1. J. K. Dietrich - FBE 524 - Fall, 2005 The Money Market and Money-Market Instruments (1) Week 10 – October 26, 2005

2. J. K. Dietrich - FBE 524 - Fall, 2005 Overview of Money Market

3. J. K. Dietrich - FBE 524 - Fall, 2005 Money Market Participants u Financial Institutions –Commercial banks –Money market mutual funds –Futures exchanges –Brokers and dealers –Federal Reserve u Primary Sectors –U. S. Government –Municipal Government –Corporations –Foreign counterparts u Purpose of the money market is to allocate money at a price for market participants who need it to pay for things

4. J. K. Dietrich - FBE 524 - Fall, 2005 Treasury Bills u Maturities of 91 days (13-week) and 182 days (26-week) -- older one-year cancelled. u Bills are quoted on a 360-day discounted basis, so that a 4% ask price corresponds to or 99% of face value (e.g. $10,000,000 face value costs $9,900,000. u Bills are in book-entry form

5. J. K. Dietrich - FBE 524 - Fall, 2005 Bill auctions u Tenders are announced, usually on Tuesdays u Auctions are conducted by Federal Reserve on Mondays, with competitive and non- competitive tenders due by 1:30pm EST u Competitive tenders are arranged in ascending order of price (descending in discount) and highest bids are taken until tender is filled at lowest winning price (uniform-price auctions since Nov. 1998)

6. J. K. Dietrich - FBE 524 - Fall, 2005 Converting discount rate to yields u Convert Bill discounts to yields using: where discount is in percent, or u This can also be expressed where discount is in decimal form

7. J. K. Dietrich - FBE 524 - Fall, 2005 Example of converting discounts u 27-day T-Bill quoted at 1.62% ask (on October 17, 2002): u Using simplified equation (Rose):

8. J. K. Dietrich - FBE 524 - Fall, 2005 History of Money Market Rates

9. J. K. Dietrich - FBE 524 - Fall, 2005 Sources of money market rates u Weekly auction results in Tuesday’s Wall Street Journal in “Credit Markets” –Bid types and amounts –Rates and yields u “Money Rates” daily in Journal –Interpretation of rates requires caution –Rates change constantly u Daily and weekly H15 Fed release

10. J. K. Dietrich - FBE 524 - Fall, 2005 Money market rates u Fed funds quoted on annualized overnight rate u Certificates of deposit quoted on 360-day basis with interest added to principal u Treasury bills, commercial paper, and bankers’ acceptances are quoted on a bankers’ discount basis u Discount rate and prime rate are posted rates, not market rates

11. J. K. Dietrich - FBE 524 - Fall, 2005 Interpreting money market rates u T-Bill auction rate doesn’t change until a new auction occurs, this is a primary market u A 30-day bill was a 91-day bill 61 days ago or a 182-day bill 152 days ago –Trading in bills occurs in secondary market u CDs have issue rate in the primary market but negotiable CDs trade in secondary market u Market rates set in secondary markets

12. J. K. Dietrich - FBE 524 - Fall, 2005 Money Market Rates since 1960

13. J. K. Dietrich - FBE 524 - Fall, 2005 Money Market Rates since 1990

14. J. K. Dietrich - FBE 524 - Fall, 2005 Primary Dealers u Market makers in U.S. Treasury debt –Quote a price for all issues –Bid on tenders –Participate in Federal Reserve Bank of New York go rounds –Report to Federal Reserve u Limited number of large money-center banks and investment banks, and now foreign banks

15. J. K. Dietrich - FBE 524 - Fall, 2005 Repo Market Assets Liabilities Federal ReserveCommercial BankSecurities Dealer DepositsReserves U.S.Notes ReservesU.S.Notes Cash u Repurchase agreements are a way for dealers to finance their inventories of securities u Market is also open to corporations with excess cash through Fed wire Repo Repo Cash

16. J. K. Dietrich - FBE 524 - Fall, 2005 Repos and Reverse-Repos u Repurchase agreements are widely used by corporate treasurers and other institutional investors u Repos and reverses may be overnight or term repos for time periods up to months u For some (like Orange County), reverse repos were a way of leveraging a portfolio u Effect of terrorist attack on repo market

17. J. K. Dietrich - FBE 524 - Fall, 2005 Repos and Reverse Repos

18. J. K. Dietrich - FBE 524 - Fall, 2005 Certificates of Deposit u Large deposits (>$100,000) u No reserve requirements (currently) u Development of the market in 1960’s –Citibank –“Credit Crunches” of 1966 and 1969 u Interest rates and Regulation Q in the l960’s

19. J. K. Dietrich - FBE 524 - Fall, 2005 Next time u Read Chapter 18 of text, concentrating on gaining a basic idea of money market instruments u Take a quick look at Instruments of the Money Market referenced in the “Data Sources” section of the class website u Bring a Wall Street Journal for next Tuesday or Wednesday to class