FINC 3340

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FINC 3340

• The Money Markets

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Learning Objectives

• After completing this material, you should
• be familiar with the key characteristics of the
  major instruments traded in the money market who
  issues them, who owns them, what the contracts
  terms and risks are, and how they are traded
• be able to compute prices and yields using a
  variety of interest rate conventions
• understand the functioning of money market mutual
  funds.

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Understanding the Money Market

• How BIG is the Money Market?

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Understanding the Money Market

• For each of the instruments, we want to get a
  "picture" of its basic characteristics (and
  consequently the types and degree of risks
  involved), as well as the major participants
  (both issuers and investors) in that security's
  markets.
• A few points about all money market securities
• all debt obligations
• all maturities
• Instruments of the Money Market
• Treasury bills
• The auction process - how are yields (and prices)
  determined?

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Results of a Treasury Auction
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Understanding the Money Market

• Instruments of the Money Market, continued
• Repurchase agreements Federal Funds
• Negotiable CD's Commercial paper
• Bankers' acceptances Eurodollars

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Federal Funds Rates relative to T-bills
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Negotiable Certificates of Deposit Comparing
Interest Rates on CDs and T-bills
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Commercial PaperCommercial Paper Rates versus
Bank Prime Rates
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Interest Rate Conventions

• Recall from Chapter 3 that many of the
  instruments traded in the money markets have
  unusual ways of determining prices/yields.
  Consequently, we have to be careful to convert
  from the unusual back to bond equivalent yields,
  which we can use to make realistic comparisons
  across securities.
• Dealing with discount pricing
• Treasury bills price this way, where interest
  earned is the difference between purchase price
  and maturity (par, or face) value
• Rates are stated on a 360 day year

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Interest Rate Conventions

• This gives us the following relationship
• And rearranging, we have

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Interest Rate Conventions

• So, to fix these, we must correct idb into a bond
  equivalent, or annualized, yield
• For example, assume that the current price on a 3
  month T-bill is 9867.50 What is the T-bills
  annual yield? What is its quoted discount yield?

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Money Market Mutual Funds

• What are the investment characteristics of
  MMMFs?
• What forces have driven the growth in these
  funds? How banks responded?
• What is liquidity intervention?