Topic 3 - Money Markets Flashcards
(99 cards)
1
Q
3.01 - What is the money market?
A
Market (not physical) where short term assets (maturity less than 1 year) are traded.
2
Q
3.02 - What are the markets called where the maturity is greater than 1 year?
A
They are the capital or fixed interest markets
3
Q
3.03 - Why are money markets around the world becoming more integrated?
A
- Financial deregulation
- Technological change
- Increasing sophistication of market participants
4
Q
3.04 - What are the two types of money markets?
A
- Primary money markets - maturities to one year
* Secondary money markets - residual maturities to one year.
5
Q
3.05 - What is the main function of the money market?
A
Facilitation of the transfer of short-term funds from those units which are in surplus to those units which are in deficit. ie Investor surplus funds to the borrowers who have a shortfall of funds.
6
Q
3.06 - What are the other functions of the money market?
A
- Mechanism by which a country’s government can raise short term funding
- Primary method by which a country’s monetary policy is implemented
- A “determinant” of the country’s interest rate structure (short term)
- The market for short-term international trade.
7
Q
3.07 - Money is not just a medium of exchange but is also a traded commodity. The Money Market operations comprise of what?
A
1) Placing of deposits
2) Short-term borrowing
3) Sale and purchase of money market securities
8
Q
3.08 - Why did the money market evolve?
A
Money historically became a unit of exchange because it allowed transfer to all parties, and the money market is a safer and reliable way of getting investor’s surplus funds to borrowers.
9
Q
3.09 - Who is the main intermediary in the transfer of funds?
A
Banks which accept deposits and then loan out funds to borrowers.
10
Q
3.10 - How do money market participants profit from partaking?
A
- Borrowers - do not make a direct profit, however the money market provides a way to achieve their objectives which could in turn be profitable.
- Intermediaries - pay lower interest to investors and charge higher interest to borrowers and therefore make a profit on the difference.
- Investors - profit from investing their surplus funds.
11
Q
3.11 - Who are the major participants in the money market?
A
- Central Bank (Reserve Bank)
- Commercial banks
- Investment banks
- Finance companies
- Brokers
- Corporations
12
Q
3.12 - What is the role of the Central Bank in the money markets?
A
Controlling role in consultation with Govt to implement policy to achieve Govt’s economic policy objectives of economic growth, external balance, full employment and price stability.
13
Q
3.13 - How does the Central Bank achieve Govt’s policy objectives in the money market?
A
By targeting interest rates in the money markets by way of Open Market Operations.
14
Q
3.14 - How do commercial banks participate in the money market?
A
- accept deposits and make loans (intermediated finance)
- assist individuals & companies to raise money through direct finance
- Provide a source of financing for Government through the purchase of Government securities
15
Q
3.15 - How do investment or merchant banks participate in the money market?
A
- Provide a range of financial services for fees / commissions
- accept fixed deposits and short-term loans
- participate in the interbank Money Market where banks manage liquidity by lending amongst each other.
16
Q
3.16 - how do Finance companies participate in the Money Market?
A
- Hire, purchase or lease finance
- Investment and portfolio management
(most activities by finance companies are long term, but the Money Market is still used to manage liquidity and short-term finance).
17
Q
3.17 - What is the important role that Brokers play in the financial markets?
A
- They match borrowers with lenders
- Provide the service of anonymity
- Provide a range of other financial services
Note: Brokers are paid fees/commissions
18
Q
3.18 - What is the major role that Corporations play in the operation of the Money Market?
A
- Borrow and invest funds in the overnight MM
- Take advantage of overdraft facilities
- Place fixed-term deposits with banks & take out fixed-term loans from banks
- Direct finance - issue commercial bills or promissory notes.
19
Q
3.19 - What is trade credit?
A
Trade credit can be an inexpensive source of funding and can often be used to meet at least some of the company’s funding requirements.
20
Q
3.20 - What does trade credit involve?
A
Delaying payment to the company’s creditors for as long as possible - within the credit terms offered by the creditor. By the time outstanding invoices need to be paid, additional purchase will have been made, giving the company an ongoing source of finance.
21
Q
3.21 - What are accruals and what do they provide the business with?
A
Accruals represent provisioning before a debt is due and payable. Accruing allows the form a spontaneous and interest-free source of finance.
22
Q
3.22 - What are common items accrued for?
A
Wages, salaries, long service leave provisions and taxes.
23
Q
3.23 - What does trade credit and accruals allow the firm to do and what is required?
A
They allow the firm to use their debt to raise funds, but will need to have accounts receivable documented in order to source these arrangements with a finance company.
