CHAPTER 4

THE MONEY MARKET

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 Learning Objectives
Describe the money market.
Know the different types of financial instruments
available in the money market.
Know what a banker's acceptance is.
Know what a treasury bill is.
Know what a certificate of deposit is.
Know what a commercial paper is.
Know what Eurodollars are.
Know what a repurchase agreement or repo is.

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MONEY MARKET: WHAT IS IT?
Borrowers issue highly liquid and short-term financial
instruments such as bankers' acceptances, treasury bills,
certificates of deposit, commercial paper and Eurodollars
Short term means a maturity period of less than one year
Money market securities are essentially IOUs issued by
governments, financial institutions and large organizations for
their short-term cash requirements.
These instruments are very liquid and considered
extraordinarily safe.
Money market securities offer significantly lower returns than
most other securities because the financial instruments
issuers are extremely conservative

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INSTRUMENTS IN THE
MONEY MARKET
Bankers Acceptances (BA)
These instruments are very liquid and
considered extraordinarily safe
Treasury Bills (TB)
Certificates Of Deposit (CD)
Commercial Paper
Eurodollars
Repurchase Agreements (Repo)

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INSTRUMENTS IN THE MONEY MARKET
BANKERS ACCEPTANCE (BA)
Bankers Acceptance is a negotiable instrument or time draft
drawn on and accepted by a bank.
Before acceptance, the draft is not an obligation of the bank,
it is merely an order by the drawer to the bank to pay a
specified sum of money on a specified date to a named
person or to the bearer of the draft.
Upon acceptance, which occurs when an authorized bank
accepts and signs it, the draft becomes a primary and
unconditional liability of the bank.
If the bank is well known and enjoys a good reputation, the
expected draft may be readily sold in an active market.
A bankers acceptance is also a money market instrument
a short-term discount instrument that usually arises in the
course of international trade.
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INSTRUMENTS IN THE MONEY MARKET
BANKERS ACCEPTANCE (BA)

A bankers acceptance starts as an order to a bank by a

banks customer to pay a sum of money at a future date,
typically within six months.
At this stage, it is like a postdated check.
When the bank endorses the order for payment as
accepted, it assumes responsibility for ultimate payment
to the holder of the acceptance.
At this point, the acceptance may be traded in secondary
markets much like any other claim on the bank.
Bankers acceptance are considered very safe assets, as
they allow traders to substitute the banks credit standing
for their own.

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INSTRUMENTS IN THE MONEY MARKET
BANKERS ACCEPTANCE (BA)
Bankers Acceptance is a short-term credit investment
created by non-financial companies and guaranteed by a
bank to make a specified payment when it is due.
Arises most often in connection with international trade.
An exporter draws a draft on a specific bank in order to
obtain payment for goods shipped to a customer in another
country.
A negotiable time draft for financing imports, exports or
other transactions in goods.
Especially useful when the creditworthiness of a foreign
trade partner is unknown.
The maturities on acceptances normally range from 30 to
180 days
A banker's acceptance needs to be held until maturity.
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BANKERS ACCEPTANCES (BA)

Acceptances are traded at discounts from their face value in the

secondary market, for example:
Face value of banker's acceptance RM1,000,000
Minus 2% per annum commission for one year RM20,000
Amount received by exporter in one year RM980,000

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Treasury bills (TB)
Treasury bills or T-bills are another type of
marketable money market security.
Issued by government when it wants to borrow
money to meet its short-term cash needs.
They are issued with three-month, six-month
and one-year maturities.
They are issued at a discount from the face value.
When the TBs mature, the government pays the
holder the full face value.

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Treasury bills (TB)
Bank Negara Malaysia facilitates the sale of
treasury bills through competitive auction.
Malaysian treasury bills are issued on a weekly
basis and auction is held one day before the issue
date.
The successful bidders are determined according
to the most competitive yield offered.
The standard trading amount is RM5 million.
Treasury bills are actively traded in the
secondary market.

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Certificate of Deposit
CD is a form of savings certificate.
The bearer of a CD is entitled to receive interest.
CDs can be issued in any denomination.
Interest rate on CDs is fixed over their stated maturity.
Maturity term of a CD generally ranges from one month
to five years.
The certificate can be purchased directly from
commercial banks or savings and loan institutions.
The certificate is a non-tradable security.
CDs are not traded on any exchange.
CDs are relatively low-risk debt instrument

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Commercial Paper
Commercial paper is unsecured,
It is short-term loan or promissory note .
It is issued by large companies.
The proceeds of commercial paper sales used to finance
working capital.
Issued at a discount,
Based on current market interest rates.
Average maturity of commercial paper is between one and
two months.
Maturities on commercial paper are usually no longer
than nine months.
Commercial paper is issued by a wide variety of domestic
and foreign firms, including finance companies, banks and
industrial firms.
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Eurodollars
Eurodollars are deposits denominated in U.S. dollars
deposited in banks outside the borders of the U.S.
International investors buy U.S. dollars and deposit them
in a bank outside the U.S. and then use these dollars to
buy goods in the world markets.
It has become convenient to businessmen to use
Eurodollars .
The term Eurodollars originated in Europe (specifically
London)
Eurodollars have very little to do with the euro or
European countries.

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Eurodollars
The average Eurodollar deposit is very large (in
the millions) and they have a maturity period of
up to about one year.
The U.S. and foreign companies borrow
Eurodollars to pay for imports from U.S. and to
invest in the U.S. securities markets.
Eurodollars are also used as an international
currency, or international medium of exchanged.

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Repurchase agreement (repo)
Repurchase agreement (or repo) is a legal contract
between a borrower and a lender.
Repo transactions involve sale of securities at a particular
price by a repo seller to a repo buyer, whereby the repo
seller gives a commitment on his part to repurchase the
equivalent securities from the repo buyer
The repo buyer also gives a corresponding commitment
to sell the equivalent securities back to the repo seller on a
certain date and at a certain price plus a stated interest
charge.
Both the date and the contract price of the same
transaction are fixed for the duration of the transaction.

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Repurchase agreement (repo)
There are two major reasons why companies with
surplus cash prefer repos to marketable securities:
The adjustable maturity provision embedded in repos.
The original repos maturity period can be adjusted to
suit the needs of investing companies. Therefore, funds
can be productively employed for a very short period of
time.
Repos are protected against price fluctuations
throughout the contract period and therefore any risk
involved in the liquidation process is removed. Thus,
companies can invest any surplus cash for a few days.
E.g. Mutual funds will buy repos as a way to park
excess cash flows for only very short periods.

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