(Topic 2) Money & Bond Markets Flashcards
(44 cards)
The Money Market refers to the trading of short-term securities (maturity < 1 year). The instruments are held as part of bank reserves and can be used as collateral if banks need to raise funds from the CB. What are the instruments?
- Treasure bills
- Commercial paper
- Bankers’ acceptances
- Certificate of Deposit
- Eurocurrency Deposits
What are some Domestic Money Market Instruments?
- Treasury Bills (T-Bills)
- Commercial papers
- Banker’s acceptance
- Repo agreements
- Eurocurrency deposits
- Certificates of deposit (CDs)
T-Bills are issued by the treasury of the country concerned to finance national debt.
What are the characteristics of a Treasury Bill?
- Risk free (gov. guarantees to pay face value upon maturity)
- Highly liquid
- Discount securities (upon issue sold at discount to face value - size of discount a determinant of the yield on holding the T-Bill)
- Sold at discount to face value and makes no coupon payment
Yield (y) = (F-P/P)(365/t)100
What is the relationship between a T-Bill’s price and yield?
Inverse.
When purchasing price increases, yield will face, and vice-versa.
What are the ways that a T-Bill can be sold? (5)
- Public issue
- Tender issue
- Auction issue
- Direct placement
- Additional tranches of existing issues
What is Commercial Paper?
Unsecured promissory note issued by a company (with good credit ratings) into the money market - promising to pay to the purchases of the issue the face value of the paper which is sold at a discount on the market.
Usually less than 270 days of duration and typical maturity range is 30-60 days
What is the Interbank Money Market?
The market where commercial and investment banks as well as other non-bank financial intermediaries can lend and borrow money with each other.
It is predominantly a short-term market with most of the loans ranging from overnight to 14 days.
What is usually higher and more volatile, and why?
LIBOR or T-bills?
LIBOR is usually marginally higher and more volatile since all loans are unsecured.
What is a Banker’s Acceptance?
It facilitates a commercial trade transaction by having a bank’s guarantee for repaying the loan to the holder.
It can be traded on the secondary market at a discount of its face value.
What is a repo agreement?
The sale of a security with a commitment by the seller to repurchase the security at a specified price at a future date.
It is a collateralised loan with the seller handing over the security as collateral.
What is a certificate of deposit (CD)?
Usually issued by a bank to acknowledge that a specified sum of money has been deposited at the institution with a determined maturity and rate of interest.
What are some of the features of an international money market?
- A market in which borrowers and lenders of funds from different countries are brought together to exchange funds
- Consists of national currencies that are held on short-term deposit in countries other than the countries issue of the currency
What are Eurocurrency markets?
Banking markets which are conducted outside of the legal jurisdiction of the authorities of the currency that is used for banking transactions.
What is the Eurodollar?
A short term deposit or loan made in dollars outside the USA.
- Accounts for 65% of all Eurocurrency transactions
What are the features of the Eurodollar market?
- Majority of activity in London, Paris, Luxembourg and Frankfurt
- Lots of offshore banking centres
- Euro banks normally free of government regulation
- Pivotal rate of interest is LIBOR
What is the Dollar LIBOR ($LIBOR)?
- Short term interest rate on the dollar in Euromarket
- London Interbank Offered Rate
What is normally higher:
3-month $LIBOR or 3-month US Treasury Bill?
3-month $LIBOR
What is the value of the TED Spread?
3-month $LIBOR - 3-month US Treasury Bill
Treasury bill - Eurodollar spread
Why might the TED Spread increase?
- Funding has become more difficult in the interbank market
- Banks are becoming more distrustful of each other
What is the competitive advantage of Eurobanks? (Over US banks)
They have the ability to offer higher deposit rates and lower loan rates
What factors contribute to the competitive advantage of Eurobanks?
- They are free of regulation (+ have no minimum reserve requirements)
- Benefit from economies of scale
- Avoid much of the cost associated with domestic banking regulations (e.g. admin)
- Competition is greater than
In domestic banking, encouraging greater efficiency and competitive pricing - Do not have to pay deposit insurance
- Lending is almost exclusively to high quality customers (with low default risk)
What are the pros of Eurocurrency markets?
- Increases the range of facilities available to borrowers and lenders (domestically & internationally)
- Competitive interest rates
- Facilitates financial transfers between private economic agents (+ between countries, financing current accounts deficits with ease)
What are the drawbacks of Eurocurrency markets?
- Lack of regulation
- No access to lender of last resort
- High degree of interbank activity can lead to illegal activity
- Ticking time bomb underneath financial system
Within the bond market, fundamental forces determine the price of bonds issued by governments. Government bonds have ____ liquidity and ___ transaction costs relative to equities and corporate bonds.
High liquidity, low transaction costs
