1. Copyright 2015 Diane Scott Docking
The Money Market
Copyright 2015 Diane Scott Docking

2. Copyright 2015 Diane Scott Docking
Learning Objectives
Define money markets
Identify the major types of money market securities
Examine the process used to issue Treasury securities
Copyright 2015 Diane Scott Docking

3. The Money Markets Defined
The term “money market” is a misnomer.
Money (currency) is not actually traded in the money markets.
The securities in the money market are short term with high liquidity; therefore, they are close to being money.
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4. Money Market Securities’ Characteristics
Maturity of ___________________from their ________ date.
Large primary market focus
Secondary market for securities
Money market securities are usually sold in large denominations.
They have low default risk.
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5. Money Market Instruments
Treasury Bills
Federal Funds
Repurchase Agreements
Commercial Paper
Negotiable Certificates of Deposit
Banker’s Acceptance
Eurodollars
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6. Copyright 2015 Diane Scott Docking
Treasury Bills
Issued by ________________
Virtually default risk free
Interest earned is at state and local government level.
A _________security.
Does not make periodic interest payments.
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7. Copyright 2015 Diane Scott Docking
T-Bill Quote Example:
As of June 9, 2015:
Maturity Bid Asked Chg Asked Yield
12/11/
Quote is end of day 6/9/2015, assume 2 days to settle.
Settle is = 6/11/2015 (do not count)…12/11/2015 is last trading day (count). So 183 days to maturity.
Bond Equivalent Yield
Discount Rate
Change from yesterday’s closing Asked Quote
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8. Copyright 2015 Diane Scott Docking
Bid & Ask Facts
- what dealers will pay for security (or what investors can sell it for)
- what dealers will sell security for (or what investors can buy it for)
- is the dealers profit or markup
Bid price Ask price
Spread is in T-Bill market because market is so deep
Bid-ask quotes for T-bills are bid yields and ask yields
- Bid yields Ask yields
- As yields , prices
Copyright 2015 Diane Scott Docking

9. Calculating Yields/Prices on U.S. Treasury Bills
Treasury bills are priced on a discount rate basis, idy or DR, is:
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10. Calculating Yields/Prices on U.S. Treasury Bills
The Wall Journal lists T-Bill yields on a bond equivalent basis (asked yield)
The effective annual return/rate
Relationship between DR and Asked Yield (ibey):
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11. Wall Street Journal Example:
Cost to buy $1,000,000 of T-bills:
Asked Yield calculation:
Effective Return calculation:
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12. Problem: Calculating the T-bill rates
You pay $ for a 28-day T-bill. It is worth $1,000 at maturity. What is its discount rate? Asked Yield? Effective Annual Return?
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13. Solution to Problem: Calculating the T-bill rates
What is its discount rate?
where F = face, P = price, and n = days to maturity
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14. Solution to Problem: Calculating the T-bill rates
What is its ask yield (or bond equivalent yield)?
where F = face, P = price, and n = days to maturity
Copyright 2015 Diane Scott Docking

15. Solution to Problem: Calculating the T-bill rates
What is its effective annual return?
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16. T-Bill Auction Noncompetitive Bidding
All non-competitive bids accepted.
Specify quantity only.
Maximum bid
Price is the competitive auction yield price.
Noncompetitive Bidding
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17. Copyright 2015 Diane Scott Docking
T-Bill Auction
Competitive Bidding
Specify price (as a yield %) and quantity desired.
Minimum purchase $100
Single price auction used since 1998
Treasury accepts highest bids prices (lowest bid yields)
Maximum amount sold to any one buyer is 35% of offering amount
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18. Treasury Bill Offering
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19. Treasury Bill Auction Results
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20. T-Bill rates vs. Inflation
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Federal Funds
lending and borrowing
Fed district bank debits and credits accounts for purchase (borrowing) and sale (lending)
Fed Funds _______________________- this is a bank liability.
Fed Funds _____________ - this is a bank asset.
Usually $5 million or more
Federal funds rate usually slightly higher than T-bill rate
Fed Funds target vs. Actual FF rate
Current FF target:
Effective FF rates:
Copyright 2015 Diane Scott Docking

