Chapter 5

MONEY MARKET

Lecturer: Doan Thi Cam Van

 CONTENTS

1. What is the money market?

2. Money Market Securities

3. Trading on Money Market

4. Investment Yield and Price Risk

5. Analysis investment yield

 What is the money market?

• A subsector of the fixed-income market.

• Consists of very short-term debt securities

• So are out the reach of individual investors.

• Easy for small investors to access this market through

money market funds.
 Money market securities

• Treasury Bills
• Certificates of Deposit
• Commercial Paper
• Banker’ Acceptances
• Repos and Term Repos
• Reverses Repos
 Treasury Bills

• Seller is the government

• Investors buy the bills at a discount from
the stated maturity value,
• And receive a payment equal to the face
value of the bills.
• The duration of the bills is short-term (≤
52 weeks).
Example
 Trading the treasury bills

• The investors do buy the treasury bills

from whom?
– Auction
– A government securities dealer on the
secondary market.
• T-bills sell in minimum denominations of
only $100
 Certificates of Deposit (CD)

• Is a time deposit with a bank.

• Not be withdrawn on demand
• Be paid interest and principal to the
depositor only at the end of the fixed
term.
• CDs can be sold to another investor if the
owner needs to cash in the certificated
before its maturity date.
• How much are CDs resold?
 Example:

• A CD with denomination is $10,000,000, and it

is deposited for 30 days at 5%
• What is its the face value (F)?
• And, after 10 days, the depositor want to
exchange the CD for cash; suppose the CD was
sold at 5.01%. The depositor would receive the
amount P?
 Commercial Paper

• Debt notes are issued by large, well-known companies.

• They very often is backed by a bank line of credit.
• Their maturities range up to 270 days or longer and their
denominations are quite large ($100,000).
• Small investors can invest in commercial paper only
indirectly, via money mutual funds.
• In current years, they are not only issued by non-
financial companies but also by financial companies
(commercial bills)
Example for a commercial bill
 Banker’s Acceptances

• As an order to a bank by a bank’s

customer to pay a sum of money at a
future date, within 6 months.
• When the bank accepted, it assumes
responsibility for ultimate payment to the
holder of the acceptance.
• They may be traded in secondary
markets.
 Banker’s Acceptances

• They are considered very safe assets

because traders can substitute the
bank’s credit standing for their own.
• Acceptances resell a discount from the
face value of the payment order.
 Repos and Reverses

• Repos are the repurchase agreements.

• Dealer sell government securities to an
investor on an overnight basis, with an
agreement to by back them the next day at a
slightly higher price.
• Its interest is the increase in the price.
• Repos are very safe in term of credit risk
because the loans backed by the government
securities.
 Repos and Reverses

• Term repos is repos with the term of the

implicit loan can be 30 days or more.
• Reverses repos is the mirror image of a
repo.
– The dealers finds an investor holding
government securities and buys them,
agreeing to sell them back at a specified
higher price on a future date.
 CDs Commercial BABs Treasury
Paper notes
Selling Deposits Dealer Panel Sold in Tender
method market
Main Fund Managers Fund Fund Banks
investors and large managers managers
companies

Yield Close to BBR - BBR + (up to BBR Below BBR

Depending on 50 bps)
bank

BABs: Bank accepted bills Nguồn: Hunt & Terry (2008)

BBR: Bank bill reference rate
 Trading on The Money Market

• The money market is an OTC market

• Dealers are principals in these markets; they trade
on their own behalf and proving a market for
wholesale clients.
• Is an electronic communications system rather than
a central trading room
 Trading on The money Market

• Transaction Method:
– The telephone
– An electronic matching system

• Trades are settled on a same-day basis (T+0)

– Morning trades are settled that afternoon

– Afternoon trades are settled the next morning.

 Trading on The money Market

• Each dealer
• maintains a portfolio of securities

• must hold securities because they must be able to

sell when their offer quote has been accepted.
 Trading on The money Market

• Dealer income from the trading services is

earned from trades that are made at their bid
and offer rates.
• EX: Trading income from a two basis point
bid-offer spread for a parcel of 90-day
securities with a face value of $20 million
purchased at 5.02% and sold at 5% is as
follows:
Trading on The money Market
 Trading on The money Market

• A dealer can induce a trade by setting either the

market’s lowest bid yield; or highest offer yield.
• What risks do the dealers face?
– An unexpected increase in the market yield in the
next few minutes
– Arising from possible information asymmetry.
 Trading on The money Market

• The telephone trading has tow important

implications:
– The market maker must quote when called by
another dealer.
• These quotes apply only if accepted by the calling
dealers
• The quote are not accepted immediately, the dealer
can change them when next called.
– Telephone quote are not displayed to the market
as a whole.
 Investment yield and price risk

• Interest is earned because the securities are sold

at a discount to their face value.
• Discount interest is the simple interest yield
• The face value comprises the amount borrowed
and the implicit interest
F=P+I
- F: the face value
- P: amount borrowed
- I: Interest
• The average returns from money market securities
have been modest relative to the returns from
bonds, shares and property investment.
• But exhibit a low volatility, because:
– The market yield are closely aligned with the cash rate.
– Holding money securities to maturity removes the risk
of capital loss (and the chance of capital gain).
Ex
• Summary:
– A drop in the market yield increases the
market price (and vice versa)
– The market price increase as the maturity
date approaches.
– But these are not linear relationships.
– The daily increase in price is not the same
amount
 Analysis investment yield

• Yield maturity: the rate of return achieved from

an investment in a security that is held to
maturity.
• Holding-period yield: the yield achieved from
an investment in a security that is sold before it
matures.
• Price risk: the form of market risk in which
price volatility is the cause of the chance of a
loss
 For example:

• Consider an investment of $ 1million in a

90-day security made at 5%, with three
questions:
1. Yield to maturity, if the market yield at 5%
2. Holding-period yield after 5 days at the
market 4,5%.
3. Holding-period yield after 5 days at the
market yield 5.2%
 Exercises

1. Suppose a bank agreed to accept 90-day

commercial bills with the face value of $ 20
million and for a company. If the initial parcel
of bills is issued at 6.35% and at fee of $
52.447. Calculate the borrower’s interest rate.
2. Suppose an active investment manager
purchased a $50 million parcel of 90-day bill
ats 6.25% and sold them 10 days later at
6.35%. Calculate the investment return.
• 3. Given the circumstances in the above
question, calculate the amount of interest
earned by the investment and the amount of
the capital loss?