24
Q
3.24 - What are the two options available to allow the firm to raise accounts receivable finance?
A
- Use of the book debts as security for a loan
* Alternatively the financial institution may ‘purchase’ the firm’s debts outright.
25
3.25 - If a finance company purchases a company's debts, the amount of cash payable to the firm will reflect what?
Heavy discounting
* to reflect the time value of the money and
* the credit risk associated with the debt.
26
3.26 - What are the two categories for instruments used to borrow and lend money in the Money Market?
* Cash products
| * Discount securities
27
3.27 - What are included under the instrument category of cash products?
* Cash (overnight & 7 day cash)
| * Loans (overdrafts, fixed term deposits and loans)
28
3.28 - What are included under the instrument category of discount securities?
* commercial bills (bank bills and non-bank bills)
* promissory notes (commercial paper)
* treasury notes
* certificates of deposit
* repurchase arrangements
29
3.29 - What are cash products?
Simplest of traded products, based on the borrowing and lending of cash between two parties.
30
3.30 - What is overnight cash also known as and how does it work?
11am cash, involves:
* deposits and loans are initially made overnight
* deposits and withdrawals must be made by 11am the next day
* rate of interest is reset daily
31
3.31 - What is 7 day cash also known as and how does it work?
24-hour cash, involves:
* deposit or loan is fixed for 7 days
* after period, money can we repaid or withdrawn (but 24 hours notice is required)
* rate is reset daily after the initial 7 day period.
32
3.32 - What is meant by the term 'spread'?
It is the difference between the two prices offered by the bank - this is the profit they make. The investor is always on the disadvantageous side.
33
3.33 - What are two loan short term options in the Money Market?
* committed loans - the line is available to draw down at all times with a commitment fee payable
* uncommitted loans - the line is available at the discretion of the bank. Fees are lower on this type of loan
34
3.34 - Which is the most common source of short term finance for business? and why is it detrimental?
The bank overdraft, but it is also most expensive.
35
3.35 - What are the features of an overdraft?
* credit arrangement offered by bank to overdraw to a limit
* interest charged daily on debit balances
* deposits reduce debit balance / increase credit balance
* overdrafts are repayable on demand
* because banks must keep funds available, they cannot earn an optimal return so interest rate is higher.
36
3.36 - What are discount securities?
They are financial products offered at a discount to their full value, so instead of interest, the investor will receive the full value when it matures.
37
3.37 - What is a bill of exchange and what are the two key types?
They are unconditional orders in writing from one person to another to pay on demand or at a future time a sum of money to a specified person.
* Commercial bills
* Trade bills
38
3.38 - What is a trade bill?
A bill used to facilitate international trade.
39
3.39 - What is a commercial bill? and what is another common name for a commercial bill?
A bill used simply to borrow money without any connection to international trade. Accommodation bill
40
3.40 - What are the three types of commercial bills?
* Bank-accepted bills
* Bank-endorsed bils
* Non-bank bills
41
3.41 - What three parties are involved in a bill?
* Drawer - borrower of the money
* Acceptor/guarantee/drawee
* Discounter - holder of the document
42
3.42 - What is the process for purchasing a bill?
Drawer writes an instruction to the acceptor instructing them to pay a certain amount at a certain time to a certain party (usually the Discounter). The party buying the bill (lending) pays a discounted amount for the security and is known as the discounter.
43
4.43 - What is the process for a bill when it matures?
The holder of the bill presents it to the acceptor and the acceptor pays the face value and then seeks reimbursement from the drawer. The agreement for the drawer to reimburse the acceptor is part of a separate agreement.
44
4.44 - What options does the discounter have with a bill that it holds?
* hold it until it matures
| * sell it in the secondary market
45
4.45 - If the bill is sold, what must the seller of the bill do?
Endorse the bill (ie. sign the back of the bill) and incur a contingent liability (which may result in a liability to repay the face value of the bill if other parties default).
46
4.46 - What is the chain of liability for a bill?
If acceptor defaults, then drawer is liable, if the drawer defaults then the last discounter to sell the bill to the current holder (the endorser) is liable.
47
4.47 - What features generally apply to commercial bills?
* Term of 7-185 days
* Traded on yields
* $5M-$10M market size parcels
* Banks quote two way prices (prices are actually yields)
* Extra fees apply to borrowers.
48
4.48 - What does the term 'traded on yields' mean in reference to commercial bills?
That the amount quoted in the market is the yield or interest rate implied by the difference between the price and the face value.
49
4.49 - What are the extra fees applicable to borrowers?
