Quizlet money market - Study well PDF

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Money Markets Study online at quizlet.com/_nmleg 1.

A. What is the NCD yield?

A. The rate is negotiated. But the banks post an "official" CD rate that serves as an approximate guide to their actual rate.

B. What are the underlying factors determining the rate?

If it's eager to attract funds, it might adjust posted rates to be higher than those of other banks and a bit higher than secondary market ones. Usually only does this for good customers unless it need funds. bigger the bank, generally the lower the IR issued because of the tiering due to lower default risk and greater marketability. B. Factors: - Current money-market conditions - Rates paid by competing banks on their CDs - Yields on other similar short-term instruments - Characteristics of the issues (such as default risk and marketability of the CD).

AFMA (Australian Financial Markets Association) makes the official reference point as the midpoint of the yields on prime bank (S&P A+) CDs. In general, nonprime banks pay a premium of at least a few bps to sell their CDs. 2.

The commonwealth government and money markets

Has a more difficult liquidity problem than the RBA. Tax receipts around the scheduled dates but expenditures are more evenly distributed throughout the year. The AOFM has to finance the federal government's debt. GFC when tax receipts dropped significantly and the Australian government presented a sizeable budgetary deficit for 2009. Consequently AOFM has recommenced issuance of T-notes to meet the shortterm liquidity shortfall. (sold on the MMs!!)

3.

Corporations and MMs

Liquidity management problems also plague corporations. Corporate cash disbursements take place in various forms - Expenditures for tax obligations, - Wages, - Inventory purchases; and - Services necessary to do business Some cash balances are held at commercial banks for liquidity needs and others are held as compensating balances as payment for bank services and can use these bank balances as a day-to-day buffer for small, unexpected variations in cash flows. For larger, more persistent cash demands, corporate treasuries arrange for lines of credit or seasonal bank loans, or even CP if it is big and credit-worthy enough.

4.

Explain how repo transactions provide short-term loans to banks?

Bank Financing - Source of funds • Way to pay interest to corporate customers. • There is a negotiated market rate between parties. Bank Investment - Reverse Repo • Security purchased under agreement to resell at given price in future. • Smaller banks are able to invest excess liquidity in a secured investment.

5.

How are commercial papers traded?

Through the commercial paper market. Firms sell through MM dealers. Major investors in commercial paper are insurance companies, non-financial business firms, banks and superannuation funds.

6.

How are T-notes settled?

Electronic settlement since 1991. Semi-government securities, and private debt securities are traded through Austraclear (since 2002).

7.

How does the bidding occur for AUS T-notes?

The competitive auction process is common throughout the world T-notes are auctioned weekly on Thursdays by the AOFM, but in by the Office of Debt Management. Bids,usually by large investors,are submitted competitively, and the bid with the lowest yield is accepted first. Any remaining T-notes are sold to subsequent bidders. Price discrimination auction where bidders pay different prices.

8.

How does the RBA use money markets?

RBA is ultimately the most important participant because of its position as manager of money supply. Monetary policy is implemented by controlling the amount of exchange settlement balances that banks hold at the RBA. MMs are a primary tool for monetary policy implementation. • Purchase securities - increases member bank reserves. • Selling securities - decreases member bank reserves. 2. Also uses open-market operations to manage technical factors.

9.

How do you actually calculate the yield on a repo?

By multiplying the principal by the rate of interest p.a., and then multiplying that by the number of days until repurchase divided by 365. This will find the yield (I) or rate of interest.

10.

How do you create a BAB?

