1 chapter 6 financial markets, instruments, and participants ©2000 south-western college publishing
TRANSCRIPT
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Chapter 6Chapter 6Financial Markets, Financial Markets, Instruments, and Instruments, and
ParticipantsParticipants
©2000 South-Western College Publishing
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MoneyMoney MarketMarket
The market for financial assets with an original maturity of less than one year
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CapitalCapital MarketMarket
The market for financial assets with an original maturity of greater than one year
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Term toTerm to MaturityMaturity
The length of time from when a financial security is initially issued until it matures
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Primary MarketPrimary Market
The market in which a security is initially sold for the first time
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SecondarySecondary MarketMarket
The market in which previously issued financial securities are sold
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Spot MarketSpot Market
Market in which the trading of financial securities takes place instantaneously
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Financial Futures MarketsFinancial Futures Markets
Organized markets that trade financial futures agreements
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SpeculationSpeculation
The buying or selling of financial securities in the hopes of profiting from future price changes
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U.S. TreasuryU.S. Treasury bills (T-bills)bills (T-bills)
Short-term debt instruments of the U.S. government with typical maturities of 3-12 months
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The Principal Money Market Instruments Amount Outstanding, End of Year Billions of Dollars
Type of Instrument
Treasury Bills
Negotiable CDs
Commercial Paper
Banker’s Acceptances
Repurchase Agreements and Fed Funds
Eurodollars
1960
$37
0
5
1
1
1
Exhibit 6-1
1970
$76
45
35
4
22
20
1980
$200
260
99
32
102
68
1990
$482
N.A.
558
52
324
N.A.
1997
$430
N.A
979
12
653
145
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The Money Market
Instrument
•Treasury Bills
•Negotiable CDs
•Commercial Paper
•Banker’s Acceptances
•Repurchase Agreements and Fed Funds
•Fed Funds
•Eurodollars
Typical Maturities
3 to 12 months
1 to 6 months
1 to 270 days
90 days
1 day, and 2 day to 3 months typical; 6 months less typical
Chiefly 1 business day
Overnight, 1 week, 1 to 6 months and longer
Exhibit 6-2a
13Exhibit 6-2b
The Money Market
Instrument
•Treasury Bills
•Negotiable CDs
•Commercial Paper
•Banker’s Acceptances
•Repurchase Agreements and Fed Funds
•Fed Funds
•Eurodollars
Principal Borrowers
U.S. Government
Depository Institutions
Financial & Business Firms
Financial & Business Firms
Banks, Securities, nonfinancial firms, governmentsDepository Institutions
Banks
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The Money MarketInstrument
•Treasury Bills
•Negotiable CDs
•Commercial Paper
•Banker’s Acceptances
•Repurchase Agreements and Fed Funds
•Fed Funds
•Eurodollars
Exhibit 6-2c
Secondary Market
Very Active
Modest Activity
Moderately Active
Limited
None, but very active primary market for short maturities
Active broker’s market
None
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Treasury Bills
MaturitySept 24 ‘98Oct 01 ‘98Oct 08 ‘98Oct 15 ‘98Oct 22 ‘98Oct 29 ‘98Oct 29 ‘98Nov 5 ‘98
Nov 12 ‘98
Daysto
Maturity62697683909797
104111
Asked4.844.894.894.944.944.814.924.984.99
Chg+0.01+0.01+0.01+0.01+0.01+0.01+0.03+0.01+0.01
AskYld4.955.005.015.075.074.945.065.125.14
Bid4.864.914.914.964.954.834.935.005.01
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Negotiable Certificates of Negotiable Certificates of DepositDeposit (CDs)(CDs)
• Certificates of deposit with a minimum maturity of $100,000 that can be traded in a secondary market• First introduced by Citibank in 1961
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Commercial PaperCommercial Paper
Short-term debt instruments issued by corporations
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Banker’sBanker’s AcceptancesAcceptances
Money market instruments created in the course of international trade to guarantee bank drafts due on a future date
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Importer
Exporter
Importer
Exporter
bank
Exhibit 6.3
Goods Now
Cash Later
Investor
No Bankers’ Acceptance
Cash Now
Discounts
Now
Accepted
Tim
e
Draft
NowCash Later
Cash Later
Cas
h L
ater
Acc
epta
nce
Now
Transaction occurs with a
bankers’ acceptance
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Repurchase AgreementsRepurchase Agreements
Short-term agreements in which the seller sells a government security to a buyer with the simultaneous agreement to buy it back on a later date at a higher price
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Federal (Fed)Federal (Fed) FundsFunds
Loans of reserves (deposits at the Fed) between depository institutions typically overnight
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EurodollarsEurodollars
Dollar-denominated deposits held abroad
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The Capital MarketExhibit 6-5
U.S. Govt. Agency Securities
U.S. Government Agency
Some activity
Instrument Typical Principal SecondaryMaturities Borrowers Market
Corporate Stock
____ Corporations
Mortgages 15 to 30 years
Homeowners and other investors
Moderately active
Corporate Bonds
2 to 30 years Corporations
U.S. Govt. Notes
Bonds 2 to 10 yrs. U.S. Government
U.S. Government
Very active
Very active
Municipals 2 to 30 years State & Local Governments
30 years
Up to 30 years
Active
Very active for large corporations
Active
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Stocks Stocks are...are...
