 What characteristics define the money markets?

(1Q)

The characteristics of the money market are stated as follows :

The money market securities are traded in large quantity .
The money market securities having less risk of default .
The maturity of money market security is less than the one year .
These securities include Treasury bills, federal funds , commercial paper ,
certificate of deposits etc.

 1. Calculate the annualized discount rate and annualized investment rate

on the purchase of 91-day T-bill, if the face value is $3,000 and purchase
price is $2,900.(1QP)
Annualized Discount Rate = (($3,000-$2,900)/$3,000)*360/91 = 0.1319
i.e. 13.19%
Annualized Investment Rate = (($3,000-$2,900)/$2,900)*365/91 = 0.1383
i.e. 13.83%

 If a 15-year bond is supposed to mature in the next three months, is it

considered to be a money market instrument?(2Q)
No, it remains a capital market instrument due to its characteristics (higher
interest rates, often tax exempt, higher risk...)

 What would be the annualized discount rate % and the annualized

investment rate % if a Treasury bill was purchased for $9,360 maturing in
270 days for $10,000?(2QP)

Solution:

For Treasury bill discount we assume 360 days a year

 Disc Rate = ((F-P) / F) x 360/n = ((10,000-9,360) / 10,000) x 360/270 =
0.0853 = 8.53%

For finding investment rate we will assume 365 days a year.

Investment rate = ((F-P) / P) x 365/n = ((10,000-9,360) / 10,000) x 365/270 =

0.0866 = 8.66%

So Discount rate = 8.53% and Investment rate = 8.66%

 What cost advantages does the money market have over the banking
sector?(3Q)
Money market instruments are cheaper in comparision to the banking
sector instruments. Thus company who need urgent money it should go to
money market in comparision to banking sector. The liquidity of money
market is also high and can be transact against many other instruments
thus money market has more cost advantages over banking sectors.

 Suppose you want to earn an annualized discount rate of 2.5%. What

would be the most you would pay for a 182-day Treasury bill that pays
$10,000 at maturity?(3QP)

let the amount to be paid be

x

((10000-x)/x)*182/365=0.025

((10000-x)/x)=0.050137

10000-x=0.050137x

1.050137x=10000

x=10000/1.050137
 x=9522.56

 What are the main purposes of money markets? Why is there a need for
money markets?(4Q)
provide a place for warehousing surplus funds for short periods of time,
provides low cost source of temporary funds, The market enables
governments, banks, and other large institutions to sell short-term
securities to fund their short-term cash flow needs. It also allows individual
investors to invest small amounts of money in a low-risk market.
 What is the minimum discount rate you will accept if you want to earn at
least a 0.25% annualized investment rate on a 182-day $1,000 T-bill?(4QP)

0.0025=1000-P/P*360/182
0.0025P=(1000-P) *1.978022
0.0025P+1.978022P=1,978.022
P=1,978.022/1.980522
P=998.7377 $

So as investor your purchase price is 998.7377$

Now we can estimate our earnings:

i(discount)=1000-998.7377/1000*360/182
i=0.001262*360/182
 i=0.002497 so as investor you can estimate your earnings at 0.2497%

 How did asset-backed commercial papers contribute to the financial crises

of 2007-2008?(5Q)
As the mortgage situation in the United States became more
serious, market participants became unwilling to purchase ABCP. This
caused trouble for financial institutions that had relied on sales of ABCP to
obtain funds for use in longer-term investments.

 Why are T-Bills a favorable money market instrument for the U.S.
government? For investors?(6Q)
 Treasury bills—commonly known as T-bills—are short-term securities issued by the U.S.
Treasury on a regular basis to refinance earlier T-bill issues reaching maturity and to help
finance federal government deficits. Of all money market instruments, T-bills have the largest
total dollar value outstanding. They are very liquid (i.e. you can easily convert them to cash).
Even before the full time period elapses, you can always decide to go for your money at any
time. This is however not encouraged, unless you are in very desperate need of cash. Note
that if you decide to go for your money (i.e. sell your T’bills) before the time elapses, you will
not be paid the full promised amount. In order words, the investment will be discounted. No
transaction cost is charged. Unlike other forms of investment where you are charged a fee by
the broker who purchases them for you, brokers do not charge you for purchasing T'Bills for
you.

