INTERNATIONAL MONEY MARKETS

International Monetary System

It involves the management of three processes

(I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates;

(2) the financing of payments imbalances among countries by the use of credit or reserves; and

(3) the provision of international money (reserves).

International Money Market Instruments

Treasury BillsCommercial papersBanker’s acceptanceCertificate of depositsRepurchase agreements

5-4Treasury Bills - short-term obligations issued by the

U.S. governmentCommercial Paper - short-term unsecured

promissory notes issued by a company to raise short-term cash

Banker Acceptances - time draft payable to seller of goods, with payment guaranteed by a bank

Negotiable Certificates of Deposit - negotiable bank-issued time deposit with specified interest rate and maturity

Repurchase Agreements - agreement involving the sale of securities between parties with a promise to repurchase the security at a specific date and price

Treasury Bills - short-term obligations issued by the U.S. government

Commercial Paper - short-term unsecured promissory notes issued by a company to raise short-term cash

Banker Acceptances - time draft payable to seller of goods, with payment guaranteed by a bank

Negotiable Certificates of Deposit - negotiable bank-issued time deposit with specified interest rate and maturity

Repurchase Agreements - agreement involving the sale of securities between parties with a promise to repurchase the security at a specific date and price

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Instrument

Treasury bills

Repurchase agreement

Commercial Paper

Negotiable CDs

Banker’s acceptances

Principal Issuer

U.S. Treasury

FRS; Comm banks;Brokers and dealers;Other FIsComm banksOther FIs; CorpsCommercial banks

Commercial banks

Principal Investor

FRS; Comm banks;Brokers and dealers;Other FIs; Corp’sFRS, Comm banksBrokers and dealersOther FIs, Corp’sBrokers and dealersCorporationsBrokers and dealers;Corps; Other FIsComm banks; Corp’s;Brokers and dealers

Methods of calculating yields5-6

• Treasury Bills - discount yield, 360 day basis. Also as bond equivalent basis using 365 day basis

• Repurchase Agreements - bond equivalent basis, 360 day basis

• Commercial Paper - discount yield, 360 day basis

• Negotiable Certificates of Deposit - discount yield, 360 day basis

• Banker Acceptances - discount yield, 360 day basis

• Treasury Bills - discount yield, 360 day basis. Also as bond equivalent basis using 365 day basis

• Repurchase Agreements - bond equivalent basis, 360 day basis

• Commercial Paper - discount yield, 360 day basis

• Negotiable Certificates of Deposit - discount yield, 360 day basis

• Banker Acceptances - discount yield, 360 day basis

Treasury Bill Basics5-7

Issued by the U.S. Treasury to cover government budget deficits and to refinance maturing debt

Standard Original Maturities of 13 weeks, 26 weeks, or 52 weeks

Denominations are $1,000 but typical round lot is $5 million

Virtually default risk free

Issued by the U.S. Treasury to cover government budget deficits and to refinance maturing debt

Standard Original Maturities of 13 weeks, 26 weeks, or 52 weeks

Denominations are $1,000 but typical round lot is $5 million

Virtually default risk free

The Auction Process for T-bills5-8

Amount of new 13-week and 26-week T-bills offered announced weekly

Bids submitted by government securities dealers, financial and nonfinancial corporations and individuals

Individual competitive bidders limited to 35% total issue size, can submit more than one bid, allocations made beginning with highest bidder

Noncompetitive bidders indicate quantity desired and agree to pay a weighted-average of the rate on winning competitive bids; get preferential allocation

Amount of new 13-week and 26-week T-bills offered announced weekly

Bids submitted by government securities dealers, financial and nonfinancial corporations and individuals

Individual competitive bidders limited to 35% total issue size, can submit more than one bid, allocations made beginning with highest bidder

Noncompetitive bidders indicate quantity desired and agree to pay a weighted-average of the rate on winning competitive bids; get preferential allocation

The Secondary Market for T-bills5-9

The largest of any U.S. money market security

Approximately 30 financial institutions “make” a market in T-bills by buying and selling securities for their own accounts and by trading for their customers, including depository institutions, insurance companies, pensions funds, etc.

T-bills are the FOMC’s instrument of choice for its open market operations

The largest of any U.S. money market security

Approximately 30 financial institutions “make” a market in T-bills by buying and selling securities for their own accounts and by trading for their customers, including depository institutions, insurance companies, pensions funds, etc.

