CHAPTER 4 :

MONEY
MARKET
5-1
Money Markets

 Money
Moneymarkets
marketsinvolve
involvedebt
debtinstruments
instrumentswith
withoriginal
original
maturities
maturitiesof
ofone
oneyear
yearor
orless
less
 Money
Moneymarket
marketdebt
debt
 issued
issuedby byhigh-quality
high-quality(i.e.,
(i.e.,low
lowdefault
defaultrisk)
risk)economic
economicunits
unitsthat
that
require
requireshort-term
short-termfunds
funds
 purchased
purchasedby byeconomic
economicunitsunitsthat
thathave
haveexcess
excessshort-term
short-termfunds
funds
 little
littleor
orno
nochance
chanceof ofloss
lossofofprincipal
principal
 low
lowrates
ratesof
ofreturn
return
 Most
Mostmoney
moneymarket
marketinstruments
instrumentshave
haveactive
activesecondary
secondary
markets
marketsto
toprovide
provideliquidity
liquidity

5-2
Money Market Yields

 Money
Moneymarket
marketsecurities
securitiesuse
usespecial
specialrate
ratequoting
quoting
conventions:
conventions:
 Discount
Discountyields
yields(D
(Dy): Interest rate is quoted on an annual basis
y): Interest rate is quoted on an annual basis
assuming
assumingaa360
360day
dayyear
yearas asaapercent
percentofofredemption
redemptionprice
priceor
or
face
facevalue
value
 Single
Singlepayment
paymentyields
yields(S(Spypy):): Interest
Interestrate
rateisisquoted
quotedononan
anannual
annual
basis
basisassuming
assumingaa360360day
dayyear yearasasaapercent
percentof ofpurchase
purchaseprice
price

 Both
Bothmay
maybebeconverted
convertedto
toaabond
bondequivalent
equivalentyield
yield(B
(BEY) for
EY) for
comparison
comparisonwith
withbonds
bonds

5-3
Interest is the amount of money charged for
borrowing or using money. When you deposit
money into a savings account, you are paid
interest. Simple interest is one type of fee paid
for the use of money.

Simple interest Rate of interest is the

is money paid percent charged or
only on the earned.
principal. I = P r t
 

Time in years that

Principal is the amount of the money is
money borrowed or invested.borrowed or investe

5-4
 Example
Mr. Zamora borrowed a sum of P35,000 from a credit
cooperative to be returned at the end of one year at 8%
simple interest, how much interest is charge?
First, find the interest he will pay.
I=P r t 
Use the formula.
I = 35,000 0.08 1
 
Substitute. Use 0.08 for 8
I = 2,800 Solve for I.

5-5
Maturity Value

MV = P + I
Where:
Where:
MVMV==Maturity
MaturityValue
Value
PP==Principal
Principal
I I==Interest
Interest

5-6
Discount Rate

D= Fdt
Where:
Where:
D=
D=Discount
DiscountRate
Rate
FF==Future
FutureValue
Value
d=Discount
d=DiscountRate
Rate
TT==Time
Time

5-7
Proceeds

P = F-D
Where:
Where:
P=
P=Proceeds
Proceeds
F=Future
F=FutureValue
Value
D=Discount
D=Discount

5-8
Important Dates in Monetary
Market Instrument
 Transaction
Transaction date date This
This isis the
the date
date where
where the the terms
terms andand conditions
conditions ofof thethe
financial
financial instrument are stated such as the term to maturity, the amount to
instrument are stated such as the term to maturity, the amount to
be
beinvester),
invester),and andthetheprice
priceagreed
agreedupon uponby bythe
thetwotwoparties.
parties.
 Value
Value date.date. ItIt isis the
the date
date when
when the the invested
invested amount
amount willwill start
start accruing
accruing
interest,
interest, The value date of the financial instrument may or may not be
The value date of the financial instrument may or may not be thethe
same as the transaction date. If the transaction
same as the transaction date. If the transaction and value date are the and value date are the
same,
same,then thenititisissaid
saidto tobebefor
forthe
thesame-day
same-dayvalue. value.On Onthetheother
otherhand,
hand,ififthethe
dates
dates are not the same, the value date is the next business day which isis
are not the same, the value date is the next business day which
also
alsoknown
knownas asthethenext-value
next-valueday dayor orthe
thevalue
valuetomorrow.
tomorrow.However,
However,there there
are
are markets
markets and and transactions
transactions where where the the value
value date
date isis two
two business
business daysdays
after
after thethe transaction
transaction date,date, inin this
this regard
regard itit isis said
said to
to be
be aa spot
spot transaction
transaction
and it is said to be for spot
and it is said to be for spot value. value.
 Maturity
Maturitydate. date.ThisThisisisthe
thedate
datewhere
wherethe thecontract
contractisisterminated
terminatedor orwill
willend.
end.
The interest will stop accruing at the term of
The interest will stop accruing at the term of maturity as agreed upon maturity as agreed upon
between
between