 Why do businesses use the money markets?(7Q)

The main purpose of the use of money market is to invest the surplus cash
for short-term. It is considered as most liquid asset in the business. The
business earns the short-term income through investing in the money
market

 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 rate % is 4%, when will the paper mature?(7QP)
 Solution: Let N = when the paper matures
Discount Rate:
[($8,000 - $7,930) / $8,000)] x (360 / N) = 0.04
($70 / $8,000) x (360 / N) = 0.04
($0.00875) x (360 / N) = 0.04
(360 / N) = 0.04 x (1/ $0.00875)
(360 / N) = 4.571429N = 78.75 = 79 days
Investment Rate:
[($8,000 - $7,930) /($7,930)] x (365 / N) = 0.04
($70 / $7,930) x (365/ N) = 0.04
(365 / N) = 0.04 x (1/ 0.008827)
365/ N = 4.53155
N = 80.55 = 81 days

 The Eurodollar market dates back to the period after World War II, when
started with the circulation of dollars overseas followed by the
development of a separate, less-regulated market. Why did the
Eurodollar market grow so rapidly?(8Q)

Due to the huge expansion in international trade from the early 1970’s,
there was a huge growth in demand for foreign currencies to settle trade
transactions. The availability of currencies for trading, and so the
development of the FX markets itself, was facilitated by the development of
the Eurodollar/Eurocurrency market.

 What is meant by the Eurodollar market? Why is it an important source of

financing? Discuss. (9Q)
The primary reason is that depositors often receive a higher rate of return
on a dollar deposit in the Eurodollar market than in their domestic market.
At the same time the borrower is often able to receive a more favorable
rate in the Eurodollar market than in their domestic market. This is because
multinational banks are not subject to the same regulations restricting U.S.
banks and because they are willing and able to accept narrower spreads
between the interest paid on deposits and the interest earned on loans.
  How are interest rates usually settled for negotiable CDs?(10Q)
The rates paid on negotiable CDs are negotiated between the bank and the
customer. They are similar to the rate paid on other money market
instruments because the level of risk is relatively low. Large money center
banks can offer rates a little lower than other banks because many
investors in the market believe that the government would never allow one
of the nation’s largest banks to fail. This belief makes these banks’
obligations less risky

 How can you characterize the Treasury bill’s interest rates? How are
investment rates different from mentioned interest rates?(11Q)

Treasury bills are very close to being risk-free. As expected for a risk-free
security, the interest rate earned on Treasury bill securities is among the
lowest in the economy.

 In a Treasury auction of $2.1 billion par value 91-day

T-bills, the following bids were submitted: (11QP)
Bidder Bid Amount ($ million) Price per $100
1 500.0 99.40
2 750.0 99.01
3 1.5 99.25
4 1.0 99.36
5 600.0 99.39
If only these competitive bids are received, who will
receive T-bills, in what quantity, and at what price?
If there are only competitive bids then the auction will settle at the highest
price which clears the auction amount. This includes bidders 1, 4 and 5. The
winning price will be $0.9936.
 What are the terms of federal funds? Why are these terms often
misleading?(12Q)
Fed funds are usually overnight investments. Banks analyze their reserve
position on a daily basis and either borrow or invest in fed funds,
depending on whether they have deficit or excess reserves The bank will
sell its excess funds to the bank that offers the highest rate. Once an
agreement has been reached, the bank with excess funds will communicate
to the Federal Reserve bank instructions to take funds out of its account at
the Fed and deposit
the funds in the borrower’s account. The next day, the funds are
transferred back,
and the process begins again. Most fed funds borrowings are unsecured.
Typically, the entire agreement is established by direct communication
between buyer and seller.
 If the Treasury also received $750 million in noncompetitive bids, who will
receive T-bills, in what quantity, and at what price? (Refer to the table in
problem 11.)(12QP)
All competitive bids are accepted at the highest yield paid to competitive
bids. Thus, all $750 million will be accepted at 0.9936.

 How does the Federal Reserve control interest rates on Fed funds? How
are interest rates settled on Fed funds?(13Q)

The forces of supply and demand set the fed funds interest rate The
Federal Reserve cannot directly control fed funds rates. It can and does
indirectly influence them by adjusting the level of reserves available to
banks in the system. The Fed can increase the amount of money in the
financial system by buying securities. When investors sell securities to the
Fed, the proceeds are deposited in their banks’ accounts at the Federal
Reserve. These deposits increase the supply of reserves in the financial
system and lower interest rates. If the Fed removes reserves by selling
securities, fed funds rates will increase.
 Why do commercial paper securities mature within 270 days or less?
(14Q)
Because is to avoid the need to register the security issue with the
Securities and Exchange Commission.

 Why is the banker’s acceptance form of financing ideal for foreign

transactions?(15Q)
Because delays in international shipping are avoided, the exporter receives
prompt payment, and the exporter is paid in domestic funds (no foreign
exchange risk), & creditworthiness of transaction is secured.