* Line fee
* Acceptance fee - reflects the credit risk of the borrower.
* Endorsement fee
50
4.50 - What is a non-bank bill?
It is created by a borrower and accepted by a non bank party, then sold in the market. There is no involvement by a bank at any stage.
51
4.51 - What is a BAB and a BEB?
* Bank Accepted Bill (BAB)
| * Bank Endorsed Bill (BEB)
52
4.52 - What is involved in a bank accepted bill?
The bank offers a 'Bill Acceptance Facility' to make it easier. Bank acts as the acceptor and charges a fee for acceptance. Bank undertakes to pay holder face value of the bill at maturity.
53
4.53 - Why are BABs the most common form of commercial bill?
Because the bank provides the bill creditworthiness because repayment is guaranteed by a bank.
54
4.54 - What is a BEB?
It is a non-bank bill that has been resold (therefore endorsed) by a bank. Not quite as creditworthy as a BAB.
55
4.55 - What are BABs and BEBs collectively referred to as?
Bank Bills.
56
4.56 - What is a P-Note? and what alternative names does it go by?
Promissory Note (P/Ns, Commercial Paper). These are a written unconditional promise to pay a certain sum to the bearer at some time in the future.
57
4.57 - Why is a promissory note also known as one name paper?
Because there is no acceptor. It is essentially an IOU written by the borrower in favour of the holder of the note.
58
4.58 - How are promissory notes sold?
* At auction via tender panel or
| * Placement (market directly approached)
59
4.59 - What are the features of a promissory note?
* There are no bank fees
* Only large corporations with excellent credit ratings are allowed to issue
* No endorsement required in secondary market (no contingent liability)
* Maturity generally 30-180 days
* Riskier than Bank Accepted Bills so yields are higher.
60
4.60 - What are T-notes?
Treasury notes. Essentially they are promissory notes issued by the Government rather than a corporation.
61
4.61 - Who issues a T-note, how often are they issued and what are the maturities offered?
* Central Bank on behalf of government
* Issued weekly by tender
* Maturities are 5, 13 and 26 weeks
62
4.62 - Who are the main traders of Treasury notes?
banks and non-bank financial institutions. Treasury notes are traded on the basis of yield and have an active secondary market.
63
4.63 - What are the advantages of trading treasury notes?
* They are the most liquid investment besides cash.
* They can be used for prime asset ratio purposes
* Because they are issued by Govt they are considered free of credit risk (which does mean interest rates are slightly lower
* T-notes can be used by banks to satisfy short term liquidity requirements.
64
4.64 - How do Central Banks use treasury notes?
To conduct their open market operations by buying and selling the notes in order to influence money supply, which in turn influences interest rates, inflation rates and rates of economic growth.
65
4.65 - What are certificates of deposit (CDs)?
They are a negotiable certificate issued by a bank to a bearer such that the bank agrees to pay a certain sum on a specified date. They are similar to a P-note but issued by a bank rather than a company.
66
4.66 - What are the advantages of a Certificate of deposit?
* Issued by banks so more secure
* They have a high credit quality
* They are negotiable which means they are trade-able.
67
4.67 - What is the disadvantages of a CD? what are their general maturities and minimum denomination?
* Yield is same as BAB so low, because of low credit risk
* 90-180 days
* $50,000
68
4.68 - What are Repos?
A repurchase agreement is an agreement under which an asset (financial eg shares or bonds) will be sold and subsequently repurchased on a certain date for a certain price. They work similar to a loan.
69
4.69 - What two transactions are common for Repos?
* Buy repo - buy securities today and sell them at a predetermined date
* Sell repo - sell securities today and buy them back at a later predetermined date.
70
4.70 - How are repos used by banks and the Reserve Bank?
By banks to manage their liquidity and by RBA to implement monetary policy.
71
4.71 - How are discount securities priced (what is the formula)?
PV = FV/(1+yt)
where t is the time the product is held (in years)
y is the yield to maturity
72
4.72 - What is the difference in interest rate year conventions between countries (for calculation purposes)?
* 365 days - AUS, Canada, UK and Singapore
| * 360 days - USA, Europe and Japan
73
4.73 - How would a bank quote a commercial bill?
Two way price where they will buy and sell a bank bill. eg. 7.65/60 meaning they will buy at 7.65 and sell at 7.60.
74
4.74 - Dealers in the market need to be fully informed, what communications will they use to do this?
* Newspapers / Journals
* The internet
* Economic News Bulletins
* Telephones
* Reuters, Telerate, Bloomberg etc
* Television (BBC World, CNN News)
75
4.75 - How are the majority of deals conducted?
