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MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 1 Money Markets Defined:  The term “money market” is a misnomer, no money/currency is actually traded  In.

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Presentation on theme: "MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 1 Money Markets Defined:  The term “money market” is a misnomer, no money/currency is actually traded  In."— Presentation transcript:

1 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 1 Money Markets Defined:  The term “money market” is a misnomer, no money/currency is actually traded  In these markets short-term, highly liquid securities are traded  usually sold in large denominations  they have low default risk  they mature in one year or less from original issue date; most have maturity less than 120 days  These are considered “cash equivalents” hence the term “money market”  Money market transactions do not occur in one particular place; they are usually done via phone or internet  Money market securities have an active secondary market  this makes money market securities very flexible instruments to use to fill short-term financial needs  Money markets are wholesale markets  most transactions are in excess of $1 million  since most investors can’t afford that much for one investment, large banks and brokerage houses bring together many investors; hence money market mutual funds Liquidity:  Economic definition: A measure of the ease with which an asset can be turned into a means of payment  Business definition: the ability to convert a non-cash asset into cash quickly and without significant loss in value  Funding Liquidity: the ability to borrow money to buy securities or make loans  Corporate Liquidity: the ability to use cash reserves to deal with an unforeseen liability or exploit an unforeseen opportunity Ch 11: The Money Markets

2 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 2 Why Do Money Markets Exist?  The banking industry exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders  banks earn profits by capitalizing on economies of scale while providing this service  however, the banking industry is subject to more regulations and government costs than are money markets  Money markets have a cost advantage over the banking industry  money that banks are required to set aside to meet federal reserve requirements is not available for investing; thus banks offer lower interest rate to depositors  money markets have no such requirement The Purpose of Money Markets They are a very good place to temporarily store money until it’s needed  The goal of most money market investors is not to earn high returns  the time may not be right to invest in other activities or securities so they temporarily store money  thus they only require a return that is better than simply holding cash  Borrower-spenders find money markets a great source for low-cost short-term loans  The high liquidity of money markets is very attractive to corporations

3 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 3 Who Participates in Money Markets?

4 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 4 Money Market Instruments  Treasury Bills: Short-term bonds issued by the U.S. government  the most widely held and most liquid security in the world  typically maturities are: 28-, 91- and 182-day  typical denominations are $100 and $1,000  sold as Original Issue Discount (OID) bonds  sold at weekly auctions in the primary market  Repurchase Agreements (Repos): work like federal funds except non- bank entities can purchase them  a firm sells securities (usually treasuries) and agrees to buy back those securities at a specified future date (not at a specified price)  usually have a very short term of 3 to 14 days  repos work essentially as a short term collateralized loan  securities dealers use repos to manage their liquidity and to take advantage of anticipated interest rate changes  Negotiable Certificates of Deposits (CDs): is a bank-issued security that documents a deposit and specifies the interest rate and the maturity date  because a maturity date is specified, a CD is a “term security” as opposed to a demand deposit  typical denominations range from $100k to $10m

5 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 5 Money Market Instruments (continued)  Commercial Paper securities: are unsecured promissory notes issued by corporations that mature in 270 days or less; most are for 20 to 45 days  because these are unsecured loans, only the most credit worthy firms may issue them  the term is less than 270 days in order to avoid registering the security issue with the SEC; this lowers transaction costs  non-bank firms use commercial paper to fund the loans they extend to their customers  most issuers of commercial paper back them up with a line of credit at a bank; this lowers the risk to the purchaser of commercial paper  Asset-backed Commercial Paper (ABCP) are backed (collateralized) by some bundle of assets such as securitized mortgages  Banker’s Acceptances: an order to pay a specified amount of money to the bearer on a given date  used to finance goods that have not yet been transferred from the seller to the buyer  became very widely used in the ‘60’s to finance international commerce  because they are payable to the bearer, they can be bought and sold until they mature

6 MGT 470 Ch 11 Money Mkts (me8ed) v1.0 Feb 16 6 Benchmark Short-term Interest Rates  Federal Funds Rate: The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight.  the federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other  the federal funds rate is one of the most influential interest rates in the U.S. economy Why?  the Fed’s Federal Open Market Committee (FOMC) sets the target value for the federal funds rate  the current federal funds target rate is 0.5000%, set December 2015  Prime Rate: The prime rate is the rate that commercial banks charge their most credit-worthy customers. In the United States, the prime rate runs approximately 300 basis points (or 3 percentage points) above the federal funds rate  LIBOR: is a rate that some of the world’s leading banks charge each other for short-term loans.  stands for London Interbank Offered Rate and serves as the first step to calculating interest rates on various loans throughout the world  LIBOR is administered by the ICE Benchmark Administration (IBA), and is based on five currencies: U.S. dollar, Euro, pound sterling, Japanese yen and Swiss franc  serves seven different maturities: overnight, one week, and 1, 2, 3, 6 and 12 months  there are a total of 35 different LIBOR rates each business day; the most commonly quoted rate is the three-month U.S. dollar rate


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