The Money Market and MoneyMarket Instruments 1

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The Money Market and Money-Market Instruments (1)

• Week 10 October 26, 2005

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Overview of Money Market
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Money Market Participants

• Financial Institutions
• Commercial banks
• Money market mutual funds
• Futures exchanges
• Brokers and dealers
• Federal Reserve

• Primary Sectors
• U. S. Government
• Municipal Government
• Corporations
• Foreign counterparts

• Purpose of the money market is to allocate money
  at a price for market participants who need it to
  pay for things

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Treasury Bills

• Maturities of 91 days (13-week) and 182 days
  (26-week) -- older one-year cancelled.
• Bills are quoted on a 360-day discounted basis,
  so that a 4 ask price corresponds toor 99
  of face value (e.g. 10,000,000 face value costs
  9,900,000.
• Bills are in book-entry form

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Bill auctions

• Tenders are announced, usually on Tuesdays
• Auctions are conducted by Federal Reserve on
  Mondays, with competitive and non-competitive
  tenders due by 130pm EST
• 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)

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Converting discount rate to yields

• Convert Bill discounts to yields usingwhere
  discount is in percent, or
• This can also be expressedwhere discount is
  in decimal form

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Example of converting discounts

• 27-day T-Bill quoted at 1.62 ask (on October 17,
  2002)
• Using simplified equation (Rose)

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History of Money Market Rates
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Sources of money market rates

• Weekly auction results in Tuesdays Wall Street
  Journal in Credit Markets
• Bid types and amounts
• Rates and yields
• Money Rates daily in Journal
• Interpretation of rates requires caution
• Rates change constantly
• Daily and weekly H15 Fed release

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Money market rates

• Fed funds quoted on annualized overnight rate
• Certificates of deposit quoted on 360-day basis
  with interest added to principal
• Treasury bills, commercial paper, and bankers
  acceptances are quoted on a bankers discount
  basis
• Discount rate and prime rate are posted rates,
  not market rates

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Interpreting money market rates

• T-Bill auction rate doesnt change until a new
  auction occurs, this is a primary market
• 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
• CDs have issue rate in the primary market but
  negotiable CDs trade in secondary market
• Market rates set in secondary markets

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Money Market Rates since 1960
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Money Market Rates since 1990
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Primary Dealers

• 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
• Limited number of large money-center banks and
  investment banks, and now foreign banks

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Repo Market
Federal Reserve
Commercial Bank
Securities Dealer
Assets
Assets
Assets
Liabilities
Liabilities
Liabilities
Deposits
Reserves
Reserves
U.S.Notes
U.S. Notes
Repo
U.S.Notes
Cash
Cash
Repo

• Repurchase agreements are a way for dealers to
  finance their inventories of securities
• Market is also open to corporations with excess
  cash through Fed wire

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Repos and Reverse-Repos

• Repurchase agreements are widely used by
  corporate treasurers and other institutional
  investors
• Repos and reverses may be overnight or term repos
  for time periods up to months
• For some (like Orange County), reverse repos were
  a way of leveraging a portfolio
• Effect of terrorist attack on repo market

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Repos and Reverse Repos
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Certificates of Deposit

• Large deposits (gt100,000)
• No reserve requirements (currently)
• Development of the market in 1960s
• Citibank
• Credit Crunches of 1966 and 1969
• Interest rates and Regulation Q in the l960s

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Next time

• Read Chapter 18 of text, concentrating on gaining
  a basic idea of money market instruments
• Take a quick look at Instruments of the Money
  Market referenced in the Data Sources section
  of the class website
• Bring a Wall Street Journal for next Tuesday or
  Wednesday to class