5-9
Money Market Yields

 Treasury
Treasury bills
bills and
and commercial
commercial paper
paper rates
rates are
are
quoted
quoted as
as discount
discount yields
yields
 Discount yields (D ) use a 360-day year
Discount yields (Dyy) use a 360-day year
( Pf  P0 ) 360
Dy  
Pf n

PPf ==the
theface
facevalue
valueofofthe
thesecurity
security
f
PP0 ==the
thediscount
discountprice
priceofofthe
thesecurity
security
0
nn==the
thenumber
numberof ofdays
daysuntil
untilmaturity
maturity

5-10
Money Market Yields

 Compare
Compare discount
discount securities
securities to
to bonds
bonds with
with bond
bond
equivalent
equivalent yields
yields (B
(BEY)
EY)
( Pf  P0 ) 365
BEY  
P0 n
 Convert
Convert bond
bond equivalent
equivalent yields
yields into
into effective
effective
annual
annual returns
returns (EAR)
(EAR)

365 / n
 BEY 
EAR  1   1
 365/ n 

5-11
Money Market Yields

 Negotiable
Negotiable(or
(orjumbo)
jumbo)CDs
CDsand
andfed fedfunds
fundsare
aremoney
money
market
marketsecurities
securitiesthat
thatpay
payinterest
interestonlyonlyat
atmaturity.
maturity. These
These
use
usesingle-payment
single-paymentyields
yields(S(Spypy))
( Pf  P0 ) 360
S PY  
P0 n
 to
toconvert
convertaasingle-payment
single-paymentyield yieldtotoaabond
bondequivalent
equivalentyield:
yield:

BEY  S PY (365/ 360)

 to
todirectly
directlyconvert
convertaasingle
singlepayment
paymentyield
yieldto
toan
anEAR:
EAR:
365 / n
 365/ 360 
EAR  1  S PY  1
 365 / n 

5-12
Money Market Instruments

 Treasury bills (T-bills)

Treasury bills (T-bills)
 Federal funds (fed funds)
Federal funds (fed funds)
 Repurchase agreements (repos or RP)
Repurchase agreements (repos or RP)
 Commercial paper (CP)
Commercial paper (CP)
 Negotiable certificates of deposit (CD)
Negotiable certificates of deposit (CD)
 Banker acceptances (BA)
Banker acceptances (BA)

5-13
Treasury Bills (T-Bills)

 T-Bills are short-term debt obligations issued

T-Bills are short-term debt obligations issued
by
by the
the government
government

 T-bills are virtually default risk free, are highly

T-bills are virtually default risk free, are highly
liquid,
liquid, and
and have
have little
little interest
interest rate
rate risk
risk

5-14
Treasury Bills (T-Bills)

 The Federal Reserve buys and sells T-bills to

The Federal Reserve buys and sells T-bills to
implement
implement monetary
monetary policy
policy

 Strong international demand for T-bills as

Strong international demand for T-bills as
safe
safe haven
haven investment
investment

5-15
T-Bill Auctions

 13-
13- and
and 26-week
26-week T-bills
T-bills are
are auctioned
auctioned weekly
weekly
 Bids
Bids are
are submitted
submitted byby government
government securities
securities
dealers,
dealers, financial
financial and
and nonfinancial
nonfinancial corporations,
corporations,
and
and individuals
individuals
 Bids can be competitive or noncompetitive
Bids can be competitive or noncompetitive
 competitive
competitivebids
bidsspecify
specifythe
thebid
bidprice
priceand
andthe
thedesired
desired
quantity
quantityof
ofT-bills
T-bills
 noncompetitive
noncompetitivebidders
biddersget
getpreferential
preferentialallocation
allocationand
and
agree
agreeto
topay
paythe
thelowest
lowestprice
priceof
ofthe
thewinning
winningcompetitive
competitive
bids
bids

