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Activity in money markets increased significantly in the late 1970s and early 1980s because

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- rising short-term interest rates - regulations that limited what banks could pay for deposits.

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Money Market securities are:

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- short-term - low risk - very liquid

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The banking industry

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- should have an efficiency advantage in gathering info that should eliminate the need for the money markets - exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders - subject to more regulations and governmental costs than are the money markets

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In situations where the asymmetric information problem is not severe:

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the money markets have a distinct cost advantage over banks in providing short-term funds

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Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firms

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- were subject to deposit reserve requirements - were not subject to deposit interest rate ceilings

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Money Markets

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Markets that trade debt securities or instruments with maturities of less than one year - not all commercial banks deal for their customers in the secondary market - used extensively by businesses both to warehouse surplus funds and to raise short-term funds. - most money market securities do not pay interest. Instead the investor pays less for the security than it will be worth when it matures. - Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet their obligations - The U.S. Treasury Department is always a demander of money market funds and never a supplier. - large banks participate in money markets by selling large negotiable CDs - U.S. Government and corps. borrow in the money markets because cash inflow and outflows are rarely synchronized - the Federal Reserve is the single most influential participant in the U.S. Money Market

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most influential participant in the U.S. Money Market

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- the Federal Reserve

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The primary function of large diversified brokerage firms in the money market is to

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make a market for money market securities by maintaining an inventory form which to buy or sell

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Finance Companies rase funds in the money market by selling

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Commercial Paper

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Finance companies play a unique role in money markets by

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giving consumers indirect access to money markets

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Money market instruments issued by the U.S. Treasury are called..

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Treasury Bills

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Treasury auctions 91-day and 182-day treasury bills once a week. it auctions 52 week bills..

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once a month

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Treasury Bills

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- The market for Treasury Bills is extremely deep and liquid - Occasionally, investors find that earnings on T-Bills do not compensate then for changes in purchasing power due to inflation

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a competitive bid for a treasury bill is successful when..

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- when you pay more than if you had submitted a noncompetitive bid

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a noncompetitive bid for a treasury bill is successful when..

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- you pay the same as other successful noncompetitive bidders

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Federal Funds

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Short-term funds transferred between financial institutions, usually for a period of one day - actually have nothing to do with the federal government - provide banks with an immediate infusion of reserves should they be short - usually overnight investments - borrowed by banks that have a deficit of reserves -lent by banks that have an excess of reserves

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The Fed can influence the federal funds interest rate by adjusting the level of reserves available to banks in the system. The Fed can..

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- Lower the federal funds interest rate by adding reserves - raise the federal funds interest rate by removing reserves - remove reserves by selling securities

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The Federal Reserve can influence the federal funds interest rate by..

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buying securities which adds reserves, thereby lowering the federal funds rate.

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The Fed can lower the federal funds interest by

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buying securities, thereby adding reserves

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If the Fed wants to lower the federal funds interest rate, it will..

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add reserves to the banking system by buying securities

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If the Fed wants to raise the federal funds interest rate, it will

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sell securities to remove reserves from the banking system

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Government securities dealers frequently engage in repos to

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- manage liquidity - take advantage of anticipated changes in interest rates -lend or borrow for a day or two with what is essentially a collateralized loan

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Repos

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- usually low risk loans - usually collateralized with Treasury Securities - Low interest rate loans

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Negotiable certificate of deposit

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- a bank-issued, fixed maturity; - interest bearing time deposit that specifies an interest rate - maturity date and is negotiable - can be bought and sold until maturity - is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest - typically have a maturity of one to four months

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Commercial Paper Securities

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An unsecured short-term promissory note issued by a company to raise short-term cash, often to finance working capital requirements - are issued only by the largest and most creditworthy corporations , as they are unsecured - carry an interest rate that varies according to the firm's level of risk - never have a term to maturity that exceeds 270 days - not generally traded in a secondary market

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Banker's Acceptance

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A time draft payable to a seller of goods, with payment guaranteed by a bank - used to finance goods that have not yet been transferred from seller to the buyers - an order to pay a specified amount of money to the bearer on a given date - can be bought and sold until they mature - are issued by large money center banks - carry low interest rates because of the very low default risk

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Eurodollar Market

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The market where Eurodollars trade Eurodollars: - are time deposits with fixed maturities and are, therefore somewhat illiquid -offer the borrower a lower interest rate than can be received in the domestic market

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Money Market Securities

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- the interest rates on all money market instruments move very closely together over time - The secondary market for Treasury Bills is extensive and well developed - There is no well-developed secondary market for commercial paper

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Money market mutual funds

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are funds that aggregate money from a group of small investors and invest in money market instruments - have grown enormously popular since their inception in the early 1970s - received flood of funds in the early 1980s as depositors withdrew their funds from banks which were restricted from paying more then 5.52 percent in the interest on savings account. - assets of money market mutual funds have increased under $100 billion in 1980 to more than $1.5 trillion in 2000

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Money market mutual funds

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- Commercial paper is by far the largest component of these funds - Although investors know that MMMFs are not investors a higher return than is available from banks

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Money Market securities are short-term instruments with an original maturity of less than one year

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TRUE

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Money Market securities include:

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- Treasury Bills - Commercial Paper - Federal funds - Repurchase agreements - negotiable certificates of deposit - banker's acceptance - Eurodollars

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The term money markets is actually a misnomer, b/c liquid securities are traded in these market rather than money

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FALSE

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Money markets are referred to as a retail markets because small individual investors are the primary buyers of money market securities

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FALSE

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The U.S. Treasury Dept. is the single most influential participant in the U.S. Money market

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FALSE

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Banks are unusual participants in the money market b/c they buy, but do not sell, money market instruments

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FALSE

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Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.

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TRUE

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The market for U.S. Treasury Bills is a shallow market b/c so few individual investors buy t-bills

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FALSE

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T-Bill is not an investment to be used for anything but temporary storage of excess funds because it barely keeps up with inflation

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TRUE

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The main purpose for federal funds is to provide banks with an immediate infusion of reserves should they be short

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TRUE

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The Fed can influence the federal funds rate by adjusting the level of reserves in the banking system

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TRUE

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Commercial Paper securities are unsecured promissory notes, issued by corporations, that mature in no more than 270 days

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TRUE

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A banker's acceptance is an order to pay a specified amount of money to the bearer on given date. Banker's acceptances have been used since the twelfth century

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TRUE

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Interest rates on banker's acceptances are low because the risk of default is very low

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TRUE

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Opportunity Cost

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The forgone interest cost from holding the cash balances when they are recieved

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Default risk

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the risk of late or nonpayment of principal or interest

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Treasury Bills

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Short-term obligations of the U.S. government issued to cover government budget deficits and to refinance maturing government debt.

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Treasury bill auctions

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the formal process by which the U.S. Treasury sells new issues of Treasury Bills

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Federal fund Rate

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The interest rate for borrowing federal funds

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Correspondent Banks

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Banks with reciprocal accounts and agreements

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repurchase agreement

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an agreement involving the sale of securities by one party to another with a promise to repurchase the securities at a specified price and on a specified date

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Reverse repurchasing agreement

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an agreement involving the purchase of securities by one party from another with the promise to sell them back

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Bearer Instrument

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an instrument in which the holder at maturity receives the principle and interest

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London Interbank Offered Rate (LIBOR)

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the rate paid on Eurodollars

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Eurodollar CDs

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Dollar-denominated deposits in non-U.S. banks

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Eurocommercial Paper

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Eurosecurities issued in Europe by dealers of commercial paper without involving a bank

Fin 3323 Chpt 5 Money Markets

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