Part IVFinancial Markets

Chapter EightThe Money Markets

The Money MarketsMoney Markets DefinedMoney market securities are usually sold in large denominationsThey have low default riskThey mature in one year or less from their issue date

Purpose of Money MarketsInvestors in Money Market: Provides a place for warehousing surplus funds for short periods of timeBorrowers from money market provide low-cost source of temporary funds

Interest Rates Available on Several Money Market Instruments

Participants in Money MarketsU.S. Treasury DepartmentFederal Reserve SystemCommercial BanksBusinessesInvestment and Securities FirmsIndividuals (mostly through money market mutual funds)

Money Market InstrumentsTreasury BillsFederal FundsRepurchase AgreementsNegotiable Certificates of DepositCommercial PaperBankers AcceptanceEurodollars

Treasury BillsShort-term borrowings of the federal governmentUsually sold at discount

Discounting ExampleYou pay $9850 for a 91-day T-bill. It is worth $10,000 at maturity. What is its annualized yield?(1)

Results of a Treasury Auction

Figure 8-1: Treasury Bill Interest Rate and the Inflation Rate, January 1973January 2002Current inflation statistics ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Federal FundsShort-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day

Federal FundsFigure 8.2: Federal Funds and Treasury Bill Interest Rates, January 1990January 2002

Negotiable Certificates of DepositA bank-issued security that documents a deposit and specifies the interest rate and the maturity dateDenominations range from $100,000 to $10 million

Negotiable Certificates of DepositComparing Interest on CDs and T-billsFigure 8.3: Interest Rates on Negotiable Certificates of Deposit and on Treasury Bills, January 1990January 2002

Commercial PaperUnsecured promissory notes, issued by corporations, that mature in no more than 270 days

Commercial PaperComparing Interest on Commercial Paper to Bank Prime RateFigure 8.4: Return on Commercial Paper and the Prime Rate, January 1990January 2002

Bankers AcceptancesAn order to pay a specified amount to the bearer on a given date if specified conditions have been met, usually delivery of promised goods

Advantages to Bankers AcceptancesExporter paid immediatelyExporter shielded from foreign exchange riskExporter does not have to assess the financial security of the importerImporters bank guarantees paymentCrucial to international trade

EurodollarsDollar denominated deposits held in foreign banks

EurodollarsLondon interbank bid rate (LIBID)The rate paid by banks buying fundsLondon interbank offer rate (LIBOR)The rate offered for sale of the fundsTime deposits with fixed maturitiesLargest short term security in the world

Figure 8-6: Interest Rates on Money Market Securities, 19902002Interest rates on money market instruments http://www.federalreserve.gov/releases

Money Market Securities and Their Depth

Money Market Mutual FundsOpen-end investment funds that invest only in short-term securitiesNo fee for purchasing or redeeming sharesMinimum initial investment of $500 to $20,000Check-writing privilegesNo fee for writing checksNo minimum check amountEarn 0.5% to 1% higher return than interest earned on money in the bankLow risk of default, low rate of riskPopular to small investors

Growth in Money Market Mutual FundsFigure 8.7: Net Assets of Money Market Mutual Funds, 19752000

Money Market Fund AssetsFigure 8.8: Average Distribution of Money Market Fund Assets, 2001