T H E

Money
Markets
Chapter 6 - Financial Markets
6.1 - Concepts and Classes

Money Markets Financing Trade

The money market is an
organized exchange market
where participants can lend and Central Bank
borrow short-term, high-quality
debt securities with average
Policies
maturities of one year or less.

One of the pillars of the global Growth of

financial system.
Industries

Commercial Banks Self-

Sufficiency
6.2 - Instruments

Money Market
Instruments
Money market instruments are short-term
financing instruments aiming to increase the
financial liquidity of businesses.
Cash Management Bills
Cash Management bills (CMBs) are short term
securities sold by the Treasury Department
CMBs are not placed up for sale consistently
and are typically only done so when the
government is experiencing a shortage of cash
reserves.
CMBs have maturation times ranging from
seven to fifty days, but they can reach as high
as three or four months. (less than 90 days)

CMBs often aim toward institutional investors

rather than individual investors because of the
greater required minimum investment.
Treasury Bills
Treasury bills are considered the safest
instruments since they are issued with a full
guarantee by the government.

They are issued by governments.

Treasury regularly to refinance Treasury bills

reaching maturity and to finance the federal
government’s deficits.

They come with a maturity of one, three, six, or

twelve months. (more than 90 days)
Repurchase Agreements
A repurchase agreement (repo) is a
short-term form of borrowing that
involves selling a security with an
agreement to repurchase it at a higher
price at a later date.

It is commonly used by dealers in

government securities who sell
Treasury bills to a lender and agree to
repurchase them at an agreed price at
a later date.
Certificate of Deposit
Offered by commercial banks that provides
interest rate premium in exchange for the
customer agreeing to leave a lump-sum
deposit untouched for a predetermined
period of time.

A certificate of deposit (CD) is issued

directly by a commercial bank, but it can be
purchased through brokerage firms.

It comes with a maturity date ranging from

3 months to 5 years and can be issued in
any denomination.
Commercial Paper
Commercial paper (CP) is a short-term note
issued by corporations to raise funds.

Unsecured loan issued by large institutions or

corporations to finance short-term cash flow
needs, such as inventory and accounts payables.

It is issued at a discount, with the difference

between the price and face value of the
commercial paper being the profit to the
investor.

Terms to maturity extend from one to 270 days.

They average 30 days.
Banker's Acceptance
A banker’s acceptance is a form of short-term debt that is
issued by a firm but guaranteed by a bank.

The banker’s acceptance is a financial instrument that the

bank (instead of the account holder) guarantees for the
payments at a future date. It simply means that the bank
has accepted the liability to pay the third party if the
account holder defaults. It is commonly used in cross-
border trade to assure exporters against counterparty
default risk.
Banker's Acceptance
Understanding Interest Rates
An interest rate tells you how high the cost of borrowing is, or
high the rewards are for saving. So, if you're a borrower, the
interest rate is the amount you are charged for borrowing
money, shown as a percentage of the total amount of the
loan.

The rate provides the exact amount of interest a person

earns or pays for a loan. For example, a loan of $100 with a
nominal interest rate of 6% would accrue $6 in interest ($100
X 0.06). The rate does not change if the amount of the loan
increases. A borrower would still pay 6% if the loan increased
to $1,000.
How to calculate Interest?
Simple Interest:
Principal loan amount x interest rate x loan term = interest
How to calculate Interest?
Continuous
Compounding
CONTINUOUS COMPOUNDING IS THE MATHEMATICAL LIMIT THAT COMPOUND
INTEREST CAN REACH IF IT'S CALCULATED AND REINVESTED INTO AN ACCOUNT'S
BALANCE OVER A THEORETICALLY INFINITE NUMBER OF PERIODS. WHILE THIS IS NOT
POSSIBLE IN PRACTICE, THE CONCEPT OF CONTINUOUSLY COMPOUNDED INTEREST IS
IMPORTANT IN FINANCE. IT IS AN EXTREME CASE OF COMPOUNDING, AS MOST
INTEREST IS COMPOUNDED ON A MONTHLY, QUARTERLY, OR SEMIANNUAL BASIS.
Effective Rate of
Interest
 AN EFFECTIVE ANNUAL INTEREST RATE IS THE REAL RETURN ON A SAVINGS
ACCOUNT OR ANY INTEREST-PAYING INVESTMENT WHEN THE EFFECTS OF
COMPOUNDING OVER TIME ARE TAKEN INTO ACCOUNT. IT ALSO REFLECTS THE
REAL PERCENTAGE RATE OWED IN INTEREST ON A LOAN, A CREDIT CARD, OR ANY
OTHER DEBT..
FORMULA:

