Money Markets

Question 1

What are money markets?

Answer 1

Markets in which MMIs are traded

Question 2

What is the typical maturity in money markets?

Answer 2

Less than 1 year

Question 3

Why are money markets low risk?

Answer 3

They are short term

Question 4

Who can issue MMIs?

Answer 4

Financial institutions or central banks

Question 5

Why are MMIs very homogeneous?

Answer 5

They are very low risk and short term

Question 6

What are MMIs expressed in?

Answer 6

Basis points

Question 7

Generally, when is interest paid in MMIs?

Answer 7

At maturity

Question 8

What are the 2 ways that MMIs have their rate of return calculated?

Answer 8

• Interest yield / yield
• Rate of discount

Question 9

What are Treasury Bills (TBs)?

Answer 9

Securities issued byt he government with initial maturities of 3 months, 6 months and 1 year

Question 10

What are Commercial Bills (CBs)?

Answer 10

Same as TBs but issued by large firms

Question 11

What are Certificates of Deposit?

Answer 11

Certificates of ownership of large time deposits, can be traded so that the owner of the time deposit can get their money back by transferring it back to the other owners

Question 12

What are interbank deposits?

Answer 12

Large deposits owned by banks made at other banks for short periods, often overnight or a 7 day notice

Question 13

What are repurchase agreements (repos)?

Answer 13

The sale of some security with a promise to repurchase on a specified date at a future price - the difference functions as a rate of interest

Question 14

Why do banks hold interbank deposits?

Answer 14

They are highly liquid assets which they can withdraw quickly to revuild reserves which may have run down as the result of unforeseen withdrawals or transfer of deposits by clients

Question 15

What does the central bank become in the event of a liquidity shortage?

Answer 15

A monopoly supplier of liquidity

Question 16

What can the central bank do as a monopoly supplier of liquidity?

Answer 16

It can set the price or quantity. In practice, central banks choose to set the price of additional liquidity and this is the policy rate

Question 17

How can central banks provide liquidity?

Answer 17

May offer to buy TBs from banks needing liquidity, but as a monopoly buyer it can set the price that it will pay. Price and rate of return are connected.
More commonly, it is done via repo deals

Question 18

What is the corridor system of interest rate setting?

Answer 18

• The bank sets an official rate of interest in the gilt repo market
• Commercial banks are expected to hold a target level of reserves with the central bank, remunerated at the mpc rate
• The central bank also offers loans and deposit facilities to commercial banks to top up a shortage of reserves or deposit a surplus
• The corridor created by the standing facilities was intended to limit fluctuations in LIBOR by arbitrage
• The corridor is in effects plus/minus 1%

Question 19

What are eurocurrency markets?

Answer 19

Eurocurrency means any currency other than domestic currency

Question 20

What can CDs be issued for?

Answer 20

Deposits in a eurocurrency

Question 21

What are most eurocurrency instruments?

Answer 21

Bank deposits

Question 22

What is the major traded instrument in eurocurrency markets?

Answer 22

Certificates of Deposit (CDs)

Question 23

When did Euromarkets start?

Answer 23

1957

Question 24

What was the reasons for the formation of eurocurrency markets?

Answer 24

• In the 60s, the USSR was reluctant to hold US$ in the US
• In 1963, Regulation Q and interest equalisation tax in the US limited interest rate payable on US deposits and increased the costs of borrowing
• In 1973, the oil price rise gave OPEC large $ earnings which they kept outside the US
• In the 1980s there was rapid growth of world trade. Euromarkets were used to finance growth in world trade
• In 1981, international bank facilities were set up to allow US banks to have their own eurobanks in the US

Question 25

What are potential problems with the Eurocurrency markets?

Answer 25

- Lack of regulation - more risky - Lack of regulation has meant that countries feel the need to deregulate their own financial markets - Could lead to loss of control over domestic money supply - causes inflation - Used to provide short-term capital requirements - short-term capital movements across countries are often felt to cause currency volatility

Question 26

What are eurobanks not subject to?

Answer 26

Regulations of domestic banks: - no reserve requirements - no deposit insurance - fewer compliance staff

Question 27

What is the result of less regulations on eurobanks?

Answer 27

- Smaller loan-deposit spreads - Assets and liabilities usually matched in terms of maturity - Benefit from economies of scale, due to size of deposits and loans - Most lending is to high-quality customers - Domestic authorities have some control over the Eurobond markets, as they can change the terms of their banking license

Question 28

What Parliamentary Act allowed building socities to demutualise and turn themselves into banks?

Answer 28

The Building Societies Act 1986

Question 29

By 2007 what % of Northern Rock's funding came from money markets and securities markets?

Answer 29

c. 77%

Question 30

What was Northern Rock's problem?

Answer 30

- Northern Rock's loans were for long-term mortgages, but its funding was very short-term - Usually short-term funding was automatically rolled over every few months - as there was plenty of liquidity in the markets in the 90s and 00s there seemed little danger that they would run out of funds - In 2007 the interbank markets seized up and these short-term funds could no longer be rolled over - In September the Bank of England injected £10 billion into the banking system