270 PART 5 Financial Markets
SUMMARY
1. Money market securities are short-term instruments
with an original maturity of less than one year. These
securities include Treasury bills, commercial paper,
federal funds, repurchase agreements, negotiable
certificates of deposit, banker’s acceptances, and
Eurodollars.
2. Money market securities are used to “warehouse”
funds until needed. The returns earned on these
investments are low due to their low risk and high
liquidity.
KEY TERMS
asset-backed commercial paper demand deposit, p. 262
(ABCP), p. 264 direct placements, p. 263
bearer instrument, p. 262 discounting, p. 256
book entry, p. 258 liquid market, p. 258
competitive bidding, p. 258 London interbank bid rate (LIBID),
deep market, p. 258 p. 266
QUESTIONS
1. What characteristics define the money markets?
2. Describe at least two distinct benefits that money
markets offer to their participants.
3. Why does the existence of banks banks not eliminate
the need for money markets?
4. Explain why asymmetric information problems do
not prevent money market participants from buying
and selling money market instruments.
5. What motivated regulators to impose interest ceil-
ings on bank savings accounts? What effect did this
eventually have on the money markets?
6. Explain why the U.S. Treasury has to make every
possible effort to keep its T-bill auctions competitive.
7. Why do businesses use the money markets?
8. What purpose initially motivated Merrill Lynch to
offer money market mutual funds to its customers?
9. Why do property and casualty insurance companies
invest more funds than life insurance companies in
the money markets?
M11_MISH9265_09_SE_C11.indd 270
3. Many participants in the money markets both buy and
sell money market securities. The U.S. Treasury, com-
mercial banks, businesses, and individuals all benefit
by having access to low-risk short-term investments.
4. Interest rates on all money market securities tend
to follow one another closely over time. Treasury
bill returns are the lowest because they are virtu-
ally devoid of default risk. Banker’s acceptances and
negotiable certificates of deposit are next lowest
because they are backed by the creditworthiness of
large money center banks.
London interbank offer rate (LIBOR),
p. 266
noncompetitive bidding, p. 258
term security, p. 262
wholesale markets, p. 250
10. The interest rate on negotiable CDs is usually very
close to the T-bill interest rate; however, the gap
between these rates increased substantially between
March 2008 and mid-2009. Why do you think this
happened?
11. Distinguish between competitive bidding and non-
competitive bidding for Treasury securities.
12. Who lends or borrows federal funds, and what is the
usual purpose of these funds?
13. Does the Federal Reserve directly set the federal
funds interest rate? How does the Fed influence this
rate?
14. Suppose the U.S. government defaults on its pay-
ments (i.e., cannot pay T-bills at their maturity date).
What would be the effect on the T-bill rate? What
would be the effect on the interest rates of other
money market instruments?
15. Why are banker’s acceptances so popular for interna-
tional transactions?
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Q U A N T I TAT I V E P R O B L E M S
1. What would be the underestimation of your earnings Would you state that commercial paper issued by
as an investor if you use the discount rate instead of CMF Corp. is default free?
the investment rate to measure the return on your 9. The annualized discount rate on a particular money
investment if you buy a $5,000 T-bill that matures in market instrument is 3.75%. The face value is
91 days for $4,999.55? $200,000, and it matures in 51 days. What is its price?
2. What are the annualized discount rate and your What would be the price if it had 71 days to maturity?
annualized investment rate on a Treasury bill that 10. The annualized yield is 3% for 91-day commercial
you purchase for $9,940 that will mature in 91 days paper and 3.5% for 182-day commercial paper. What
for $10,000? is the expected 91-day commercial paper rate 91 days
3. If you want to earn an annualized discount rate of from now?
3.5%, what is the most you can pay for a 91-day 11. In a Treasury auction of $2.1 billion par value 91-day
Treasury bill that pays $5,000 at maturity? T-bills, the following bids were submitted:
4. What is the minimum discount rate you will accept if
you want to earn at least a 0.25% annualized invest- Bid Amount Price per
ment rate on a 182-day $1,000 T-bill? Bidder ($ million) $100
5. The price of 182-day commercial paper is $7,840. If
the annualized investment rate is 4.093%, what will 1 500.0 99.40
the paper pay at maturity? 2 750.0 99.01
6. Your minimum discount rate bid of 0.35% for a 3 1.5 99.25
$10,000 T-bill that matures in 91 days has been 4 1.0 99.36
accepted. Calculate your annualized investment rate.
5 600.0 99.39
7. The price of $8,000 face value commercial paper is
$7,930. If the annualized discount rate is 4%, when
will the paper mature? If the annualized investment If only these competitive bids are received, who will
rate is 4%, when will the paper mature? receive T-bills, in what quantity, and at what price?

8. A $5,000 commercial paper issued by CMF Corp. 12. If the Treasury also received $750 million in non-
matures in 182 days and sells for $4,995. The invest- competitive bids, who will receive T-bills, in what
ment rate on same maturity T-bills is currently 0.1%. quantity, and at what price? (Refer to the table in
problem 11.)

WEB EXERCISES
The Money Markets Compare the rates for items a–c to those reported in
1. Up-to-date interest rates are available from the Table 11.1. Have short-term rates generally increased
Federal Reserve at http://www.federalreserve.gov/ or decreased?
releases. Locate the current rate on the following 2. The Treasury conducts auctions of money market
securities: treasury securities at regular intervals. Go to http://
a. Prime rate treasurydirect.gov/instit/instit.htm?upcoming
and locate the schedule of auctions. When is the next
b. Federal funds auction of 4-week bills? When is the next auction of
c. Commercial paper (financial) 13- and 26-week bills? How often are these securities
d. Certificates of deposit auctioned?
e. Discount rate
f. One-month Eurodollar deposits