Chapter 7 Money Markets 1

Treasury Bills Pricing of Treasury Bills: – Treasury bills are priced on a bond-equivalent yield basis. The bond-equivalent yield, Y BE, is the annualized difference between the face value and the purchase price of the bill. 2Dr. Hisham Handal Abdelbaki - FIN Chapter 7

3 1- the formula for the bond equivalent yield (y be ) : Where Pf is the face price, P0 is the purchase price and n is the number of days to maturity. 2- the formula for purchase price on bond equivalent yield basis:

Dr. Hisham Handal Abdelbaki - FIN Chapter 74 Example 1: You are given the following data: Face price = 10,000, buying price = 9760, days to maturity = 100. what is the yield on a bond – equivalent basis? Solution Y BE = [(Face Value - Price)/Price] x [(365/Days to Maturity) ] x 100% Y BE = [(10000 – 9760) / 9760] [365 / 100] [100%] = (0.025 )(3.65)(100%) = 8.9%

Dr. Hisham Handal Abdelbaki - FIN Chapter 75 Example 2: You are given the following data: Face price = 10,000, days till maturity = 91 and yield = 8.19%. what is buying price on a bond – equivalent basis? Solution Price = [face price] / [1 + (Y BE * days to Maturity / 365) = / = 9800 Class work In example 1, assume the purchase price is unknown and calculate it by using other information.

Repurchase Agreements (Repos) Repo is the sale of a short-term security (collateral) and buying it back in the future at a predetermined (higher) price. Reverse Repo is the purchase of a short- term security (collateral) and selling it back in the future a predetermined (higher) price. Repos and reveres repos are just opposite sides of the same transaction. Repos are used by the Federal Reserve in open market operations. 6Dr. Hisham Handal Abdelbaki - FIN Chapter 7

7 The formula for the repo yield (yrepo) or interest rate is: Where Prepo = repurchase price of the security, which equals the selling price plus interest. P0 = sale price of the security N = number of days to maturity

Commercial Papers Characteristics of Commercial Papers – Maturity up to 270 days – Unsecured securities issued by high- quality borrowers, but backed by lines of credit from banks to support or guarantee quality. – Large denominations - $100,000 and up – Sold at a discount from par 8Dr. Hisham Handal Abdelbaki - FIN Chapter 7

9 1- the formula for the bond equivalent yield (y be ) : Where Pf is the face price, P0 is the purchase price and n is the number of days to maturity. 2- the formula for purchase price on bond equivalent yield basis:

Creating a Banker's Acceptance Importer wants to make a purchase from foreign exporter, payable in the future. Importer needs financing; exporter needs guarantee of payment in future. Importer's bank writes a letter of credit for exporter that specifies purchase order and authorizes exporter to draw time draft on bank. Exporter draws the draft on the importer's bank and collect its money. The importer’s bank accepts the draft and creates a banker's acceptance. 10Dr. Hisham Handal Abdelbaki - FIN Chapter 7

The Sequence of a Banker’s Acceptance Transaction 11Dr. Hisham Handal Abdelbaki - FIN Chapter 7