Part IV
Financial Markets
Chapter Eight
The Money Markets
Slide 8–4
The Money Markets
• Money Markets Defined1. Money market securities are usually sold in large
denominations
2. They have low default risk
3. They mature in one year or less from their issue date
Slide 8–5
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
Slide 8–6
Interest Rates Available on Several Money Market Instruments
Slide 8–7
Participants in Money Markets
• U.S. Treasury Department
• Federal Reserve System
• Commercial Banks
• Businesses
• Investment and Securities Firms
• Individuals (mostly through money market mutual funds)
Slide 8–8
Money Market Instruments
• Treasury Bills
• Federal Funds
• Repurchase Agreements
• Negotiable Certificates of Deposit
• Commercial Paper
• Banker’s Acceptance
• Eurodollars
Slide 8–9
Treasury Bills
1. Short-term borrowings of the federal government
2. Usually sold at discount
Slide 8–10
Discounting Example
• You pay $9850 for a 91-day T-bill. It is worth $10,000 at maturity. What is its annualized yield?
iyt F PP
365
n
iyt $10,000 $9,850
$9,850
365
910.0611 6.11%
(1)
Slide 8–11
Results of a Treasury Auction
Slide 8–12
Figure 8-1: Treasury Bill Interest Rate and the Inflation Rate, January 1973–January 2002
Current inflation statisticsftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
Slide 8–13
Federal Funds
• Short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day
Slide 8–14
Federal Funds
Figure 8.2: Federal Funds and Treasury Bill Interest Rates, January 1990–January 2002
Slide 8–15
Negotiable Certificates of Deposit
• A bank-issued security that documents a deposit and specifies the interest rate and the maturity date
• Denominations range from $100,000 to $10 million
Slide 8–16
Negotiable Certificates of DepositComparing Interest on CDs and T-bills
Figure 8.3: Interest Rates on Negotiable Certificates of Deposit and on Treasury Bills, January 1990–January 2002
Slide 8–17
Commercial Paper
• Unsecured promissory notes, issued by corporations, that mature in no more than 270 days
Slide 8–18
Figure 8.4: Return on Commercial Paper and the Prime Rate, January 1990–January 2002
Commercial PaperComparing Interest on Commercial Paper to Bank Prime Rate
Slide 8–19
Banker’s Acceptances
• An order to pay a specified amount to the bearer on a given date if specified conditions have been met, usually delivery of promised goods
Slide 8–20
Advantages to Banker’s Acceptances
1. Exporter paid immediately
2. Exporter shielded from foreign exchange risk
3. Exporter does not have to assess the financial security of the importer
4. Importer’s bank guarantees payment
5. Crucial to international trade
Slide 8–21
Eurodollars
• Dollar denominated deposits held in foreign banks
Slide 8–22
Eurodollars
• 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
• Time deposits with fixed maturities– Largest short term security in the world
Slide 8–23
Figure 8-6: Interest Rates on Money Market Securities, 1990–2002
Interest rates on money market instrumentshttp://www.federalreserve.gov/releases
Slide 8–24
Money Market Securities and Their Depth
Slide 8–25
Money Market Mutual Funds
• Open-end investment funds that invest only in short-term securities
• No fee for purchasing or redeeming shares
• Minimum initial investment of $500 to $20,000
• Check-writing privileges– No fee for writing checks– No minimum check amount
• Earn 0.5% to 1% higher return than interest earned on money in the bank
• Low risk of default, low rate of risk
• Popular to small investors
Slide 8–26
Growth in Money Market Mutual Funds
Figure 8.7: Net Assets of Money Market Mutual Funds, 1975–2000
Slide 8–27
Money Market Fund Assets
Figure 8.8: Average Distribution of Money Market Fund Assets, 2001