The importer initiates purchase from foreign exporter, payable in future.The importer needs financing; exporter needs assurance of payment in future. Importer's bank writes irrevocable letter of credit for exporter and specifies purchase order and then authorises exporter to draw the time draft on importer's bank. When goods are shipped, the exporter draws the draft on the Australian bank and then transfers the draft at a discount to its local bank, receiving immediate cash payment. The exporter's bank then sends the time draft, along with the proper shipping documents, to the importer's bank who accepts the draft (stamps it and creates a BAB). The importer's bank either returns the time draft (acceptance) to the exporter's bank or immediately pays the exporter's bank for it at a discounted price reflecting the time value of money during the waiting period. If the Australian bank pays the exporter's bank for the acceptance, it can then either hold the accepted draft as an investment or sell it in the open market as a source of funds. When the draft matures, the Australian importer is responsible for paying the exporter's bank. If for some reason the importer fails to pay, the accepting (exporter's) bank has legal recourse to collect from the Colombian exporter (paid already by the bank for the importer).

11.

How do you find commercial paper yields?

Like T-notes they are discount (no coupon interest) and priced using 365day year. Commercial paper (annualised) yield equals (face value over purchase price minus 1) multiplied by 1 divided by n/365.

12.

How do you find the yield of a T-note?

Rearrange so: Simple rate of interest per year equals the value of the security at maturity over the price of the security today minus 1, multiplied by 1 over the number of days to maturity divided 365 (1/(n/365)

13.

How do you price Tnotes?

T-notes are sold on a discount basis and pay no coupons. The pricing formula is very similar to the zero-coupon bond formula, except simple interest is used. And used the 365 day year. The value of the security at maturity equals the price of the security today, multiplied by, 1 plus the simple rate of interest per year x the number of days to maturity over 365.

14.

How has the commercial paper market developed over two centuries?

It emerged in the early 1800s, and originally the issuers were non-financial businesses and banks were the buyer. It's aim was to provide seasonal and working capital. Typical issuers were textile mills, railroads, tabacco companies In the 1920s issuers expanded to include finance companies.There was a growing demand for consumer durables. Part of the purchase price of these consumer durables was financed by borrowing. In the 1950s investors other than banks began to buy commercial paper

15.

How is commercial paper issued?

Through dealers: • They can price new issue + guarantee the sale of the entire issue. • They earn an underwriting fee. • Firms issuing commercial paper can sell it either through an underwritten or nonunderwritten offer. • Underwriting guarantees the issue will be taken up by investors. • However, non-underwritten issues are cheaper for the firm because commissions are not paid to an underwriter.

16.

How is the calculation determined?

Buyers and seller negotiate the rate charged but it still needs to be competitive.

In what sense is a repo a collateralised loan?

Alternative means for banks and financial institutions for liquidity management.

17.

Credit risk default is really low because of the underlying collateralising securities, so the 1day repo rate is usually less than the 1day rate for uncollateralised loans. (5-10bps)

The rate charged on a repo is negotiated between the two parties. The IR on a repo is lower than the interbank cash rate, because it's backed by collateral (e.g. T-bill) and the agreed price eliminates interest rate risk. Repos are used by the RBA (and RBNZ) in open market operations.

18.

What are commercial banks?

The most important participants in MMs. Engage actively in almost all the money markets and are continuously in the process of adjusting their liquidity because of short-term nature of their liabilities, wide variations in loan demand and desire to keep liquid assets on hand.

19.

What are money markets?

Money markets are a collection of markets each trading a different financial instrument. Over-the-counter (dealer) markets, so there's no central exchange. The Australian Financial Markets Association represents the interests of participants and lists conventions but if both parties to a contract disregard the conventions they are free to do so. Most of the transactions are settled by RITS, but it's still usual for physical transfers to occur though with the RBA, Austraclear etc. and others acting as registries usually physically hold the security and register participant's entitlements to them by keeping an electronic copy.

20.

What are negotiable certificates of deposit (NCDs)?

SImply a term deposit that is negotiable! (can be sold and traded before maturity). Issued at face value. Interest rates are add-on rates. This means it can be traded any number of times in the secondary market before its maturity. Highly liquid secondary market for short-term ones (usually $1m +). Higher yields than T-notes (higher creidit risk, lower marketability). $100,000 - $1m but very few are smaller than $500,000 because smaller ones tend to be less marketable! Usually maturities are up to 33 months. There is a market for longer-maturity CDs but beyond the three months the volume is small and the secondary market isn't very liquid.