22. Repurchase Agreements (Repo)
Bank Financing – Source of funds – a bank liability
“Security sold under agreement to repurchase” at given price in future.
Reverse Repo
Bank Investment/Loan – Use of funds – a bank asset
“Security purchased under agreement to resell” at given price in future.
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23. Repurchase Agreements (cont.)
Negotiated market rate.
Over telecommunications network
Dealers and brokers used or direct placement
No secondary market
Rate is lower than the fed funds rate, since it is backed up by a security.
Used by:
Federal Reserve in open market operations.
Government securities dealers to secure funds to invest in new Treasury issues.
Banks to secure funds to meet temporary liquidity needs as well as lend funds when they have excess reserves.
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24. Copyright 2015 Diane Scott Docking
Estimating Repo Rate
For Repurchase agreements:
Prepo= Repurchase price of security, which equals selling price plus interest
P0= Sales price of the security
N=number of days to maturity
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25. Copyright 2015 Diane Scott Docking
Example: Reverse Repurchase Agreement (Aka: Securities Purchased Under Agreement to Resell)
Bank buys a security from a customer for $100,000 with the agreement to sell it back to customer for $101,000 within 90 days.
Bank takes possession and title of security
In effect, a loan with collateral
Bank accounting entries:
Dr) Reverse Repurchase Agreements $100,000
Cr) Cash $100,000
. . .
Dr) Cash $101,000
Cr) Reverse Repurchase Agreements $100,000
Cr) Interest Revenue ,000
Repo Rate:
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26. Copyright 2015 Diane Scott Docking
Example: Repurchase Agreement (Aka: Securities Sold Under Agreement to RePurchase)
Bank sold its own security to a dealer/bank for $100,000 with the agreement to repurchase it within 90 days for $101,000. The value of the securities that the bank sold was $120,000.
Bank releases possession and title of security
In effect, a bank debt with security used collateral
Bank accounting entries:
Dr) Cash $100,000
Cr) Repurchase Agreement $100,000
Dr) Securities Sold Under Repo $120,000
Cr) AFS Securities $120,000
…..
Dr) Repurchase Agreement $100,000
Dr) Interest Expense ,000
Cr) Cash $101,000
Dr) AFS Securities $120,000
Cr) Securities Sold Under Repo $120,000
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27. Copyright 2015 Diane Scott Docking
Repurchase Agreement (Aka: Securities Sold Under Agreement to RePurchase)
Bank sold its own security to a dealer/bank with the agreement to repurchase it within so many days (say 90 days).
Repo Rate:
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Commercial Paper
Alternative to bank loan
Short-term debt instrument
Initial maturities ____________ days
Usually ___________ days.
Used only by well-known and creditworthy firms
________________
Credit ratings important
Minimum denominations of $100,000
Placement
Directly by a sales force of the borrowing firm.
Indirectly through dealers.
Not a large secondary market (generally held to maturity)
Sold at a discount from par – just like T-bills.
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29. Commercial Paper Rates vs. Prime Rates
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30. Commercial Paper Outstanding
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31. Negotiable Certificates of Deposit
Development of the CD Market
Issued by Citibank in 1961.
Offset declining demand deposits as a source of funds.
CD Issuers
Money center banks and large regional banks are the primary issuers of domestic CDs
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32. Negotiable Certificates of Deposit
Characteristics of Negotiable CDs
Large denomination time deposit, less than six month's maturity.
minimum is ______ days
most are less than _________
Negotiable - may be sold and traded before maturity.
Primary market - denominations of at least $100,000.
Secondary market - $1 million or more.
Issued at face value with coupon rate.
Interest computed on a 360 day year.
Rate negotiated between buyer and seller.
Rates higher than on T-Bills
higher credit risk, lower marketability and higher taxability.
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33. Copyright 2015 Diane Scott Docking