EXAMPLE:

CONSIDER THESE TWO OFFERS: INVESTMENT A PAYS 10%

INTEREST, COMPOUNDED MONTHLY. INVESTMENT B PAYS

10.1%, COMPOUNDED SEMIANNUALLY. WHICH IS THE
BETTER OFFER?

THEREFORE:

INVESTMENT B HAS A HIGHER STATED NOMINAL INTEREST RATE,

BUT THE EFFECTIVE ANNUAL INTEREST RATE IS LOWER THAN THE
EFFECTIVE RATE FOR INVESTMENT A. THIS IS BECAUSE
INVESTMENT B COMPOUNDS FEWER TIMES OVER THE COURSE OF
THE YEAR. IF AN INVESTOR WERE TO PUT, SAY, $5 MILLION INTO
ONE OF THESE INVESTMENTS, THE WRONG DECISION WOULD
COST MORE THAN $5,800 PER YEAR.

What happens when interest rates

rise?
Rising interest rates typically make all debt
more expensive, while also creating higher
income for savers. Higher interest rates can
also lead to higher inflation, which is when the
prices of goods, services, and interest rates
rise.
Why interest rates are important?
One way that interest rates matter is they
influence borrowing costs and spending
decisions of households and businesses.
Lower interest rates, for example, would
encourage more people to obtain a mortgage
for a new home or to borrow money for an
automobile or for home improvement
Are high interest rates good for
the economy?
It can slow down the economy because
people have less money to spend. Higher
interest rates can also lead to higher inflation,
which is when the prices of goods, services,
and interest rates rise
How to compute
Stock Price:
Gordon Growth
Model
3 Ways of computing Dividends

1 2 3
Computation of Finding Total Finding The
Net Dividends Dividends from Dividend Yield
Dividend Per
Share (DPS)
1 Computation of Net Dividends

Dividends = annual net income - net retained

earnings
2 Finding Total Dividends from Dividend Per Share (DPS)

Dividend per Share (DPS) is the sum of declared dividends issued by

a company for every ordinary share outstanding.

Dividend Per Share Formula:

Dividend Per Share = Total Dividends Paid / Shares Outstanding

Or

Dividend Per Share = Earnings Per Share x Dividend Payout Ratio

2 Finding Total Dividends from Dividend Per Share (DPS)

Calculating DPS from the Income Statement

1.) Figure out the net income of the company

2.) Determine the number of shares outstanding
3.) Divide net income by the number of shares outstanding
4.) Determine the company’s typical payout ratio
5.) Multiply the payout ratio by the net income per share to
get the dividend per share
3 Finding Dividend Yield
The dividend yield is the percentage of your investment that a stock
will pay you back in the form of dividends. Dividend yield can be
thought of as an "interest rate" on a stock.

Diividend Yield = Dividend Per Share / Share Price

1.) Determine the share price of the stock you’re analyzing

2.) Determine the DPS of the stock.
3.) Divide the DPS by the share price.
4.) Use dividend yields to compare investment opportunities.
Bond Valuation

Bond valuation is the process of determining the

fair price, or value, of a bond. Typically, this will
involve calculating the bond’s cash flow—or the
present value of a bond’s future interest payments
—as well as its face value (also known as par
value), which refers to the bond’s value once it
matures.
Bond Valuation
Some other terms that can be helpful in understanding bond valuation
include:

1. Maturity date: This refers to the length of time until the bond’s
principal is scheduled to be repaid to the bondholder.

2. Coupon rate/discount rate: This refers to the interest payments that

a bondholder receives.

