Money Market (MM)

1. Money Market (MM) • MM is where organizations go to adjust their liquidity. • Market is a collection of dealers that specialize in one or more MM instruments. • Liquidity is stored in the MM by investing in MM securities (lending). Liquidity is purchased in the MM by selling MM securities (borrowing). • Ideal place for temporary investments. • Short-term debt market. • Large, wholesale open-market transactions where $1 million is a tiny trade

2. Ideal MM Instruments have… • low default risk. • short maturity (to have low price risk). • high marketability (typically facilitated by standardized features). By selling in large denominations, per-dollar transaction costs kept low.

3. Typical MM Instruments typical maturities U.S. Treasury Bills 13 and 26 weeks Repurchase agreements 1 to 15 days Commercial paper 30 to 90 days (270 days max) Negotiable CDs 12 to 180 days Fed funds 1 to 7 days Banker’s acceptances 30 to 180 days

4. Auctioning New T-Bills • Weekly auction by U.S. Treasury of 13-week, and 26-week bills. Other bills (e.g., 1-day, 4-week, 52-week) sold on an as announced basis. • Sold on a discount basis. • Sold in multiples of $100. • $100 million is not a large institutional purchase. • All winning bidders pay same price which is the price of the lowest successful bid. Thursday/Monday/Thursday schedule.

5. For Instance, This Past Week’s Schedule • Thursday (Oct 31), Treasury Department announced sale of $33 billion of 13-week and $29 billion of 26-week T-bills, that were auctioned off on Monday (Nov 4). • Noncompetitive tenders for T-bills due by 11:00 am. Competitive tenders due by 11:30 am EST (each Monday). • Results of auction announced minutes after 11:30 am. • Bills issued and payments made on Thursday (Nov 7).

6. www.treasurydirect.gov/instit/annceresult/press/preanre/2013/2013.htmwww.treasurydirect.gov/instit/annceresult/press/preanre/2013/2013.htm

7. http://www.treasurydirect.gov/RI/OFBills

8. http://www.treasurydirect.gov/RI/OFBills Bid-to-Cover Ratio = 133.2/28.0 = 4.76

9. CUSIP Number Committee on Uniform Security Identification Procedures A 9-digit alphanumeric identifier, such as 00817Y 10 8 Uniquely identifies each U.S. and Canadian security. CUSIP system, operated by Standard & Poor’s, but owned by American Bankers Association, is designed to facilitate bookkeeping and the settlement of trades. First 6-characters identify “issuer” Next two identify “exact issue” Last is a “check digit”

10. Competitive Bids • Institutions specify • quantity • discount rate (in multiples of .005% such as 2.100%, 2.105%, etc) they are willing to accept. • Submitted by dealers & large banks. • Treasury Dept. ranks bids according to bank discount rate, then allocates down the list. • Bid-to-Cover Ratio signals how easy it is for Gov’t to borrow money. • No more than 35% of an issue can be sold to any competitive bidder to ensure a competitive secondary market.

11. Noncompetitive Bids • Small part of offering, all noncompetitive bids accepted. • $5 million max per noncompetitive bidder. • Noncompetitive bidders specify only • quantity • mostly individuals and small banks. • can purchase online through TreasuryDirect at www.treasurydirect.gov • receive the “High Rate” of accepted competitive bid tenders.

12. Book-Entry Securities No paper certificates (all new bills issued, held, and paid for electronically). For noncompetitive bidders: Set up TreasuryDirectaccount (with bank routing number & bank account number). Treasury electronically debits your bank account at beginning & credits it at end. Interest on US Treasuries taxed as ordinary income at the federal level, but not taxed at the state level.