5-16
T-Bill Auctions

Noncompetitive Bids
Bid Price 1
SC ST
2
3
4
5
6
Stop-out
price (PNC) 7

Quantity of
T-bills

5-17
The Secondary Market for T-Bills

 The
The secondary
secondary market
market for
forT-bills
T-bills isis the
the largest
largest of
of
any
any U.S.
U.S. money
money market
market instrument
instrument
 22 primary dealers “make” a market in T-bills by
22 primary dealers “make” a market in T-bills by
buying
buying the
the majority
majority sold
sold at
at auction
auction and and by by creating
creating
an
an active
active secondary
secondary market
market
 primary
primarydealers
dealerstrade
tradefor
forthemselves
themselvesand
andfor
forcustomers
customers
 T-bill
T-billpurchases
purchasesand
andsales
salesare
arebook-entry
book-entrytransactions
transactions
conducted
conductedover
overFedwire
Fedwire
 T-Bills
T-Bills are
are sold
sold on
on aa discount
discount basis
basis

5-18
T-Bill Prices

 T-Bill
T-Billprices
pricescan
canbe
becalculated
calculatedfrom
fromquotes
quotes(e.g.,
(e.g.,from
from The
The
Wall
WallStreet
StreetJournal)
Journal)by
byrearranging
rearrangingthe
thediscount
discountyield
yield
equation
equation

 Or,
Or,by
byrearranging
rearrangingthe
thebond
bondequivalent
equivalentyield
yieldequation
equation

5-19
Federal Funds

 The
Thefederal
federalfunds
funds(fed
(fedfunds)
funds)rate
rateisisthe
thetarget
targetrate
ratein
inthe
the
conduct
conductof ofmonetary
monetarypolicy
policy
 Fed
Fedfund
fundtransactions
transactionsareareshort-term
short-term(mostly
(mostlyovernight)
overnight)
unsecured
unsecuredloans
loans
 Banks
Bankswith
withexcess
excessreserves
reserveslend
lendfed
fedfunds,
funds,while
whilebanks
bankswith
with
deficient
deficientreserves
reservesborrow
borrowfed
fedfunds
funds
 Multimillion
Multimilliondollar
dollarloans
loansmay
maybe bearranged
arrangedin inaamatter
matterof
of
minutes
minutes
 Fed
Fedfunds
fundsarearesingle-payment
single-paymentloansloansand
andthus
thususe
usesingle-
single-
payment
paymentyields
yields

5-20
Repurchase Agreement

 AArepurchase
repurchaseagreement
agreement(repo(repoor
orRP)
RP) isisthe
thesale
saleofofaa
security
securitywith
withan
anagreement
agreementto tobuy
buythe
thesecurity
securityback
backatataa
set
setprice
pricein
inthe
thefuture
future
 Repos
Reposare areshort-term
short-termcollateralized
collateralizedloans
loans(typical
(typicalcollateral
collateral
isisU.S.
U.S.Treasury
Treasurysecurities)
securities)
 Similar to a fed fund loan, but collateralized
Similar to a fed fund loan, but collateralized
 Funds may be transferred over FedWire system
Funds may be transferred over FedWire system
 If collateralized by risky assets, the repo may involve a
If collateralized by risky assets, the repo may involve a
‘haircut’
‘haircut’

5-21
Repurchase Agreement

 Typical
Typicaldenominations
denominationson
onrepos
reposof
ofone
oneweek
weekor
orless
lessare
are
$25
$25million
millionand
andlonger
longerterm
termrepos
reposusually
usuallyhave
have$10
$10million
million
denominations
denominations

 AAreverse
reverserepurchase
repurchaseagreement
agreementisisthethepurchase
purchaseofofaa
security
securitywith
withan
anagreement
agreementto
tosell
sellititback
backin
inthe
thefuture
future

5-22
Repurchase Agreement

 The
The yield
yield on
on repurchase
repurchase agreements
agreements (RA (RAYY)) uses
uses
aa 360-day
360-day year
year like
like the
the discount
discount rate,
rate, but
but uses
uses the
the
current
current price
price in
in the
the denominator
denominator like
like the
the bond
bond
equivalent
equivalent yield
yield
( Pf  P0 ) 360
RAY  
P0 n

PPf ==the
therepurchase
repurchaseprice
priceof
ofthe
thesecurity
security
f
PP0 ==the
theselling
sellingprice
priceofofthe
thesecurity
security
0
nn==the
thenumber
numberof ofdays
daysuntil
untilthe
therepo
repomatures
matures

