1. Participants Instruments
Money Markets
Participants
Instruments

2. Money Markets - Participants & Instruments
Remember
Money Market instruments implies an original maturity of <= 12 months
Securities generally don’t pay a coupon and are sold at a discount
2nd Feb 2012
Money Markets - Participants & Instruments

3. Money Markets - Participants & Instruments
Market Participants
Original lenders & borrowers
Households, firms & governments
Brokers
Don’t always bring two parties together. Often act on behalf of a borrower or lender to get the best deal
Issuing House
Intermediary who issues new securities on behalf of a borrower
Merchant or investment Banks
2nd Feb 2012
Money Markets - Participants & Instruments

4. Money Markets - Participants & Instruments
Market Participants
Market Makers
Intermediaries who hold securities and quote buy/sell prices
Securities division of major banks
Arbitrageurs
Buy and sell to make a profit from pricing anomalies
As you know these anomalies disappear quickly
Move large quantities of money to make profit
2nd Feb 2012
Money Markets - Participants & Instruments

5. Money Markets - Participants & Instruments
Market Participants
Speculators
Takes a position hoping to beat the market
Unlike arbitrageurs, speculators take on a risk
Hedgers
Buys or sells instruments to avoid a risk
For example an importer entering a contract today to take deliver of foreign currency at a point in the future
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Money Markets - Participants & Instruments

6. Money Markets - Participants & Instruments
The City of London has two broad classifications of Money Markets
Traditional Market
The Discount Market
Parallel Market
Interbank Market
Certificate of Deposit Market
Gilt & Repo Market
Local Authority Market
Eurocurrency Markey
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Money Markets - Participants & Instruments

7. Money Markets - Participants & Instruments
The Markets
Volumes are large and a small variation can result in a large monetary swing
Therefore interest rate changes are usually quoted in basis points
One basis point = one hundredth of one percent
Like stock markets there is:-
A primary market
Where borrowers raise money
A secondary market
Where investors can trade existing securities
2nd Feb 2012
Money Markets - Participants & Instruments

8. Money Markets - Participants & Instruments
Common MM Securities
Treasury Bills
No coupon, sold at discount to par value
Short maturities – eg 4, 13, 26 week
Commercial Paper
Finance inventory and accounts receivable
High min denomination
Only reputable companies can sell
No coupon – sold at a discount
Discount often depends on ratings agency rating
Limited secondary market
2nd Feb 2012
Money Markets - Participants & Instruments

9. Money Markets - Participants & Instruments
Common MM Securities
Negotiable Certificates of Deposit
Certificates issued by large commercial banks and other depository institutions as a short term source of funds
Secondary market exists
Repurchase Agreements
Interbank Markets
EURIBOR, LIBOR, Federal Funds (US)
Bankers Acceptance
2nd Feb 2012
Money Markets - Participants & Instruments

10. Repurchase Agreements
In a repo one party sells securities with an agreement to buy back at a future date and price
Why?
In essence a loan backed by the security
Gov paper, commercial paper, or NCD
In a reverse repo, one party buys a security with an agreement to sell back on a future date at an agreed price
Can be same transaction but from different perspective
2nd Feb 2012
Money Markets - Participants & Instruments

11. Repurchase Agreements
Repo market is approx $4.5 trillion
Transaction amounts usually >= $10million
Maturities -> 1 to 15 days, 1, 3, 6 months
Secondary market does not exist
Usually firms borrow for minimal period and refinance using new repos if they still have a financing need at maturity
Brokers and repo dealers arrange transactions
Or some large companies have in house teams
Firms can be borrowers at one stage and lenders at another time
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Money Markets - Participants & Instruments

12. Money Markets - Participants & Instruments
Bear Stearns
Large securities firm that relied on repo’s to raise finance
Used mortgage backed securities as collateral in the repurchase agreements
During credit crisis in 2008, uncertainty surrounding mortgage securities mean Bear Stearns couldn’t raise finance
Almost collapsed, but US govt. bailed out
Collateral must be trusted by the market!
2nd Feb 2012
Money Markets - Participants & Instruments

13. Repurchase Agreements
Yield
Repo rate is determined by the difference between selling price and agreed repurchase price, annualized with a 260 day year
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Money Markets - Participants & Instruments

14. Money Markets - Participants & Instruments
Bankers Acceptance
Bank accepts responsibility for future payment
Used to guarantee payment in international trade
Essentially a draft that bank guarantees to pay
Exporter can hold the acceptance until maturity date receive payment
But frequently they need the money sooner, so they sell at a discount
Investor makes return on the difference between the repayment amount and the discounted price paid.
2nd Feb 2012
Money Markets - Participants & Instruments

15. Money Markets - Participants & Instruments
Bankers Acceptance
Maturities typically range between 30 and 270 days
There is a default risk associated with banks so the yield is typically higher than treasury bills
An active secondary market exists
Dealers match buyers and sellers
Spread of between 1/8% and 7/8%
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Money Markets - Participants & Instruments

16. Money Markets - Participants & Instruments
Sequence of Events
Example – US imported of Japanese goods
Importer places a purchase order
Exporter will probably seek payment up front if they are unfamiliar with the importer
Importer will not agree to that
Compromise with Banker’s Acceptance
Importer asks their bank to draw up a letter of credit
Commitment by bank to back the payment to the importer
2nd Feb 2012
Money Markets - Participants & Instruments

17. Money Markets - Participants & Instruments
Sequence of Events
LC presented to exporters bank (bank to bank)
This bank in turn informs the exporter
Exporter ships goods..
And shipping documents to it’s bank
These are then passed to importer’s bank
At this point bankers acceptance is created, which obligates the importers bank to make a payment to the bearer at a specified future date.
2nd Feb 2012
Money Markets - Participants & Instruments

18. Money Markets - Participants & Instruments
Bankers Acceptance
The BA allows the importer to receive the goods without having to pay up front
Exporter can receive payment earlier than normal by selling the acceptance (at a discount)
Risk to investor is similar to NCD
Though the exporting firm also backs the asset, so the perceived risk is slightly lower
2nd Feb 2012
Money Markets - Participants & Instruments