21.

What are NZ Bank Bills?

NZ's NCD's closest equivalent. Issued for 30, 60 and 90 days. They are the most liquid MM securities in NZ. The IR in the secondary market for 90-day bank bills is the main reference rate for the NZ money market and the short-term interest rate for the economy.

22.

What are repos and reverse repos?

They are just opposites of THE SAME DEAL.

23.

What are some advantages of BABs?

Exporter receives funds by selling BAB in the secondary market. Exporter eliminates foreign exchange risk. Importer's bank guarantees payment of draft in future. Everyone is happy and gets their money when needed (importer doesn't want to pay until made some money but obviously the exporter wants the payment as soon as they export the goods).

24.

What are the characteristics of ABCPs?

ABCP vehicles are used for the following purposes: 1. The funding of loans 2. The funding of investments in securities Funding can take several forms: 1. for loans with short durations (leases and margin loans) 2. longer term financing of mortgages. The credit quality is potentially higher than that of assets that back the paper because most ABCP programs have credit enhancement to protect investors against default. So ABCP is generally highly rated. Also offers diversification to investors as it's issued against a pool of assets and can provide exposure to traditionally non-marketable assets such as trade receivables.

25.

What are the credit ratings in commercial paper markets?

Moody's and S&P rate commercial paper. Moody's: (high to low) P-1, P-2, P-3 S&P: (high to low) A-1, A-2, A-3 Extremely difficult to sell low rated commercial paper, but more receive the highest rating. (usually only the -1 and -2 ones sell)

26.

What are the main characteristics of money market instruments?

- Low default rate risk Issuers usually need a very high credit rating to borrow on the MM. - Short Maturity less than one year, usually much less. - Low price risk - Higher marketability They usually have highly liquid secondary markets - Sold in large dominations Therefore, the cost-per-dollar for executing transactions is very low.

27.

What are the origins of NCDs?

First issued by Citibank in 1961. Prior to 1961 CDs were generally not negotiable. Offset long-term trend of declining demand for business deposit balances at large banks as a source of funds. banks were feeling it because treasurers were investing in T-notes (safe) over CDs, so Citibank created the NCD and it's secondary market at the same time to provide marketability. Highly liquid secondary market, entry and exit is easy.

28.

What are treasury notes?

A type of debt issued by the AOFM on behalf of CG to finance the operation of the CG (cover current deficits and refinance maturing government debt). Traditionally the most important form and effectively a wholesale market. Auctions, and prior to July 2000 they had maturities of 5 weeks, 13 weeks or 26 weeks, but now issued at anything under a year. Minimum bids are $100,000 and in increments of $5000 thereafter, but are typically issued in tranches of $200, 300, 400, 500m, and $1b. Sold on a discount basis

29.

What happens in cash market transactions?

Interbank borrowing and lending make up most cash market transactions and can be secured or unsecured. When a transaction is made, the ESA of one bank is debited and the ESA of the other bank is credited. Short periods mean the interest accrued on funds needs to be enough to satisfy lenders to make a reasonable return after paying transaction fees. The interbank borrowing and lending market is extremely important and can rock the rest of the credit market if something is malfunctioning. GFC required government intervention worldwide to assist banks to ensure the rest of the markets were ok too. The freeze in the interbank markets flowed through the financial system.

30.

What happens in the NCD market?

The rate is negotiated between buyer and seller. Market is sensitive to rates above or below the market rates. Rates are lower for the big four banks and are tiered upward for smaller banks. Purchased mainly by corporate businesses.

31.

What instruments do commercial banks use?

