MONEY MARKET issues T-bills with a one-year maturity on a monthly basis.
Treasury bills were formerly issued in paper form but are
- used to facilitate the transfer of short-term funds from
individuals, corporations, or governments with excess
funds to those with deficient funds.
-Even investors who focus on long-term securities tend to
hold some money market securities
-enable financial market participants to maintain liquidity.
MONEY MARKET SECURITIES
1. debt securities with a maturity of one year or less
2. issued in the primary market through a
telecommunications network by the Treasury,
corporations, and financial intermediaries that wish to
obtain short-term financing.
3. The U.S. Treasury issues money market securities
(Treasury bills) and uses the proceeds to finance the
budget deficit.
4. Issued by Corporations and use the proceeds to
support their existing operations or to expand their
operations.
5. May be issued by financial institutions and bundle the
proceeds to make loans to households or
corporations.
6. The Treasury and some corporations commonly pay
off their debt from maturing money market securities
with the proceeds from issuing new money market
securities. In this way, they are able to finance
expenditures for long periods of time even though
money market securities have short-term maturities.
7. allow households, corporations, and the U.S.
government to increase their expenditures; thus the
markets finance economic growth.
8. commonly purchased by households, corporations
(including financial institutions), and government
agencies that have funds available for a short-term
period.
9. Because they have a short-term maturity and can
typically be sold in the secondary market, they provide
liquidity to investors
More popular money market securities
1. Treasury bills (T-bills)
2. Commercial paper
3. Negotiable certificates of deposit
4. Repurchase agreements
5. Federal funds
6. Banker’s acceptances
T-BILLS
-When the U.S. government needs to borrow funds, the
U.S. Treasury frequently issues short-term securities
known as Treasury bills.
-The Treasury Issues T-bills with 4-week, 13-week, and 26-
week maturities on a weekly basis.
-It periodically issues T-bills with terms shorter than four
weeks, which are called cash management bills. It also
now maintained electronically.
COMMERCIAL PAPERS
1. a short-term debt instrument issued only by well-
known, creditworthy firms that is typically unsecured.
2. normally issued to provide liquidity or to finance a
firm’s investment in inventory and accounts
receivable.
3. The issuance is an alternative to short-term bank
loans.
4. Preferred to be issued by some large firms rather than
borrow from a bank because it is usually a cheaper
source of funds.
5. Nevertheless, even the large creditworthy firms that
are able to issue commercial paper normally obtain
some short-term loans from commercial banks in
order to maintain a business relationship with them.
Major issuers of Commercial Paper
-Financial institutions such as finance companies and bank
holding companies are major issuers of commercial paper.
Denomination
 minimum denomination is usually $100,000, and
typical denominations are in multiples of $1 million.
 Maturities are normally between 20 and 45 days but
can be as short as 1 day or as long as 270 days.
 The 270-day maximum is due to a Securities and
Exchange Commission ruling that paper with a
maturity exceeding 270 days must be registered.
 Because of the high minimum denomination,
individual investors rarely purchase commercial paper
directly, although they may invest in it indirectly by
investing in money market funds that have pooled the
funds of many individuals.
 Money market funds: major investors in commercial
paper.
 Although the secondary market for commercial paper
is very limited, it is sometimes possible to sell the
paper back to the dealer who initially helped to place
it. However, in most cases, investors hold commercial
paper until maturity
Credit Risk
 issued by corporations that are susceptible to
business failure so it is subject to credit risk.
 The risk of default is affected by the issuer’s financial
condition and cash flow.
 Investors can attempt to assess the probability that
commercial paper will default by monitoring the
issuer’s financial condition.
  The focus is on the issuer’s ability to repay its debt
over the short term because the payments must be
completed within a short-term period.
 Although issuers of commercial paper are subject to
possible default, historically the percentage of issues
that have defaulted is very low, as most issuers of
commercial paper are very strong financially.
 In addition, the short time period of the credit reduces
the chance that an issuer will suffer financial problems
before repaying the funds borrowed.
 However, during the credit crisis in 2008, Lehman
Brothers (large securities firm) failed. This made
investors more cautious before purchasing securities
Credit Risk Ratings
 Commercial paper is commonly rated by rating
agencies such as:
o Moody’s Investors Service
o Standard & Poor’s Corporation
o Fitch Investor Service.
