1. CHAPTER 7
Money Markets

2. Economic Role of the Money Market
The money market is a market for liquidity.
Liquidity is sold in money markets by buying short-term securities (lending).
Liquidity is bought in money markets by issuing short-term securities (borrowing).

3. Characteristics of Money Market Securities
Short-Term Maturity – up to 1 year, but most under 120 days → Low Price Risk
High Quality Borrowers → Low Default Risk
Active Secondary Market → High Marketability
Close Substitutes → interest rates move together over time
Large Denominations (Wholesale Market)

4. Treasury Bills Characteristics of T-Bills Maturity up to one year
Denominations are in multiples of $1,000
Sold at a discount from face value
Book-entry securities

5. Treasury Bills Pricing of Treasury Bills
Treasury bills are priced on a bond-equivalent yield basis. The bond-equivalent yield, YBE, is the annualized difference between the face value and the purchase price of the bill.
YBE = (Face Value - Price)/Price x (365/Days to Maturity) x 100%

6. Federal Funds Characteristics of Federal Funds
Most are one-day, unsecured loans between depository institutions
Most liquid of all financial assets
Originally a market for excess reserves. Now a source of investment (federal funds sold) and financing (federal funds purchased).
The federal funds rate depends on the level of bank excess reserves.
Open-market operations (buying and selling of government securities by the Federal Reserve) is the primary tool for conducting monetary policy.
Open-market purchase - increases bank reserves and lowers the federal funds rate.
Open-market sale - decreases bank reserves and raises the federal funds rate.

7. 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.

8. 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

9. Negotiable Certificates of Deposit
Characteristics of Negotiable CDs
Maturity up to 6 month
Large denomination time deposits
Negotiable - may be sold and traded before maturity
Issued at face value with an “add on” rate paid over the face value.
Issued by banks to offset declining demand deposits as a source of funds.

10. Bankers' Acceptances Characteristics of Commercial Papers
Time drafts - orders to pay in the future
Drafts are drawn on and accepted by bank → direct liability of bank
Mostly relate to international trade
Sold at a discount
Standard maturities of 30, 60, or 90 days - maximum of 180

11. 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.

12. The Sequence of a Banker’s Acceptance Transaction

13. Money Market Participants