3. Current price: This refers to a bond’s current value, and is typically

what’s discussed when someone mentions “bond valuation.”
Depending on several different factors, including market conditions, the
current price of a bond may be at, above, or below par value.
How to Price a Bond
1. Determine the Face Value, Annual
Coupon, and Maturity Date

2. Calculate Expected Cash Flow

Cash Flow = Annual Coupon Rate x Face

Value
How to Price a Bond
3. Discount the Expected Cash Flow to the
Present

After calculating cash flow, discount the

expected cash flow to the present.

Cash Flow ÷ (1+r)t

How to Price a Bond
4. Value the Various Cash Flows

To value your cash flows, use the following formula for each year:

Cash Flow Value = Cash Flow ÷ (1+r)1 + Cash Flow ÷ (1+r)2... + Cash
Flow ÷ (1+r)t

And

Final Face Value Payment = Face Value ÷ (1+r)t

*Add together the cash flow value and the final face value
placement, and you’ve successfully calculated the value of your
bond.
The Yield Curve: Risk and Term Structure
What is a yield curve and how it works
The Yield Curve is a graphical representation
of the interest rates on debt for a range of
maturities. It shows the yield an investor is
expecting to earn if he lends his money for a
given period of time. The graph displays a
yield on the vertical axis and the time to
maturity across the horizontal axis. The
curve may take different shapes at different
points in the economic cycle, but it is
typically upward sloping.
It is used to predict changes in economic
output and growth.
Three Main Types of Yield
Curve:
Normal Yield Curve
Inverted Yield Curve
Flat Yield Curve
Humped Yield Curve (Rare)
Normal Yield Curve
A normal or up-sloped yield curve
indicates yields on longer-term
bonds may continue to rise,
responding to periods of economic
expansion.
A normal yield curve thus starts with
low yields for shorter-maturity
bonds and then increases for bonds
with a longer maturity, sloping
upwards.
This is the most common type of
yield curve as longer-maturity
bonds usually have a higher yield to
maturity than shorter-term bonds.
Inverted Yield Curve
An inverted yield curve instead
slopes downward and means that
short-term interest rates exceed
long-term rates.
Such a yield curve corresponds to
periods of economic recession,
where investors expect yields on
longer-maturity bonds to become
even lower in the future.
Moreover, in an economic downturn,
investors seeking safe investments
tend to purchase these longer-dated
bonds over short-dated bonds,
bidding up the price of longer bonds
driving down their yield.
Flat Yield Curve
The flat yield curve is a yield curve
in which there is little difference
between short-term and long-term
rates for bonds of the same credit
quality.
This type of yield curve flattening is
often seen during transitions
between normal and inverted
curves.
Humped Yield Curve
A humped yield curve is formed when
medium-term fixed income securities’
interest rates are higher than the rates
of long- and short-term instruments,
making it a relatively rare yield curve.
It can also form when short-term
interest rates are expected to rise and
then fall, resulting in bell-shaped
curves.
 Such a flat or humped yield
curve implies an uncertain
economic situation. It may
come at the end of a high
economic growth period that
is leading to inflation and
fears of a slowdown. It might
appear at times when the
central bank is expected to
increase interest rates.
Current Yield

The Current Yield measures the expected annual return

of a bond and is calculated by dividing the annual
coupon by the current market price.
Yield-To-Maturity
Where:
C – Interest/coupon payment
FV – Face value of the security
PV – Present value/price of the
security
t – How many years it takes the
security to reach maturity

The Yield to Maturity (YTM) represents the expected

annual rate of return earned on a bond under the
assumption that the debt security is held until maturity.
What is a Yield Curve Risk?
Yield Curve Risk refers to the risk investors of
fixed-income instruments (such as bonds)
experience from an adverse shift in interest rates.
Yield curve risk stems from the fact that bond
prices and interest rates have an inverse
relationship to one another. For example, the
price of bonds will decrease when market
interest rates increase. Conversely, when interest
rates (or yields) decrease, bond prices increase.
Some related risk are Inversion of the Yield Curve
and Rates of Return Change when Interest Rates
Shift.
Interbank Market

FX, Foreign Exchange

An interbank market is a place where foreign money is
bought and sold. It is an institutional arrangement for
buying and selling foreign currencies.
The largest financial market in the world.
How interbank market works?
Thank You!