 Rating serves as an indicator of the potential risk of
default.
 Some investors rely heavily on the rating to assess
credit risk, rather than assess the risk of the issuer
themselves.
 A money market fund can invest only in commercial
paper that has a top-tier or second-tier rating, and
second-tier paper cannot represent more than 5
percent of the fund’s assets.
 Thus, corporations can more easily place commercial
paper that is assigned a top-tier rating.
 Junk Commercial Paper: commercial paper that is
rated low or not rated at all.
Placement
 Some firms place commercial paper directly with
investors.
 Other firms rely on commercial paper dealers to sell
their commercial paper at a transaction cost of about
one-eighth of 1 percent of the face value.
 This transaction cost is generally less than it would
cost to establish a department within the firm to place
commercial paper directly.
 However, companies that frequently issue commercial
paper may reduce expenses by creating such an in-
house department.
 Most nonfinancial companies use commercial paper
dealers rather than in-house resources to place their
commercial paper.
 Their liquidity needs, and therefore their commercial
paper issues, are cyclical, so they would use an in-
house, direct placement department only a few times
during the year.
 Finance companies typically maintain an in-house
department because they frequently borrow in this
manner
Backing Commercial Paper
 Some commercial paper is backed by assets of the
issuer.
 Commercial paper that is backed by assets should
offer a lower yield than if it were not secured by
assets.
 However, the issuers of asset-backed commercial
paper tend to have more risk of default than the well-
known firms that can successfully issue unsecured
commercial paper, and the value of assets used as
collateral may be questionable.
 Thus yields offered on asset-backed commercial
paper are often higher than the yields offered on
unsecured commercial paper.
 Some issuers of asset-backed commercial paper
obtain credit guarantees from a sponsoring institution
in the event that they cannot cover their payments on
commercial paper. This allows them to more easily
sell their commercial paper to investors
 Issuers of commercial paper typically maintain backup
lines of credit in case they cannot roll over (reissue)
commercial paper at a reasonable rate because, for
example, their assigned rating has been lowered.
 A backup line of credit provided by a commercial
bank gives the company the right (but not the
obligation) to borrow a specified maximum amount of
funds over a specified period of time.
 The fee for the credit line can either be a direct
percentage (e.g., 0.5 percent) of the total accessible
credit or be in the form of required compensating
balances (e.g., 10 percent of the credit line).
Estimating the Yield
 Like T-bills, commercial paper does not pay interest
and is priced at a discount from par value.
 At a given point in time, the yield on commercial paper
is slightly higher than the yield on a T-bill with the
same maturity because commercial paper carries
some credit risk and is less liquid.
 The nominal return to investors who retain the paper
until maturity is the difference between the price paid
for the paper and the par value.
 Thus the yield received by a commercial paper
investor can be determined in a manner similar to the
T-bill yield, although a 360-day year is usually used.
 When a firm plan to issue commercial paper, the price
(and hence the yield) to investors is uncertain.
 Thus the cost of borrowing funds is uncertain until the
paper is issued.
 When firms sell their commercial paper at a lower
(higher) price than projected, their cost of raising
funds will be higher (lower) than they initially
anticipated.
 Ignoring transaction costs, the cost of borrowing with
commercial paper is equal to the yield earned by
investors holding the paper until maturity.
 The cost of borrowing can be adjusted for transaction
costs (charged by the commercial paper dealers) by
 subtracting the nominal transaction fees from the
price received.

Commercial Paper Yield Curve

 represents the yield offered on commercial paper at

various maturities, based on the assumption that the
paper is held to maturity.
 typically established for a maturity range from 0 to 90
days because most commercial paper has a maturity
within that range.
 Important because it may influence the maturity that is
used by firms that issue commercial paper and by the
institutional investors that purchase commercial
paper.
 The shape of this yield curve could be roughly drawn
from the short-term range of the traditional Treasury
yield curve. However, that curve is graphed over a
long time period, so it is difficult to derive the precise
shape of a yield curve over a three-month range from
that graph.
 The same factors that affect the Treasury yield curve
affect the commercial paper yield curve, but they are
applied to very short-term horizons. In particular,
expectations regarding the interest rate over the next
few months can influence the commercial paper yield
curve.