Financial Markets

and Instruments
Markets and Instruments

 Money Market
 Debt Instruments
 Capital Market
 Long-term debt
 Equity
 Derivatives
Markets and Instruments

The money market is a subsector of the debt

market.
Include short-term, highly liquid, and relatively
low-risk debt instruments.
Money Market Instruments

 Treasury bills
 Certificates of deposit
 Commercial Paper
 Bankers Acceptances
 Eurodollars
 Repurchase Agreements (RPs) and Reverse RPs
 Federal Funds
Money Market Instruments: Treasury Bill
Money Market Instruments: Treasury Bill

Treasury bills (T-bills) are short-term government securities issued

at a discount from face value and returning the face amount at
maturity.
 T-bills are issued with initial maturities of 4, 13, 26, or 52 weeks
 T-bills can be purchased directly from the Treasury or on the
secondary market from a government securities dealer. (usually
auction sales)
 T-bills are highly liquid
 Three-month bill is known as the “risk-free” rate
Money Market Instruments: Treasury Bill
  There are two methods of calculating return on MM instruments
1) Bank discount method :

2) Bond-eqvivalent method :

F- face value of security

P- purchase price of security
N- number of days to maturity
Money Market Instruments: Certificate
of Deposit
A certificate of deposit (CD) is a time deposit with a bank.
 Issued by banks to raise short-term money
 Negotiable CDs are issued as securities (versus CDs which are a form of deposit at retail
banks)
 Time deposits may not be withdrawn on demand
 The bank pays interest and principal to the depositor only at the end of the
fixed term of the CD
 CDs usually are issued in denominations larger than $100,000
 Typical maturity one to twelve months
Money Market Instruments: Certificate
of Deposit
Money Market Instruments: Commercial
Paper
Commercial paper is a short-term unsecured debt securities issued
by large corporations for commercial purposes:
• for financing working capital
• bridge financing
Features of CP :
 Issued on a discount basis in maturities ranging from one to 270 days.
 Securities in this maturity range are exempt from SEC registration
requirements.
 Sometimes, CP is backed by a bank line of credit
Money Market Instruments: Bankers’
Acceptances
Bankers’ acceptance is an order to a bank by a customer to pay a
sum of money at a future date.
Features of BA:
 Form of short-term bank borrowing created by facilitating import/export
transactions.
 Bank provides a letter of credit to an exporter. LC guarantees payment at
the end of a set periods for goods that they have exported.
 The holder of BA can sell (exchange) it for cash at a discount to a buyer
who is willing to wait until the maturity date for the funds in the deposit
 Very safe security, because issued and backed by reputable banks.
Money Market Instruments: Bankers’
Acceptances
Money Market Instruments: Eurodollars

Eurodollars are dollar-denominated deposits at foreign

banks or foreign branches of American banks (outside of
United States)

 Most Eurodollar deposits are for large sums, and most

are time deposits of less than six months’ maturity.
Money Market Instruments: Eurodollars
Rates
 London interbank bid rate (LIBID)
The rate paid by banks buying funds

 London interbank offer rate (LIBOR)

The rate offered for sale of the funds
Money Market Instruments:
Federal Funds
Federal funds are the funds in the accounts of commercial banks at
the Federal Reserve Bank.
 Short-term funds transferred (loaned or borrowed) between
financial institutions, usually for a period of one day.
 Used by banks to meet short-term needs to meet reserve
requirements.
Money Market Instruments: Repurchase
Agreements
 Repurchase agreements (repos) - short-term
sales of government securities with an
agreement to repurchase the securities at a
higher price.
 Typically overnight investments
 Collateralized.
 A term repo is essentially an identical
transaction, except the term of the implicit loan
can be 30 days or more
Money Market Instruments: Brokers’ Call
Loan
Brokers’ Call Loan is a callable loan made by financial institutions
to a broker.
 The broker may borrow the funds from a bank, agreeing to
repay the bank immediately (on call) if the bank requests it.
 The rate paid on such loans is usually about one percentage
point higher than the rate on short-term T-bills.
 Individuals who buy stocks on margin borrow part of the funds to
pay for the stocks from their broker.
Money Market Instruments