.S. Treasury of 13-week, and 26- week bills. Other bills (e.g., 1-day, 4-week, 52-week) sold on an as announced basis. Sold at a discount basis. Sold in multiples of $100. $100 million is not a large institutional purchase. All winning bidders pay same price which is the price of the lowest successful bid. Thursday/Monday/Thursday schedule.

5. 5 For Instance, This Past Week’s Schedule Thursday (Oct 29), Treasury Department announced sale of $26 billion of 26-week T-bills, that were auctioned off on Monday (Nov 2). On auction dates, noncompetitive tenders due by 11:00 am, competitive tenders due by 11:30 am. Results of auction announced minutes later. Bills issued and payments made on Thursday (Nov 5).

6. 6 http://www.treasurydirect.gov/instit/annceresult/press/preanre/2015/A_20151029_1.pdf

7. 7 http://www.treasurydirect.gov/instit/annceresult/annceresult.htm

8. http://www.treasurydirect.gov/instit/annceresult/press/preanre/2015 8 Bid-to-Cover Ratio = 9.74/26.0 = 3.75

9. 9 CUSIP Number Committee on Uniform Security Identification Procedures A 9-digit alphanumeric identifier, such as 00817Y 10 8 Uniquely identifies each U.S. and Canadian security. CUSIP system, operated by Standard & Poor’s, but owned by American Bankers Association, is designed to facilitate bookkeeping and the settlement of trades. First 6-characters identify “issuer” Next two identify the “issue” Last is a “check digit”

10. 10 Competitive Bids Competitive bidders (dealers and large banks) specify quantity discount rate willing to accept (in multiples of.005%) Treasury Dept. ranks bids according to bank discount rate, then allocates down the list. Bid-to-Cover Ratio signals how easy it is for US Gov’t to borrow money. No more than 35% of an issue can be sold to any competitive bidder to ensure a competitive secondary market.

11. 11 Noncompetitive Bids  Small part of offering, all noncompetitive bids accepted.  Noncompetitive bidders (individuals and small banks) specify only quantity $5 million max per noncompetitive bidder. receive the “High Rate” of accepted competitive bid tenders Can buy online. Set up TreasuryDirect account (with bank routing number & bank account number). Treasury electronically debits your bank account at beginning & credits it at end. Interest on US Treasuries taxed as ordinary income at the federal level, but not taxed at the state level.

12. 12 Example 1: Overview offering noncompetitive $18 B $2.1 B $15.9 B accepted $33.6 B rejected competitive ($49.5 B total) Tenders with lowest discount rate bids accepted

13. 13 Example 1: Auction Process Offering Amount $18.0 billion Noncompetitive tenders $2.1 billion Competitive tenders $49.5 billion High Rate (highest accepted rate) 3.945% Bid-to-Cover Ratio (49.5 + 2.1)/18 = 2.87 Competitive tenders Allocated at High rate.4/4.5 = 8.89% Median Rate (of accepted competitive tenders) 3.910% Low Rate 3.880% Competitive tenders $2.5 billion 3.880% $5.0 billion 3.895 $6.0 billion 3.910 $2.0 billion 3.930 $4.5 billion 3.945 $9.0 billion 4.290 $11.0 billion 4.305 $9.5 billion 4.315

14. 14 Secondary Market for T-Bills discount ratesinvestment rate Bid & Asked are bank discount rates. Bid applies when customer sells, Asked applies when customer buys. Asked Yield is bond equivalent rate.

15. 15 Discount Rate The (bank) discount rate y d is given by: Solving for P 0 we have where P f is face value P 0 is discounted price (today’s price) n is calendar days to maturity

16. 16 Bond Equivalent Rate Bond equivalent rate y be is given by Solving for P 0 we have Bond equivalent yields are reported to facilitate comparison against other debt instruments. (note 365 annualizer and discounted price is in denominator)

17. 17 Example 2: Using Bank Discount Rate Consider a $1,000 T-bill that matures in 133 days whose Bid and Asked quotes are 4.96 and 4.92, respectively. If selling, would get If buying, would cost

18. 18 Example 3: Using Bond Equivalent Rate Bond Equivalent Rate is same as Investment Rate as on slides 7 & 17. Suppose you are contemplating a $1,000 T-bill that matures in 67 days whose Asked Yield is 5.23. How much would it cost?

19. 19 Fed Funds Unsecured loans between banks. Overnight interest rate called the fed funds rate. Term “fed funds” is misleading. Typically done in units of $1 million. Yields on fed funds assume 360-day year. Conversion to bond equivalent yield is as follows.

20. 20 Commercial Paper Review slides 14-17 of Module 2.3. Compete head-to-head against T-bills. Consequently, sold at discount, and quoted using bank discount rate There is a secondary market. Virtually impossible to sell without backup line of credit and a P-1 or A-1 rating.

21. 21 Federal Agencies (GSEs) Agencies created by Congress for public policy reasons to assure availability of capital in areas of the economy where credit might otherwise be insufficient or too costly. Mostly in Home mortgages Agriculture GSEs often provide loan guarantees and conduct securitizations. Obtain the money they need by issuing agency securities. Such agency securities qualify as legal instruments to be held by banks, insurance companies, and pension funds.

22. 22 Government Sponsored Enterprises Agency (i.e, GSE) debt perceived to have only slightly greater default risk than US Treasuries. Marketability very good. (Fannie Mae) Federal National Mortgage Association (Freddie Mac) Federal Home Loan Mortgage Association (Ginnie Mae) Government National Mortgage Association See list of GSEs on p. 214.

23. 23 Retail Certificates of Deposit Issued by banks to finance their business activities. Not negotiable – no secondary market, can only be sold back to issuing bank early, with penalty. Issued at face value with interest as an “add on”. Interest based on a 365 day year. Can be in any denomination. FDIC insured up to standard amounts. Banks typically use standard maturities such as 0.5, 1.0, 1.5, 2.0 and 5.0 years.

24. 24 Negotiable Certificates of Deposit Large-denomination CDs issued by well-known banks are negotiable (exists a secondary market for them). Issued at face value with interest as an “add on”. Stated interest computed on a 360-day year (like Fed Funds). Interest rates on negotiable CDs are higher than on T-Bills because of higher credit risk and lower marketability. Purchased mainly by corporate businesses.