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The Money Market and Money-Market Instruments (1)

The Money Market and Money-Market Instruments (1). Week 10 – October 26, 2005. Overview of Money Market. Financial Institutions Commercial banks Money market mutual funds Futures exchanges Brokers and dealers Federal Reserve. Primary Sectors U. S. Government Municipal Government

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The Money Market and Money-Market Instruments (1)

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  1. The Money Market and Money-Market Instruments (1) Week 10 – October 26, 2005

  2. Overview of Money Market

  3. Financial Institutions Commercial banks Money market mutual funds Futures exchanges Brokers and dealers Federal Reserve Primary Sectors U. S. Government Municipal Government Corporations Foreign counterparts Money Market Participants • Purpose of the money market is to allocate money at a price for market participants who need it to pay for things

  4. Treasury Bills • Maturities of 91 days (13-week) and 182 days (26-week) -- older one-year cancelled. • Bills are quoted on a 360-day discounted basis, so that a 4% ask price corresponds toor 99% of face value (e.g. $10,000,000 face value costs $9,900,000. • Bills are in book-entry form

  5. Bill auctions • Tenders are announced, usually on Tuesdays • Auctions are conducted by Federal Reserve on Mondays, with competitive and non-competitive tenders due by 1:30pm EST • Competitive tenders are arranged in ascending order of price (descending in discount) and highest bids are taken until tender is filled at lowest winning price (uniform-price auctions since Nov. 1998)

  6. Converting discount rate to yields • Convert Bill discounts to yields using:where discount is in percent, or • This can also be expressedwhere discount is in decimal form

  7. Example of converting discounts • 27-day T-Bill quoted at 1.62% ask (on October 17, 2002): • Using simplified equation (Rose):

  8. History of Money Market Rates

  9. Sources of money market rates • Weekly auction results in Tuesday’s Wall Street Journal in “Credit Markets” • Bid types and amounts • Rates and yields • “Money Rates” daily in Journal • Interpretation of rates requires caution • Rates change constantly • Daily and weekly H15 Fed release

  10. Money market rates • Fed funds quoted on annualized overnight rate • Certificates of deposit quoted on 360-day basis with interest added to principal • Treasury bills, commercial paper, and bankers’ acceptances are quoted on a bankers’ discount basis • Discount rate and prime rate are posted rates, not market rates

  11. Interpreting money market rates • T-Bill auction rate doesn’t change until a new auction occurs, this is a primary market • A 30-day bill was a 91-day bill 61 days ago or a 182-day bill 152 days ago • Trading in bills occurs in secondary market • CDs have issue rate in the primary market but negotiable CDs trade in secondary market • Market rates set in secondary markets

  12. Money Market Rates since 1960

  13. Money Market Rates since 1990

  14. Primary Dealers • Market makers in U.S. Treasury debt • Quote a price for all issues • Bid on tenders • Participate in Federal Reserve Bank of New York go rounds • Report to Federal Reserve • Limited number of large money-center banks and investment banks, and now foreign banks

  15. Repo Market Federal Reserve Commercial Bank Securities Dealer Assets Liabilities Assets Liabilities Assets Liabilities U.S. Notes Reserves Reserves Deposits U.S.Notes Repo Cash U.S.Notes Cash Repo • Repurchase agreements are a way for dealers to finance their inventories of securities • Market is also open to corporations with excess cash through Fed wire

  16. Repos and Reverse-Repos • Repurchase agreements are widely used by corporate treasurers and other institutional investors • Repos and reverses may be overnight or term repos for time periods up to months • For some (like Orange County), reverse repos were a way of leveraging a portfolio • Effect of terrorist attack on repo market

  17. Repos and Reverse Repos

  18. Certificates of Deposit • Large deposits (>$100,000) • No reserve requirements (currently) • Development of the market in 1960’s • Citibank • “Credit Crunches” of 1966 and 1969 • Interest rates and Regulation Q in the l960’s

  19. Next time • Read Chapter 18 of text, concentrating on gaining a basic idea of money market instruments • Take a quick look at Instruments of the Money Market referenced in the “Data Sources” section of the class website • Bring a Wall Street Journal for next Tuesday or Wednesday to class

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