Definition and Purpose of Money Markets

1
Definition and Purpose of Money Markets

• The Money Markets are associated with the
  issuance and trading of short-term debt
  obligations of large corporations, FIs and
  government
• Only High-Quality Entities can borrow in the
  Money Markets and individual issues are large
• Investors in Money Market Instruments include
  corporations and FIs who have idle cash but are
  restricted to a short-term investment horizon

2
Money Market Instruments

• US Treasury Bills
• Commercial Paper
• Negotiable CDs
• Repurchase Agreements
• Federal Funds
• Bankers Acceptances

3
Money Market Instruments Outstanding(in billions
of dollars)
Rate of Return 1990 2001
Amount Outstanding
1990
2001
Treasury bills 527.0
811.2 6.68 1.73
Federal funds and
repurchase agreements 372.3
1,237.9 7.31 1.82
Commercial paper 537.8
1,440.9 8.14 1.79
Negotiable certificates of deposit
546.9 1,118.4
8.13 1.84 Bankers acceptance
52.1 4.8
7.95 1.87
4
Treasury Bill Basics

• Issued by the U.S. Treasury to cover government
  budget deficits and to refinance maturing debt
• Standard Original Maturities of 13 weeks, 26
  weeks, or 52 weeks
• Denominations are 1,000 but typical round lot is
  5 million

5
Secondary Market for T-bills

• The largest of any U.S. money market
• Approximately 30 financial institutions make a
  market in T-bills by buying and selling
  securities for their own accounts and by trading
  for their customers,
• T-bills are the FOMCs instrument of choice for
  its open market operations

6
Commercial Paper

• An unsecured short-term promissory note issued by
  a corporation to raise short-term cash, often to
  finance working capital requirements
• The largest (in terms of dollar value) of the
  money market instruments
• Generally sold in denominations of 100,000,
  250,000, 500,000 and 1 million with maturities
  of 1-270 days (if maturity is greater than 270
  days, SEC requires registration)
• Generally held until maturity so there is not an
  active secondary market

7
Negotiable Certificates of Deposits

• A bank-issued time deposit that specifies an
  interest rate and maturity date and is negotiable
  in the secondary market
• Bearer Instrument
• whoever holds the CD when it matures receives the
  principal and interest
• Denominations that range from 100,000 to 10
  million, 1 million being the most common

8
Repurchase Agreements (RPs or Repos)

• An agreement involving the sale of securities by
  one party to another with a promise to repurchase
  the securities at a specified price on a
  specified date
• Essentially a collateralized loan with collateral
  in the form of securities
• Terminology
• Borrower repo
• Lender reverse repo

9
Federal Funds Basics

• Short-term funds transferred between financial
  institutions, usually for a period of one day
• Federal Funds rate
• the interest rate for borrowing fed funds
• a focus or target rate in the conduct of monetary
  policy

10
Money Market Participants
11
International Aspects of Money Markets

• While U.S. money markets are the largest, the
  international market is growing
• Euro money market instruments
• Eurodollar deposits, Eurodollar CDs, Euro notes,
  Euro CP
• London Interbank Offered Rate (LIBOR)
• the rate paid on Eurodollars

12
Money Market Risks

• Credit (or Default) Risk
• Treasury Bills are considered credit risk free
• Relatively low risk in other markets
• Interest Rate Risk
• Relatively low due to short terms
• Collateral Risk
• In repo market this is the risk that the
  collateral was not legally transferred to lender

13
Treasury Auction Schedule

• Bills
• 13-week Weekly
• 26-week Weekly
• Notes
• 2-year Monthly
• 5-year Feb, May, Aug, Nov
• 10-year Feb, May, Aug, Nov
• Inflation Indexed Notes and Bonds
• 10-year Jan, Jul
• 30-year Apr, Oct