Chapter Eight The Money Markets
Copyright © 2004 Pearson Education Canada Inc. Slide 8–3 The Money Markets Money Markets Defined 1.Money market securities are usually sold in large denominations 2.They have low default risk 3.They mature in one year or less from their issue date
Copyright © 2004 Pearson Education Canada Inc. Slide 8–4 Purpose of Money Markets Investors in Money Market: Provides a place for warehousing surplus funds for short periods of time Borrowers from money market provide low-cost source of temporary funds
Copyright © 2004 Pearson Education Canada Inc. Slide 8–5 Interest Rates Available on Several Money Market Instruments March 6/2006March 10/2006 Overnight rate3.4466%3.6893% Overnight Repo Rate3.3761%3.6869% One Month Com Paper3.8000% Three Month Com Paper3.9300% One Month T Bill3.5700% Two Month T Bill3.6700% Three Month T Bill3.7400% Six Month T Bill3.8700%3.8500% One Year T Bill4.0200%3.9500% Source: Bank of Canada Website – March 13, 2006
Copyright © 2004 Pearson Education Canada Inc. Slide 8–6 Participants in Money Markets Government of Canada Bank of Canada Commercial Banks Businesses Investment and Securities Firms Individuals (mostly through money market mutual funds)
Copyright © 2004 Pearson Education Canada Inc. Slide 8–7 Money Market Instruments Treasury Bills Overnight Funds Repurchase Agreements (Repos) Negotiable Certificates of Deposit Commercial Paper Banker’s Acceptance Eurodollars
Copyright © 2004 Pearson Education Canada Inc. Slide 8–8 Treasury Bills 1.Short-term borrowings of the federal (& some provincial) governments 2.Sold at a discount & matures at face value
Copyright © 2004 Pearson Education Canada Inc. Slide 8–9 Discounting Example You pay $9,850 for a 91-day T-bill. It is worth $10,000 at maturity. What is its annualized yield? (1)
Copyright © 2004 Pearson Education Canada Inc. Slide 8–10
Copyright © 2004 Pearson Education Canada Inc. Slide 8–11
Copyright © 2004 Pearson Education Canada Inc. Slide 8–12
Copyright © 2004 Pearson Education Canada Inc. Slide 8–13
Copyright © 2004 Pearson Education Canada Inc. Slide 8–14 Overnight Funds Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day
Copyright © 2004 Pearson Education Canada Inc. Slide 8–15 Overnight Funds
Copyright © 2004 Pearson Education Canada Inc. Slide 8–16 Negotiable Certificates of Deposit A bank-issued security that documents a deposit and specifies the interest rate and the maturity date Denominations range from $100,000 to $10 million
Copyright © 2004 Pearson Education Canada Inc. Slide 8–17 Negotiable Certificates of Deposit Comparing Interest on CDs and T-bills
Copyright © 2004 Pearson Education Canada Inc. Slide 8–18 Commercial Paper Unsecured promissory notes, issued by corporations, that mature in no more than 270 days
Copyright © 2004 Pearson Education Canada Inc. Slide 8–19 Commercial Paper Comparing Interest on Commercial Paper to Bank Prime Rate
Copyright © 2004 Pearson Education Canada Inc. Slide 8–20
Copyright © 2004 Pearson Education Canada Inc. Slide 8–21 Banker’s Acceptances A method whereby smaller companies can access the money market The company issues a Promissory Note The company’s bank stamps the Note “Accepted” and charges the company a stamping fee The Note is then sold into the money market, carrying the risk rating of the bank that accepted the note, rather than the risk rating of the company that issued it.
Copyright © 2004 Pearson Education Canada Inc. Slide 8–22 Advantages to Banker’s Acceptances 1.Smaller companies gain access to lower rates in the money market 2.Bank earns a stamping fee to offset the loss of interest income on their traditional lending activities 3.The BA facility is “carved out” of the borrower’s line of credit – thus risk to the bank is identical to lending under an operating line of credit 4.Bank guarantees payment of the Note at maturity – provides confidence to the market
Copyright © 2004 Pearson Education Canada Inc. Slide 8–23 Eurodollars US dollar denominated deposits held in banks outside of the US London interbank bid rate (LIBID) –The rate paid by banks buying funds London interbank offer rate (LIBOR) –The rate offered for sale of the funds Time deposits with fixed maturities –Largest short term security in the world TED spread –Spread between US T Bill futures and Eurodollar futures of the same maturity –Is a barometer of confidence in the international banking system. The spread will narrow when confidence is high and become larger when perceived bank sector risk rises
Copyright © 2004 Pearson Education Canada Inc. Slide 8–24
Copyright © 2004 Pearson Education Canada Inc. Slide 8–25 Money Market Securities and Their Depth
Copyright © 2004 Pearson Education Canada Inc. Slide 8–26 Money Market Mutual Funds Open-end investment funds that invest only in short-term securities No fee for purchasing or redeeming shares Minimum initial investment of $500 to $20,000 U.S. money market funds have check-writing privileges –No fee for writing checks –No minimum check amount Earn 0.5% to 1% higher return than interest earned on money in the bank Low risk of default, low rate of return Popular with small investors
Copyright © 2004 Pearson Education Canada Inc. Slide 8–27 Growth in Money Market Mutual Funds
Copyright © 2004 Pearson Education Canada Inc. Slide 8–28 Money Market Fund Assets Figure 8: Average Distribution of U.S. Money Market Fund Assets, 2001