5-23
Commercial Paper

 Commercial
CommercialPaperPaper(CP)
(CP)isisunsecured
unsecuredshort-term
short-termcorporate
corporate
debt
debtissued
issuedtotoraise
raiseshort-term
short-termfunds
funds(e.g.,
(e.g.,for
forworking
working
capital)
capital)
 Generally
Generallysold
soldin
inlarge
largedenominations
denominations(e.g.,
(e.g.,$100,000
$100,000to to$1
$1
million)
million)with
withmaturities
maturitiesbetween
between11and
and270270days
days
 CP
CPisisusually
usuallysold
soldto
toinvestors
investorsindirectly
indirectlythrough
throughbrokers
brokersand
and
dealers
dealers(approximately
(approximately85% 85%of
ofthe
thetime)
time)
 CP
CPisisusually
usuallyheld
heldby
byinvestors
investorsuntil
untilmaturity
maturityand
andhashasno
no
active
activesecondary
secondarymarket
market
 Yields
Yieldsare
arequoted
quotedon onaadiscount
discountbasis
basis(like
(likeT-bills)
T-bills)

5-24
Asset-Backed Commercial Paper

 AAtype
type ofof commercial
commercial paper
paper that
that isis backed
backed by
by assets
assets
of
of the
the issuing
issuing firm
firm

 Grew
Grew very
very rapidly
rapidly prior
prior to
to thethe financial
financial crisis
crisis peaking
peaking
at
at $2.16
$2.16 trillion,
trillion, much
much ofof itit was
was backed
backed byby mortgage
mortgage
investments
investments

 The
The market
market collapsed
collapsed during
during the
the financial
financial crisis
crisis

5-25
Negotiable Certificate of Deposit

 AAnegotiable
negotiable certificate
certificate ofof deposit
deposit (CD)
(CD) isis aa bank-
bank-
issued
issued time
time deposit
deposit that
that specifies
specifies the
the interest
interest rate
rate
and
and the
the maturity
maturity date
date
 CDs are bearer instruments and thus are salable in
CDs are bearer instruments and thus are salable in
the
the secondary
secondary market
market
 Denominations range from $100,000 to $10 million;
Denominations range from $100,000 to $10 million;
$1
$1 million
million being
being the
the most
most common
common
 Often purchased by money market mutual funds
Often purchased by money market mutual funds
with
with pools
pools of
of funds
funds from
from individual
individual investors
investors

5-26
Banker’s Acceptance

 AABanker’s
Banker’sAcceptance
Acceptance(BA)(BA) isisaatime
timedraft
draftpayable
payabletotoaa
seller
sellerof
ofgoods
goodswith
withpayment
paymentguaranteed
guaranteedby byaabank
bank
 Used
Usedin ininternational
internationaltrade
tradetransactions
transactionsto tofinance
financetrade
tradeinin
goods
goodsthat
thathave
haveyet
yetto
tobe
beshipped
shippedfromfromaaforeign
foreignexporter
exporter
(seller)
(seller)to
toaadomestic
domesticimporter
importer(buyer)
(buyer)
 Foreign
Foreignexporters
exportersprefer
preferthat
thatbanks
banksact actas
aspayment
payment
guarantors
guarantorsbefore
beforesending
sendinggoods
goodsto toimporters
importers
 Banker’s
Banker’sacceptances
acceptancesarearebearer
bearerinstruments
instrumentsand andthus
thusare
are
salable
salableininsecondary
secondarymarkets
markets

5-27
Money Market Participants

 The
The U.S.
U.S.Treasury
Treasury
 The
The Federal
Federal Reserve
Reserve
 Commercial banks
Commercial banks
 Money market mutual funds
Money market mutual funds
 Brokers and dealers
Brokers and dealers
 Corporations
Corporations
 Other financial institutions
Other financial institutions
 Individuals
Individuals

5-28
International Money Markets

 U.S.
U.S.dollars
dollarsheld
heldoutside
outsidethetheU.S.
U.S.are
aretracked
trackedamong
among
multinational
multinationalbanks
banksin inthe
the Eurodollar
Eurodollarmarket
market
 The
Therate
rateoffered
offeredfor
forsale
saleononEurodollar
Eurodollarfunds
fundsisisthe
the
London
LondonInterbank
InterbankOffered
OfferedRate Rate(LIBOR)
(LIBOR)
 Eurodollar
EurodollarCertificates
Certificatesof ofDeposit
Deposit are
areU.S.
U.S.dollar-
dollar-
denominated
denominatedCDs CDsheld
heldin inforeign
foreignbanks
banks
 Eurocommercial
Eurocommercialpaper paper(Euro-CP)
(Euro-CP) isisissued
issuedininEurope
Europe
and
andcan
canbebein
inlocal
localcurrencies
currenciesor orU.S.
U.S.dollars
dollars

5-29