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Chapter 22

Chapter 22. THE MARKETS FOR BANK OBLIGATIONS. Types of Banks Operating in the United States. Money Center Banks Regional Banks Japanese Banks Yankee Banks. Large-Denomination Negotiable CDs. Bank-issued security with specified interest rate and maturity date.

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Chapter 22

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  1. Chapter 22 THE MARKETS FOR BANK OBLIGATIONS

  2. Types of Banks Operating in the United States • Money Center Banks • Regional Banks • Japanese Banks • Yankee Banks

  3. Large-Denomination Negotiable CDs • Bank-issued security with specified interest rate and maturity date. • Nonnegotiable CDs must be held until maturity to obtain the funds, otherwise an early withdrawal penalty is imposed. • Negotiable CDs can be sold in the secondary market prior to maturity. • Maturity cannot be less than 7 days.

  4. CD Issuers • Types of CDs based on issuing institution • domestic CDs • Eurodollar CDs • Yankee CDs • thrift CDs • Primary Issuers • money center banks • large regional banks

  5. Term CDs maturity of more than one year yields are quoted on an interest-bearing basis semiannual interest payments Floating-Rate CDs interest rate changes according to a predetermined formula coupon may be reset daily, weekly, monthly, quarterly, or semiannually maturity ranges from 18 months to 5 years Types of CDs

  6. Yields on CDs • Yields on CDs depend on: • credit rating of the issuing bank • maturity of the CD • supply and demand for CDs

  7. Risks of CDs • CD yields are higher than yields on Treasury securities of the same maturity due to two risk factors: • Credit Risk • Prime CDs • Non-prime CDs • Liquidity Risk

  8. Federal Funds • Borrowing and lending of excess reserve balances among depository institutions • Characteristics: • one-day maturity • unsecured

  9. Repurchase Agreements • Sale of security and agreement by bank to repurchase it later. • Agreement with nonbank customer. • Rate charged is the repo rate. • Alternative to borrowing in the federal funds market.

  10. Federal Funds Rate • The rate paid by depository institutions for loans in the federal funds market. • Fed funds rate is determined by the supply and demand for federal funds. • Fed funds rate is targeted by Fed’s monetary policy.

  11. Federal Funds versus Repo Rate • Fed funds rate and repo rate are tied together because both are a means for a bank to borrow. • Fed funds rate is higher because fed funds are borrowed on an unsecured basis. • In repo, the lender has security as collateral.

  12. Market for Federal Funds • Typical maturity of fed funds is overnight but can be longer term transactions. • maturity of one week to six months • Trading of fed funds • directly between buyer and seller • use of a broker

  13. Bankers Acceptances • An order to pay a specified amount on a specified date in the future. • Facilitates commercial trade transactions. • Sold on a discounted basis prior to maturity.

  14. Creation of Bankers Acceptances • Importing of goods into the U.S. • Exporting of goods from the U.S. to foreign entities • Storing and shipping of goods between two foreign countries where neither the importer nor the exporter is a U.S. firm • Storing and shipping of goods between tow entities in the U.S.

  15. Accepting Banks • Created by all four groups of banks • money center banks • regional banks • Japanese banks • Yankee banks • Eligible BAs can serve as collateral for discount window loans of the Fed. • BA rate is determined in open market.

  16. Dealers in Bankers Acceptances • Banks may sell bankers acceptances • directly to investors • directly to dealers

  17. Risks in Bankers Acceptances • Credit Risk • risk that neither borrower nor accepting bank will be able to pay the principal at maturity • Yield includes premium for: • credit risk • liquidity risk

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