Albay, Jeremy James G.

BSA-3A
Assignment 2: Debt security markets – money markets and bond markets

1. Explain how the Treasury uses the primary market to obtain adequate funding.

The government or specifically the Treasury taps the primary market to support or fund their
various expenditures. The Treasury commonly issues treasury bills or T-bills which are short-
term in nature in order to get quick inflow of cash from investors. T-bills are so prominent in the
primary market because investors knew these instruments are risk-free. Treasury maintains
consistent funding by issuing new T-bills in primary market, then when there’s a maturing T-bill
they could just issue another T-bill to get money to cover those maturing debts, thus creating a
cycle of highly consistent funding with almost no worries.

2. Describe the activity in the secondary T-bill market. How can this degree of activity
benefit investors in T-bills?

The secondary market for T-bills is active because of its marketability, highly liquid in
nature, and safe because it’s risk-free. Investors have two main reasons why they invest for
money market securities such as T-bills. Firstly, to earn money for short period of time and
secondly, when emergency comes and they need to get money quickly, investors can easily sell
their T-bills in the secondary market even if it’s not yet matured. That what makes the secondary
market for T-bills active and attractive. Such investors have the option to hold their T-bills till
maturity or sell them when needed. Both situations are win-win so investors diversify their
portfolios by investing through said instruments.

3. Explain how the downgrading of bonds for a particular corporation affects the prices of
those bonds, the return to investors that currently hold these bonds, and the potential
return to other investors who may invest in the bonds in the near future.

Bonds are graded by rating agencies based on the performance of the corporation issuing the
bonds. Performance in terms of repaying their debts or for short, to measure their credit risk.
This might be necessary to some investors because they rely on it whether they’re going to invest
or not. Bonds that are investment-grade or higher offers higher price but lower in yields. This
means when a bond is downgraded, expect that its price will drop and yields will be higher than
normal. This is to compensate the risk involved in investing said bonds. The return to current
investors in a downgraded bond expects higher return resulting from the change of rating. When
this trend continues for said bonds, yes it might be riskier considering the corporation is
experiencing difficulty in paying its debt but this calls for potentially more earnings in the future
for potential investors. Higher the risk, higher the return. Thus, junk bonds are not necessarily
bad and some investors who are willing to bet their excess funds still invest to these kinds of
bonds.