MONEY MARKET SECURITIES

 Short term (can be in days)

 Low default risk
 Sold usually in large denominations
 Are traded electronically
 Active secondary market.
 Do not pay interest. Securities are sold at a discount.
 Flexibility to investors (Liquidity)
Types of securities:
I. Treasury Bills
- Issued by the Federal Government
- Default risk is practically zero
- Deep market (many buyers and sellers)
- Liquid market
With T-Bills, the Federal Reserve quotes two rates:
1. Discount Rate
(F – P) / F x (360/n)
F= Face Value
P = Present Value
n = maturity in days

2. Investment Rate
(F – P) / P x (365/n)
Face Value = $10,000
Present Value = $9,850
N = 45 days

Discount rate = (10,000 – 9850 / 10,000) (360/45) = 12%

Investment rate = (10,000 – 9,850 / 9,850) (365/45) = 12.35%

II. Federal Funds
Funds transferred among financial institutions usually for one day.

- Banks lend each other the excess amount of the legal reserves.

Bank A Bank B
$500,000 $ 200,000

Amount of legal reserve of A is $420,000 and that of B is $280,000.

Bank A has an excess of $80,000 and Bank B has a deficit of $80,000.
Bank A instructs the central bank to transfer the amount to the account of Bank B
and transfer the amount back (with interest) to its account on the agreed day.
Federal Funds (Continued):
- Agreement is done by direct communication among the banks.
- The loan is unsecured.
- The Federal Fund rate is set according to supply and demand. Competitive
market.
- The central bank (Federal Reserve) has indirect control over the rate through
trading in securities.
* Eg. – Federal Reserve buys securities
- Investors deposit the money in their bank accounts.
- Increase in the money supply
- Decrease in the Federal Funds rate
III. Repurchase Agreements (REPOS):
It is a collateralized loan

B sells it back to A
------------------------------------------
A(Borrower) B(Lender)

-------------------------------------------
Sells a T-Bill to B

REPO from perspective of A

Reverse REPO from perspective of B
Maturity usually in days and risk is very low
IV. Commercial Paper:
- Issued by corporations
- Unsecured
- Largest and most creditworthy corporations
- Maximum maturity of 270 days (if longer, have to register with the SEC).
- Lower rating corporations can issue CP, backed by line of credit
V. Banker’s Acceptance:
- Created through international trade.
1) Importer sends a detailed request to the exporter
2) Exporter sends importer a time draft.
3) Importer’s bank stamps the time draft. Becomes a Banker’s Acceptance.

- Importer’s bank takes responsibility in case of default.

- Exporter can sell the BA.
V. Banker’s Acceptance