T-bills are the FOMC’s instrument of choice for its open market operations

T-bill Rates and Yields5-10

No interest paid on T-bills (coupon rate is zero), issued at a discount from their par (or face) value

T-bill rates are quoted in Wall Street Journal

Discount Yield the price dealers are willing to pay T-bill holders to

purchase their T-bills for themAsked

the discount yield based on the current purchase price set by dealers that is available to investors

Spread the percentage difference in the ask and bid yield;

part of transaction cost; the profit for dealers

No interest paid on T-bills (coupon rate is zero), issued at a discount from their par (or face) value

T-bill rates are quoted in Wall Street Journal

Discount Yield the price dealers are willing to pay T-bill holders to

purchase their T-bills for themAsked

the discount yield based on the current purchase price set by dealers that is available to investors

Spread the percentage difference in the ask and bid yield;

part of transaction cost; the profit for dealers

Repurchase Agreements (RPs or Repos)

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An agreement involving the sale of securities by one party to another with a promise to repurchase the securities at a specified price on a specified date

Essentially a collateralized fed funds loan with collateral in the form of securities (e.g. T-bills and Fannie Mae securities)

Reverse repurchase agreement involves the purchase of securities between

parties with the promise to sell them back at a given date in the future

An agreement involving the sale of securities by one party to another with a promise to repurchase the securities at a specified price on a specified date

Essentially a collateralized fed funds loan with collateral in the form of securities (e.g. T-bills and Fannie Mae securities)

Reverse repurchase agreement involves the purchase of securities between

parties with the promise to sell them back at a given date in the future

Trading Process for Repurchase Agreements

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Arranged either directly between two parties or with the help of brokers and dealers

The repo buyer arranges to purchase T-bills from the repo seller with an agreement that the seller will repurchase the T-bills within a stated period of time

Arranged either directly between two parties or with the help of brokers and dealers

The repo buyer arranges to purchase T-bills from the repo seller with an agreement that the seller will repurchase the T-bills within a stated period of time

Commercial Paper5-13

An unsecured short-term promissory note issued by a corporation to raise short-term cash, often to finance working capital requirements

The largest (in terms of dollar value) of the money market instruments

Generally sold in denominations of $100,000, $250,000, $500,000 and $1 million with maturities of 1-270 days (if maturity is greater than 270 days, SEC requires registration)

Generally held until maturity so there is not an active secondary market

An unsecured short-term promissory note issued by a corporation to raise short-term cash, often to finance working capital requirements

The largest (in terms of dollar value) of the money market instruments

Generally sold in denominations of $100,000, $250,000, $500,000 and $1 million with maturities of 1-270 days (if maturity is greater than 270 days, SEC requires registration)

Generally held until maturity so there is not an active secondary market

Trading Process for Commercial Paper

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CPs are sold either directly to investors (25%) or indirectly through brokers and dealers such as investment banks or major bank subsidiaries

Selling through brokers more expensive for issuer due to underwriting costs

CPs are sold either directly to investors (25%) or indirectly through brokers and dealers such as investment banks or major bank subsidiaries

Selling through brokers more expensive for issuer due to underwriting costs

Negotiable Certificates of Deposits5-15

A bank-issued time deposit that specifies an interest rate and maturity date and is negotiable in the secondary market

Bearer Instrument whoever holds the CD when it matures receives

the principal and interestDenominations range from $100,000 to $10

million; $1 million being the most common Often purchased by money market mutual

funds with pools of funds from individual investors

A bank-issued time deposit that specifies an interest rate and maturity date and is negotiable in the secondary market

Bearer Instrument whoever holds the CD when it matures receives

the principal and interestDenominations range from $100,000 to $10

million; $1 million being the most common Often purchased by money market mutual

funds with pools of funds from individual investors

Trading Process for NCDs5-16

Banks issuing NCDs post daily rates for the more popular maturities and subject to funding needs, tries to sell to investors who are likely to hold them as investments rather than sell them to the secondary market

In some cases, the bank and investor negotiate the size, rate and maturity

Secondary market consists of a linked network of approximately 15 brokers and allows investors to buy existing CD’s rather than new issues

Banks issuing NCDs post daily rates for the more popular maturities and subject to funding needs, tries to sell to investors who are likely to hold them as investments rather than sell them to the secondary market

In some cases, the bank and investor negotiate the size, rate and maturity

Secondary market consists of a linked network of approximately 15 brokers and allows investors to buy existing CD’s rather than new issues

Banker’s Acceptances5-17

A time draft payable to a seller of goods with payment guaranteed by a bank

Arise from international trade transactions and are used to finance trade in goods that have yet to be shipped from a foreign exporter (seller) to a domestic importer (buyer)

Foreign exporters prefer that banks act as guarantors for payment before sending goods to importer

A time draft payable to a seller of goods with payment guaranteed by a bank

Arise from international trade transactions and are used to finance trade in goods that have yet to be shipped from a foreign exporter (seller) to a domestic importer (buyer)

Foreign exporters prefer that banks act as guarantors for payment before sending goods to importer

International Aspects of Money Markets

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While U.S. money markets are the largest, the international market is growing U.S. securities bought/sold by foreign investors foreign money market securities

Euro money market instruments Eurodollar deposits, Eurodollar CDs, Euro notes,

Euro CP

London Interbank Offered Rate (LIBOR) the rate paid on Eurodollars

While U.S. money markets are the largest, the international market is growing U.S. securities bought/sold by foreign investors foreign money market securities

Euro money market instruments Eurodollar deposits, Eurodollar CDs, Euro notes,

Euro CP

London Interbank Offered Rate (LIBOR) the rate paid on Eurodollars