Chapter 9 Money Markets

Question 1

Name three forms of cash on deposit

Answer 1

1. Call deposits: Instant access to cash
2. Term deposits No access to cash before maturity
3. Notice deposits: Give notice before you can access the cash

Question 2

Name three different ways in which interest rates can be structured on cash on deposit

Answer 2

1. Fixed for the term
2. Fixed for the initial period
3. Variable

Question 3

Discuss the term money markets

Answer 3

Money markets refer to the financial markets for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less.

Question 4

Give four examples of money market instruments

Answer 4

1. Treasury bills: Issues by gov., purchased at a discount and redeemable at par
2. Local authority: similar to t-bills
3. Commercial paper: Issues by company, purchased at a discount and redeemable par. Cheaper than loans at the bank
4. Certificate of Desposit

Question 5

What are the main players in money markets? (3)`

Answer 5

1. Clearing bank: Use MM to lend excess funds and borrow when they need short-term funds. Interest rates as JIBOR are used as the benchmark for short-term interest rates
2. Central bank: Lender of last resort, i.e., stand ready to provide liquidity to the banking sector needed. Influence short term interest rates. Sell T-Bills increasing interest rates, buying T-Bills back decrease interest rates
3. Financial institutions and other institutions: Lend and borrow funds in short-term interest rates

Question 6

What are the characteristics of money market instruments?

Answer 6

S - Security
* Low default, however depends on issuer

Y - Yield

• Lower than most other assets
• Return usually known in nominal terms

S - Spread

• Good diversification from other asset classes
• Low volatility

T - Term
* Short-term, usually year or less in term

E - Expenses
* Low
E - Exchange rate risk
* Currency risk

M - Marketability

• Not all marketable, due not all tradable (e.g., term deposits)
• Highly liquid, due to closeness of cash in nature

T - Tax

• Depends on country.
• Income is usually treated as income for tax

Question 7

Reasons for holding money market instruments

POURS GRID

Answer 7

General reasons:
P - Protect market value of the assets

O - Opportunities, so to have cash on hand should one arise

U - Uncertainty of liabilities

R - Recent cashflow, cash inflow that isn’t immediately reinvested

S - Short-term liabilities, that they know will occur

Economic Reasons

G - General economic uncertainty

R - Recession

I - Interest rate rises (higher interest rates increase borrowing cost)

D - Depreciation of domestic currency

Question 8

Reasons not to hold money market instruments

Answer 8

Nature: Does not match a lot of liabilities in nature

Term = Poor match to long-term liabilities can roll over year on year but introduces reinvestment risk

Yield = Low expected returns compared to equities or bonds in the long term