Financial Markets and Institutions: Money Markets,Preview,We review the money markets and the securities that are traded there. In addition, we discuss why the money markets are important in our financial system. Topics include: The Money Markets Defined The Purpose of Money Markets Who Participates in Money Markets? Money Market Instruments Comparing Money Market Securities,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.,The Money Markets Defined,Money market securities They mature in one year or less from their issue date, although most mature in less than 120 days They are usually sold in large denominations ($1,000,000 or more) They have low default risk,The Purpose of Money Markets,Investors in Money Market: Provides a place for warehousing surplus funds for short periods of time Borrowers from money market provide low-cost source of temporary funds Corporations and governments use these markets because the timing of cash inflows and outflows are not well synchronized. Money markets provide a way to solve these cash-timing problems.,Money Market Instruments,We will examine each of these in the following slides: Treasury Bills Federal Funds Repurchase Agreements Negotiable Certificates of Deposit Commercial Paper Eurodollars,General Formula for Valuation,For any financial instrument, its value is determined by its discounted future cash flows,Money Market Instruments: Treasury Bills,T-bills have 28-day maturities through 12- month maturities. Discount bonds: sell at a discount, no interest payment Discounting: When an investor pays less for the security than it will be worth when it matures, and the increase in price provides a return. This is common to short-term securities because they often mature before the issuer can mail out interest checks.,Money Market Instruments: Treasury Bills Discounting Example,Suppose it is year of 2012. You pay $996.37 for a 28-day T-bill. It is worth $1,000 at maturity. What is its discount yield?,Money Market Instruments: Treasury Bills Discounting Example,You pay $996.37 for a 28-day T-bill. It is worth $1,000 at maturity. What is its annualized yield (bond-equivalent yield)? (2012 is a leap year!),Money Market Instruments: Treasury Bills Discounting Example,You pay $996.37 for a 28-day T-bill. It is worth $1,000 at maturity. What is its annualized yield (effective yield)?,Money Market Instruments: Federal Funds (Fed Funds),Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day (in the form of overnight loans). Single-payment loan: one payment (principal and interest) at maturity Used by banks to meet reserve requirements in the short term. Fed funds rate is particularly important in the conduct of monetary policy because it is the interest rate that the Fed tries to influence directly and it is indicative of the Feds stance on monetary policy,Money Market Instruments: Fed Funds Rates,Notice that the two rates track fairly closely. What does this suggest about the market for T-bills and the market for fed funds?,Money Market Instruments: Repurchase Agreements,A repurchase agreement (repo or RP) is the sale of a security with an agreement to buy the security back at a set price in the future (usually 3-14 days later) Repos are short-term collateralized single-payment loans (typical collateral is U.S. Treasury securities) A reverse repurchase agreement is the opposite side of a repo (i.e., it is the purchase of a security with an agreement to sell it back in the future),Money Market Instruments: Negotiable Certificates of Deposit,A negotiable certificate of deposit (CD) is a bank-issued time deposit that specifies the interest rate and the maturity date and negotiable (i.e., salable) in the secondary market A negotiable CD is a bearer instrument Whoever holds the CD when it matures receives the principal and interest Denominations range from $100,000 to $10 million; $1 million being the most common Often purchased by money market mutual funds with pools of funds from individual investors,Money Market Instruments: Negotiable CD Rates,Again, notice that the two rates track fairly closely. What does this suggest about the market for T-bills and the market for CDs?,Money Market Instruments: Commercial Paper （商业票据，短期融资券，短融）,CP is unsecured short-term corporate debt issued to raise short-term funds (e.g., for working capital) Generally sold in large denominations (e.g., $100,000 to $1 million) with maturities between 1 and 270 days CP is usually held by investors until maturity and has no active secondary market Yields are quoted on a discount basis (like T-bills) The use of commercial paper increased significantly in the early 1980s in U.S. because of the rising cost of bank loans.,Money Market Instruments: Bankers Acceptances