34. Example 5-9 in text: Negotiable Certificates of Deposit
Q1: A bank has issued a 6-month (180 day), $1 million NCD with a 0.72% annual interest rate. How much will the NCD holder receive at maturity? A:
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35. Example 5-9 in text: Negotiable Certificates of Deposit
Q2: What is the Bond equivalent yield and the EAR? A: A.
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36. Example 5-9 in text: Negotiable Certificates of Deposit
Q3: Immediately after the CD is issued, the secondary market price falls to $999,651. What is the new bey on the CD, the new EAR, and the new single-payment yield?
A: 𝑏𝑒𝑦= 𝐹𝑉 𝑃𝑉 − 𝑛
𝑏𝑒𝑦= 1,003, ,651 − =0.8010% A:
A: iNCD,sp = bey(360/365) = x 360/365 = %
Copyright 2015 Diane Scott Docking

37. Example 1: Negotiable Certificates of Deposit
Q1: A bank has issued a 3-month (90 day), $1 million NCD with a 0.80% annual interest rate (current market rates). How much will the NCD holder receive at maturity? A:
Copyright 2015 Diane Scott Docking

38. Example 1: Negotiable Certificates of Deposit
Q2: What is the Bond equivalent yield and the EAR? A: A.
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39. Example 1: Negotiable Certificates of Deposit
Q3: Thirty days pass. Market rates are now 8.25%. What is the PV of the NCD?
A:  𝑃𝑉= 𝐹𝑉 1+ 𝑖 𝐷𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
𝑃𝑉= 1,002, = 1,002, =$𝟗𝟖𝟖,𝟒𝟎𝟗.𝟑𝟕 
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40. Copyright 2015 Diane Scott Docking
Bankers' Acceptances
Time draft
Drafts are drawn on and/or accepted by commercial bank.
Direct liability of bank.
Mostly relate to international trade.
Secondary market - dealer market.
Discounted in market to reflect yield.
Standard maturities of 30, 60, 90 days –270 days max.
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41. Exhibit: Bankers Acceptance (see chart next page)
Importer (U.S.) places P.O. for goods.
Exporter (Japan) demands payment before shipment. So, Importer asks American Bank to issue a Letter of Credit.
American Bank presents LOC to Japanese Bank.
Japanese Bank notifies Exporter that they have a LOC and okay to ship.
Exporter ships goods.
Exporter sends shipping documents and Time Draft (like an invoice) to Japanese Bank.
Japanese Bank sends shipping documents and Time Draft to American Bank.
American Bank “stamps” Draft as “accepted” and a BA is created. American Bank will pay owner of BA (i.e. the Draft) so many $ in n-days.
American Bank returns BA to Japanese Bank who gives it to Exporter.
Exporter can sell BA at its current discounted PV or hold it until maturity.
At maturity of BA, Importer pays American Bank, who pays holder of BA.
Copyright 2015 Diane Scott Docking

42. Exhibit: (Bankers Acceptance)
Importer 1
Purchase Order
Exporter
Shipment of Goods 5 10
B/A sent to Exporter who keeps or sells it 2
L/C (Letter of Credit) Application 6
Shipping Documents & Time Draft 4
L/C Notification
American Bank
(Importer’s Bank)
Japanese Bank
(Exporter’s Bank)
AB pays holder
of B/A at maturity 11
L/C 3
B/A created 8
Shipping Documents & T
ime Draft
Draft
Accepted (B/A
Created) 7
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B/A sent to Japanese Bank 9

43. Banker’s Acceptance
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44. Copyright 2015 Diane Scott Docking
Eurodollars
Deposits of U.S. dollars in banks located outside the U.S.
London interbank bid rate (LIBID)
The rate paid by banks buying funds
London interbank offer rate (LIBOR)
The rate offered for sale of the funds (rate paid on ED)
Time deposits with fixed maturities
Largest short term security market in the world
No reserve requirements at banks outside U.S.
Copyright 2015 Diane Scott Docking