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Flashcards in Short term Lending and borrowing instruments Deck (45)
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Money market is

not a physical location;
it is a virtual market place made up of
electronic communications
between banks,
dealers and
major corporations.


Basis upon which Money market operates:

a “wholesale” level,
with individual transactions of tens or hundreds of million pounds sterling.
mostly discounted quotes


also collective investment vehicles (“money market funds”)

offering access to the money market for individuals and small companies.


three basic ways for investors to access the money markets:

1. directly on their own account –
⁃ most suitable for large financial firms 

2. hire a professional investment management firm –
⁃ suitable for investors who will make transactions of large amounts
⁃ but who don’t have the expertise to deal in the market themselves 

3. via a money market fund –
⁃ these provide a diversified holding
⁃ of money market instruments
⁃ and are most suitable for smaller investors.


Distinction is often made between domestic and international money markets.

The latter consists of funds
in a particular currency deposited in banks that are located outside that currency’s domestic market
(and are therefore not subject to the regulation and taxation that governs the domestic market).


Quoting MM instruments:

In the UK,
money market interest rates
are often quoted
relative to LIBOR
(the London Inter Bank Offered Rate).

is true of currencies other than just sterling,

eg a US bank may be prepared to lend to a US company at “1.5% over LIBOR”.


List the money market instruments introduced in Subjects A201 and A103.

1  Treasury bills 

2  local authority bills 

3  bills of exchange 

4  certificates of deposit (CDs) 

5  commercial paper 

6  term deposits 

7  call deposits.


Factors influencing the spreads of money market rates will include :

1. default risk and
2. market liquidity.


Most money market securities operate on a

discount basis;
do not pay explicit interest but
rather generate returns by
the difference between
the purchase price and
the maturity proceeds.


return is in the form of

a capital gain and
there is no explicit income payment.


taxation authorities

will generally
regard the returns as income,
and tax it accordingly.


Give 2 reasons why the risk of default is generally less for money market instruments issued by a company than for corporate bonds issued by the same company.

Reasons are:
1  The short-term future is more certain than the long-term future.
Investors can be more confident that a particular company
will survive a few weeks than they can
that it will survive the next twenty years. 

2  Only the more reliable companies
⁃ can borrow using short-term instruments
⁃ such as commercial paper.


Example of MM instrument

A 3-month Treasury bill is being issued at an annual (simple) discount rate of 4%. Therefore, an investor would pay $99 at issue for each $100 nominal.


Lending in money markets

money markets provide a means for institutions (or individuals)
with excess short- term cash to
make a return on that cash.


The institutions involved in short term lending include :

companies and
national and
local governments and
government agencies.


The available investments for short term lending are:

1  Treasury bills 

2  commercial paper 

3  repos 

4  government agency securities 

5  bank time deposits and certificates of deposit 

6  bankers’ acceptances and eligible bills.


major forms of money market investment in most markets are:

1 Treasury bills,
2 commercial paper and
3 repo agreements


Treasury bills

most economies
major issuer of money market instruments is
national government. Bills issued by the government are
usually known as Treasury bills and
are typically issued in
3-month (91-day),
6-month (182-day) and
one-year forms.


Treasury bills issue is by

where competitive and non-competitive bids may be entered –
latter are then filled at
the average price of
the successful competitive bids.


In a UK Treasury bill auction:

all bids must be on a competitive basis.


In a US Treasury bill auction,

investors must choose whether to bid competitively or non-competitively;

they cannot do both in the same auction.

If bidding competitively,
the investor submits a tender specifying the discount rate he requires (eg 0.51%).
If the specified discount rate is too high,
the investor may not receive any bills or
may not receive their full allocation bid. 

With a non-competitive bid,
the investor is guaranteed to receive the full amount of bills requested.
The price the investor pays will be
the average price determined from the successful competitive bids.
The upper limits on how much each investor can bid for
are lower for non-competitive bids than for competitive ones.


Secondary Market for T-bills is

deep and liquid


Commercial paper is

unsecured notes
issued directly by a company
(overriding the need for financial intermediation)

issued at a discount,
usually for a term of a few months,
but can typically be presented
to the issuer (or to a dealer)
for repurchase.


The main features of commercial paper:

1  a bearer document. 

2  Terms at vary from a few days up to several months
⁃ with terms up to two months being the most common. 

3  single-name instrument,
⁃ the security is provided
⁃ only by the company issuing the paper,
⁃ ie borrowing the money. 

4  Companies who wish to raise finance by issuing commercial paper have to
⁃ meet certain minimum standards. 

5  The effective rate of interest paid will be
⁃ slightly higher than the equivalent rate
⁃ on a risk-free investment (such as a Treasury bill).
⁃ The size of the “margin” over the risk-free rate of interest
⁃ will depend on the company’s credit rating. 

6  Rating agencies such as Moody’s and Standard and Poor’s publish ratings for commercial paper.


A repo is

an agreement whereby one party
sells stock to another
with a simultaneous agreement to repurchase it
at a later date at an agreed price.


Usage of repos

Holders of government bonds and
other high quality assets
can use repos
as a short-term financing tool,
whilst maintaining their underlying economic exposure to these assets.
Repo stock usually used is
The “stock” involved is usually
either Government bonds or
Treasury bills.


Repo interest rate is:

The difference between the repurchase price and the selling price
is quoted as the repo interest rate.


Overnight repos

are very common and
so they are a very liquid instrument.


Open repos

also available.
ave no fixed maturity date and
either side can withdraw
after giving the specified notice,
usually 1 day.

For example,
the investor can give notice and
get the return on his cash (ie the agreed price for the Treasury bill)
in return for handing back the bill.


A “reverse repo” is

the opposite side of the agreement.
This is a form of secured lending
as cash is being lent for the duration of the repo
by the party buying the stock,
with the security as collateral.