Bank assets or investments include: • Treasury Notes • Bankers' acceptances (from other banks). • Funds sold in the inter-bank market. • Reverse repurchase agreements (securities purchased under agreements to resell). Bank liabilities or borrowing: • Negotiable CDs. • Commercial paper. • Bankers' acceptances. • Funds purchased in the interbank market. • Repurchase agreements Due to fluctuations in loans and deposits banks need MM securities to provide sources and uses of liquidity.

32.

What is a bank accepted bill?

This is a time draft (order to pay specified sum to bearer on given date) drawn on and accepted by a commercial bank. When accepted, bank unconditionally promises to pay holder FV of the draft at maturity even if the bank encounters difficulty collecting from customers. Bank substitutes its creditworthiness in for that of the issuer so it makes bankers' acceptances marketable instruments. (Considered to be safe) Discounted in market to reflect yield. Mostly relate to trade and have maturities of 30, 60, or 90 days or a max of 180.

33.

What is a repurchase agreement?

"repo" - simple transactions that are short-term agreements to sell and buy back a financial instrument that is secured by a security of the same dollar value that gives the seller access to cash resources for the duration of the agreement. Mostly short periods (>1-1week) but there's a growing market for longer-term ones (1-3 months). convention for min sizes = 1m for 1 day 20m for a week 50m for periods longer

34.

What is assetbacked commercial paper?

Short- term securities backed by financial assets including mortgages, receivables and long-term securities. Usually less then 1 year to maturity. Essentially short-term paper issued to fund investments, so in longer-term assets this type of funding strategy relies on the ability to "roll over" the paper when it matures i.e. new ABCPs are issued repay maturing ABCPs. Commonly issued in AUS by conduits "sponsored" by banks.

35.

What is commercial paper?

Short term, unsecured promissory notes usually issued by large corporations to finance short-term working capital needs. no assets to protect the investor, so only high quality borrowers can issue. Wholesale and sold at discount from par and has higher yields than equivalent T-notes. Low default risk, short maturity and relatively high yields for investors

36.

What is one name paper?

Short-term debt where the liability is endorsed by the signature of only a single issuer. There is no reliance on the credit enhancement that would arise from acceptance (a second signature). One-name paper major types include: - Treasury notes - Commercial paper - Negotiable certificates of deposit - Asset-backed commercial paper Generally, less corporate paper is issued during high-interest periods and more when money is readily available. The 2010 GFC the liquidity and funding requirements of AUS banks uncertain in the near future.

37.

What is the cash market?

1. The cash market is the market for cash held in the ESAs at the RBA. It's like a "short-term money market" 2. This market allows commercial banks to immediately borrow or lend large amount of excess ESA balances (1 day or less). 3. The relevant interest rate is the cash rate which is the overnight or 1-day IR. This measures the return on the most liquid of all financial assets and is closely related to the conduct of monetary policy. It influences commercial bank decisions concerning IRs on loans.

38.

What is the economic purpose of money markets?

They are effectively wholesale markets because of the large nature of transactions involved, and instruments allow economic units to bridge the gap, solving their liquidity problems. They provide liquidity adjustments. 1. The money market is a market for liquidity: • Liquidity is stored in MM by investing in MM securities (lending). • Liquidity is bought in MM by issuing securities (borrowing). 2. Liquidity status of commercial banks is reflected in their buying and selling on the MM. 3. Provides a place for the Reserve Bank transactions (open market operations). 4. The activity in the MM is an indicator of economic conditions.

39.

40.

What is the interrelationship of the money market IRs?

MM instrument serves as a close substitutes in investment portfolios. So their IRs fluctuate closely.

What is the market for BABs like?

Requires a lot of specialised knowledge on accepting bank's behalf.

Short periods, spreads may get out of line but forces restore the rates to their normal spread. quickly eliminated by "interest rate arbitrage".

Secondary market for BABS is created as banks sell accepted drafts, BABs endorsed by major prime banks trade at the lowest yield in the market in exactly the same way as negotiable CDs do. (They also have the same reference point, so often considered interchangeable.) 41.

What is the money market's ...