Chapter 5 - Money Markets Flashcards
(39 cards)
Money Market Participants
(1) Issuers: sells / issues securities to borrow short term funds e.g. govt, securities dealers, commercial banks, corporations
(2) Investor: buys securities as an investment for excess cash / manage short term surplus cash because of the relative liquidity of the instruments and the assumed security of principal
Government Sponsored Enterprises (GSEs)
private companies that act as financial intermediaries to provide funds for loans made in the housing, education, and agriculture sectors
e.g. Federal National Mortgage Association (FNMA aka Fannie Mae) and Federal Home Loan Mortgage Corporation (FHLMC aka Freddie Mac)
GSEs do NOT have explicit credit backing of the US govt but their importance to public welfare has motivated federal govt to intervene in past crises”
Central Banks
central banks play an important role in money markets including
(1) managing initial sale and settlement of most book-entry US Treasury security sales / purchases
(2) implement monetary policy through FOMC via purchase / sale of Treasury securities in secondary markets (often using repos)
(3) buys, sells, and redeems Treasury securities in its role as fiscal agent for the US Treasury
Intermediaries in the money market
(1) broker dealers: place majority of new issues in the primary market and provide secondary markets with the necessary liquidity for outstanding issues
(2) asset managers: manage a client’s cash / investment activities
(3) central securities depositories (CSDs): hold securities for book entry transfer of securities, provide trade matching (match sales details to purchase details), and provide clearing and settlement
Central Securities Depositories
companies that hold securities to enable book entry transfer of securities, provide trade matching, as well as clearing and settlement which increases the liquidity of the money market
(1) international CSDs: settle trades in int’l securities
(2) national CSDs: settles trades in domestic securities
Two primary entities that process and clear most money market instruments
(1) Commercial Book Entry System (CBES): processes US Treasury securities
(2) Depository Trust & Clearing Corporation (DTCC): processes all forms of book-entry securities
Commercial Book-Entry System (CBES)
is a multi-tiered automated system for purchasing, holding, and transferring marketable treasury securities
it is a delivery system that simultaneously transfer securities against settlement of funds
(1) top tier - National Book-Entry System (NBES) operated by the Fed in its capacity as the fiscal agent for the US Treasury, maintain book entry accounts for depository institutions, US Treasury, foreign central banks, and most GSEs
(2) middle tier - depository institutions hold book-entry accounts for customers (e.g. broker dealer, institutional investor)
(3) lower tier - each broker, dealer, FI maintain book entry accounts for individual customers, corporations, etc.
Depository Trust & Clearing Corporation (DTCC)
owned by member FIs
is a corporation that provides clearing, settlement, and info services for equities, corporate & muni bonds, govt securities, mortgage backed securities, money market instruments, and OTC derivatives
brings significant efficiency to the market clearing process by acting as a legal depository (holding place) for most stock / bond certificates and nets transactions among brokers, dealers, funds, etc.
also provides custody and asset servicing for millions of securities issues
operate on an at-cost basis, charging transaction fees for services and returning any excess revenue to members
Commercial Paper
tradable promissory notes that represent an unsecured obligation or debt of the issuer
- usually does NOT pay interest
- is issued at a discount and face value is paid at maturity
- dollar discount and yield is influenced by credit rating of issuer and credit rating of specific issue
- CP are purchased for a specific maturity and held to term but can be traded in the secondary market prior to maturity
CP Pros and Cons
Advantages:
- range of available maturities so investors can pick their desired maturity
- investment grade CP are highly liquidx
- can diversify risk with CPs from different industries and sectors
Disadvantages:
- not secured against particular asset
- commonly issued with credit enhancement - backup line of credit or SBLC
Asset-Backed Commercial Paper (ABCP)
secured against specific assets - typically short term trade receivables from one company (single seller) or multiple companies (multi-seller)
issued through a sponsoring FI vs. directly though an issuing company
ABCP Pros and Cons
Advantages:
- more security than standard CP
- credit enhancement from sponsoring bank is designed to facilitate timely repayment at maturity
- investors tend to be rewarded for extra complexity with a moderately higher rate of return than standard CP
Disadvantages:
- complex structure of ABCP makes it harder to appraise overall risk of security and may require third party credit monitoring
- ABCP market is smaller than standard CP market which increases liquidity risk
Maturity for CPs
US:
- maturity can range from overnight to 270 days for publicly traded CP
- up to 397 days for private-placement CP
- most CP matures in less than 45 days
UK:
- max maturity of 364 days
Bank Obligations (aka bank paper)
banks raise funds in the money markets through time deposits, banker’s acceptances, and repurchase agreements - collectively referred to as bank obligations
Examples of Time Deposits
(1) savings accounts
(2) negotiable CDs
(3) non-negotiable CDs (retail CDs)
Negotiable CDs
high value time deposits issued by banks and other Fis that are bought and sold on the open market
usually traded in multiples of 100,000 o rmore
Non-Negotiable (retail) CDs
issued in many different denominations to consumers and businesses
CONS:
- no secondary marketx
- cannot redeem prior to maturity (penalty for early redemption)
Eurodollar Deposits
used by non-US banks and foreign branches of US banks to raise funds in the global money markets
-USD denominated deposits held in FI’s outside the US
- may be issued as negotiable Eurodollar CDs or non-negotiable Eurodollar time deposits - both are interest bearing
- many MNCs invest in these foreign bank issues because they allow the ability to invest in USD based securities that have historically had a higher rate of interest than comparable US bank securities due to fewer reguations and lack of US reserve requirement
Yankee CDs
USD denominated CDs sold by US branches (NY branch hence name Yankee) of non-US banks
- minimum investment of $100k
- higher rate of interest than comparable US bank securities due to differences in regulation and no US reserve requirement
- rate differential have mostly gone away but investors stil use Yankee CDs to provide geographical diversification
Deposit Insurance on cash investments
private companies (e.g. American Deposit Management Co and IntraFi Network Deposits) can provide service enabling investors to receive full FDIC coverage on cash investments up to $50mm by distributing funds among CDs issued by a network of banks
similarly, FDIC coverage can be obtained for other money market products such as MMDAs by distributing cash across a network of banks
Banker’s Acceptance
a time draft that is issued by a purchaser of goods to pay a supplier and the draft has been accepted by the bank on which the draft is drawn
- BA represents the bank’s unconditional promise to pay the time draft at maturity
- beneficiary can either wait until maturity to receive payment in full or sell the BA prior to maturity at a discount
Government Paper
govt agencies raise funds in the money market by issuing short-term promissory notes called govt paper
-govt paper are issued in a wide range of maturities but only those with a maturity less than 1 year are considered money market instruments
- variety of maturities let investors to closely match liqudity requirements
- govt paper is issed on a discount relative to their par value
- yield on govt paper tends to be lower than yield of comparable instruments due to lower default risk and lower liquidity risk
US Govt Paper
US T-Bills are money market instruments sold at a discount relative to their par value at maturity with original maturities of less than one year
- newly issued T-bills are sold through a multiple price, sealed-bid auction
- T-bills can be purchaed on either a competitive or noncompetive basis
(1) competitive bids - bids are accepted starting with the highest price offered(aka lowest yield for the investor) down to the lowest price necessary to sell the entire issue
(2) non-competitive bids - guarantees the bidder to receive the desired amount of T-bills at the average price from the competitive bid process
Dealer’s Bid-Ask Discount
(1) bid discount > ask discount (always) - higher discount = lower price
(2) bid discount - discount at which dealer is willing to buy a security
(3) ask discount - discount at which dealer is willing to sell a security