* Telephone, but sum may also occur through systems such as Reuter's direct dealer
76
4.76 - What sort of information is generally supplied on a Dealing system?
* latest market prices
* volume of deals to be dealt at a price level
* financial market news
* political and economic news.
77
4.77 - What sort of 'add on' services may be available from a dealing system?
* graphics
* charting
* data manipulation capacity
78
4.78 - What is the independent body associated with the financial markets in Australia?
Australian Financial Markets Association
79
4.79 - What does the global financial system comprise of?
* Domestic financial systems that have deregulated and integrated into the global financial system
* The eurocurrency markets
80
4.80 - What are the eurocurrency markets?
Large money and capital markets primarily located in international financial centres (London, Bahrain etc) with participants comprising residents from a number of different countries.
81
4.81 - Who dominates the eurocurrency markets?
International banks who provide traditional intermediated banking services, accepting deposits and making loans along with the provision of other financial services.
82
4.82 - What does the term 'eurocurrency' refer to?
A currency that is traded outside the country of that currency. eg yen held outside of Japan.
83
4.83 - When the eurocurrency market expanded, what did it include?
* Other currencies and locations (other than USD)
| * Securitised international debt such as discount securities and bonds
84
4.84 - From the 1970s the role of intermediated finance came under pressure in the euromarkets as a result of what?
* Economic and political pressures
* options such as tax free eurobonds which have higher returns
* Better features elsewhere - terms, lower cost and less scrutiny
* financial institutions became arranges, underwriters ect rather than a net interest margin
85
4.85 - How are eurocurrency markets similar to financial markets forming part of a domestic financial system?
* There is both intermediated and direct finance
| * Over recent time direct finance has become relatively more important as markets have experienced disintermediation.
86
4.86 - What are the two key intermediated eurocurrency products?
* short term bank advance - main form of eurocurrency loan that is traded int he global money market (US$1-5M)
* standby facilities - short term credit that a borrower can draw upon if needed, during the term of the facility.
87
4.87 - What is the normal maturity of a short term bank advance and how can it be extended / repaid?
Less than one year but can be extended to a medium term loan by including a revolving facility. Short term advances are repaid by a lump sum payment at a specified time.
88
4.88 - How is the interest rate set for a short term bank advance?
In terms of marker rates such as LIBOR or SIBOR which are widely quoted. Both assume a 360 day year so therefore must be multiplied by 365/360 to compare to Australian rates.
89
4.89 - When are standby facilities generally used and for what maturity are the usually set?
They represent a backup facility that can be drawn against in periods of tight liquidity. They are normally 12-24 months but can be arranged for shorter periods.
90
4.90 - What are the two charges on a standby facility?
* a commitment fee for making the facility available
| * an interest charge on drawn funds, based on a marker rate
91
4.91 - Why is the interest charge on a standby facility generally higher than the interest charge on a standard eurocurrency loan?
Because the facility will only be used in periods of liquidity pressure, there is a higher risk to the lender.
92
4.92 - What are the three key direct eurocurrency products?
* Euronote issuance facilities (NIF)
* Eurocommercial paper (ECP)
* Medium term notes (MTN)
93
4.93 - What are NIFs?
Euronote issuance facilities (NIFs) are short term bearer promissory notes drawn by the borrower in its own name.
94
4.94 - What are the main features of a NIF?
* Normally $100K - $500K USD
* Maturity between 30-180 days
* Underwritten by a syndicate of banks who agree to purchase those notes not sold in the market below a certain interest rate
* Sold at a discount by a tender process with LIBOR the most common rate.
95
4.95 - ECPs are similar to notes, but differ in what two main ways?
* ECP programmes are not underwritten
| * ECP is issued through a select panel of dealers (not by tender).
96
4.96 - As an ECP programme is not underwritten how is the risk that they will be under-subsribed managed?
The risk is hedged by a standby facility.
97
4.97 - Notes and paper that are denominated in AUD are mainly sold where? and what is the marker rate?
In Hong Kong and Singapore with the Australian Bank bill rate as the market rate.
98
4.98 - What are medium term notes (MTNs)? their general maturity and how is interest paid?
They are debt obligations that do not have a uniform maturity, nor do they have a need to be fully drawn when issued. Normally they have maturities of 9 months to 5 years and have similar features as bonds with interest paid by means of coupon payment.
99
4.99 - What makes medium term notes so flexible?
* mix of maturities
* range of currency denominations
* fixed and floating interest rates
* can be issued in small denominations