13. Example 1: Overview offering competitive ($49.5 B total) Tenders with lowest discount rate bids accepted $15.9 B accepted $18 B noncompetitive $2.1 B $33.6 B rejected

14. Example 1: Auction Process Competitive tenders $2.5 billion 3.880% $5.0 billion 3.895 $6.0 billion 3.910 $2.0 billion 3.930 $4.5 billion 3.945 $9.0 billion 4.290 $11.0 billion 4.305 $9.5 billion 4.315 Offering Amount $18.0 billion Noncompetitive tenders $2.1 billion Competitive tenders $49.5 billion High Rate (highest accepted rate) 3.945% Bid-to-Cover Ratio (49.5 + 2.1)/18 = 2.87 Competitive tenders Allocated at High rate .4/4.5 = 8.89% Median Rate (of accepted competitive tenders) 3.910% Low Rate 3.880%

15. Secondary Market for T-Bills discount rates investment rate • Bid & Asked are bank discount rates. Bid applies when customer sells, Asked applies when customer buys. • Asked Yield is bond equivalent rate.

16. Discount Rate The (bank) discount rate yd is given by: Solving for P0 we have wherePfis face value P0is discounted price (today’s price) nis calendar days to maturity

17. Bond Equivalent Rate Bond equivalent rate ybe is given by Solving for P0 we have Bond equivalent yields are reported to facilitate comparison against other debt instruments. (note 365 annualizeranddiscounted price is in denominator)

18. Example 2: Using Bank Discount Rate Consider a $1,000 T-bill that matures in 133 days whose Bid and Asked quotes are 4.96 and 4.92, respectively.If selling, would get If buying, would cost

19. Example 3: Using Bond Equivalent Rate Bond Equivalent Rate is same as Investment Rate as on slides 7 & 17. Suppose you are contemplating a $1,000 T-bill that matures in 67 days whose Asked Yield is 5.23. How much would it cost?

20. Fed Funds Unsecured loans between banks. Overnight interest rate called the fed funds rate. Term “fed funds” is misleading. Typically done in units of $1 million. Yields on fed funds assume 360-day year. Conversion to bond equivalent yield is as follows.

21. Commercial Paper Review slides 34-36 of Module 2.2. Compete head-to-head against T-bills. Consequently, sold at discount, and quoted using bank discount rate There is a secondary market. Virtually impossible to sell without backup line of credit and a P-1 or A-1 rating.

22. Federal Agencies (GSEs) Established by Congress for public policy reasons to assure availability of capital in areas of the economy where credit might otherwise be insufficient or be too costly. • Farm credit • Home mortgages • Others They obtain their money to lend out by issuing agency securities. Such agency debt qualifies as legal instruments to be held by banks, insurance companies and pension funds.

23. Government Sponsored Enterprises Agency (i.e, GSE) debt perceived to have only slightly greater default risk than US Treasuries. Marketability generally very good. Government National Mortgage Association (Ginnie Mae) Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Association (Freddie Mac), privatized in 1968, 1970, respectively, but still GSEs. Note: Student Loan Marketing Association (Sallie Mae) used to be a GSE. Privatized in 1997. No longer a GSE as it no longer has any ties to US Government. See list on p. 214.

24. Retail Certificates of Deposit Issued by banks to finance their business activities. Not negotiable – no secondary market, can only be sold back to issuing bank early, with penalty. Issued at face value with interest as an “add on”. Interest based on a 365 day year. Can be in any denomination. FDIC insured up to standard amounts. Banks typically use standard maturities such as 0.5, 1.0, 1.5, 2.0 and 5.0 years.

25. Negotiable Certificates of Deposit Large-denomination CDs issued by well-known banks are negotiable (exists a secondary market for them). Issued at face value with interest as an “add on”. Stated interest computed on a 360-day year (like Fed Funds). Interest rates on negotiable CDs are higher than on T-Bills because of higher credit risk and lower marketability.

26. Negotiable Certificates of Deposit Developed by Citibank in 1961, to offset declining demand deposits (at time banks couldn’t pay interest on corporate checking accounts) as a way of raising additional funds. Rates often negotiated between buyer and seller. Purchased mainly by corporate businesses.