Equity claims that represent ownership of the net assets and income of a corporation
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MortgagesMortgages
Loans made to purchase single or multiple family residential housing, land, or other real structures, with the structure or land serving as collateral for the loan
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The Principal Capital Market Instruments Amount Outstanding, End of Year Billions of Dollars
Type of Instrument
Corporate Stock
Mortgages
Corporate & Foreign Bonds
U.S. Government Securities
U.S. Government Agency Securities
Municipal Securities
1960
$451
142
75
178
10
71
Exhibit 6-4
1970
$906
297
167
156
51
144
1980
$1,920
965
319
394
170
N.A.
1990
$3,530
3,804
1,704
1,595
426
N.A.
1997
$12,958
5,288
3,421
3,804
995
1,368
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Corporate BondsCorporate Bonds
Long-term debt instruments issued by
corporations
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U.S. Government U.S. Government SecuritiesSecurities
Long-term debt instruments of the U.S.
government with original maturities of 2-30 years
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U.S.U.S. Government AgencyGovernment Agency SecuritiesSecurities
Long-term bonds issued by various government agencies including those that support commercial, residential and farm real estate lending, and student loans
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State and Local Government State and Local Government BondsBonds (Municipals) (Municipals)
Long-term instruments issued by state and local governments to finance expenditures on schools, roads, etc.
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Revenue BondsRevenue Bonds
Bonds used to finance specific projects with proceeds of those projects used to pay off bondholders
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General Obligation BondsGeneral Obligation Bonds
Bonds that are paid out of the general revenues and are backed by the full faith and credit of the issuer
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Money RatesMoney Rates
Prime Rate- The interest rate that serves as a basis for quoting rates to customers; an indicator of the cost of business borrowing from banksFederal Funds Rate- The interest rate charged on overnight loans in the federal funds market; a sensitive indicator of the cost to banks of borrowing fundsTreasury Bill Rate - The interest rate on Treasury bills; an indicator of borrowing moneyDiscount Rate - The rate charged by the Federal Reserve Banks for loaning reserve asset deposits to depository institutions
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Money RatesMoney RatesFederal Home Loan Mortgage Rate (Freddie Mac)- The interest rate on “Fannie Mae” guaranteed mortgages; an indicator of the cost of financing conventional residential housing purchasesFederal National Mortgage Association Rate (Fannie Mae)- The interest rate on “Fannie Mae” mortgages; an indicator of the cost of financing conventional housing purchasesLondon Interbank Offered Rate (Libor)- The interbank rate for dollar-dominated deposits in the London market among international banks; the interest rate that serves as a basis for quoting other international rates
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Market MakerMarket Maker
A dealer who links up buyers and sellers of financial securities and sometimes takes positions in the securities
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BrokerBroker
Person who arranges trades between buyers and sellers
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DealerDealer
•Person who arranges trades between buyers and sellers AND can be a principal in a transaction•A market maker
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Bid PriceBid Price
The price at which a market maker is willing to buy securities
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Asked PriceAsked Price
The price at which a market maker is willing to sell securities
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Assist in raising funds to finance deficits by marketing a borrower’s new securities in the primary market
Market Makers
Stand ready to buy or sell outstanding
securities in the secondary market
Advise potential buyers and sellers of
securities on the course of action
likely to minimize costs and maximize
returns
Market Makers
Exhibit 6.6
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APEI wants to issue bonds to finance investment
Merrill Lynch agrees (for a fee) to design a bond offering and to
market (sell) the bonds
The Marketing and Trading of a Corporate Bond
Exhibit 6.7
Primary Market Activity
SSUs and financial intermediaries buy APEI bonds that will mature in 20 years
One year later SSUs (or financial intermediaries) decide to sell some of their APEI
Secondary Market Activity
Salomon sells “used” APEI bonds to another SSU
Salomon Bros. Makes a market in APEI bonds by buying bonds
from SSUs