Money market

 We review the money markets and the securities

that are traded there. In addition, we discuss why
the money markets are important in our financial
system. Topics include:
 The Money Markets Defined
 The Purpose of Money Markets
 Who Participates in Money Markets?
 Money Market Instruments
 Comparing Money Market Securities

1
The Money Markets Defined

 Regulations The term “money market” is a

misnomer( 用词不当 ). Money (currency) is
not actually traded in the money markets.
 The securities in the money market are short
term with high liquidity, therefore they are
close to being money.

2
 The Money Markets Defined
 Money Markets Defined
1. Money market securities are usually sold in large
denominations ($1,000,000 or more, wholesale
market) .
2. They have low default risk
3. They mature in one year or less from their issue date
4. Money market transactions do not take place in any
one particular location or building. Instead, traders
usually purchase and sell over the phone and
electronically.

3
 The Money Markets Defined:
Why Do We Need Money

Markets?
In theory, the banking industry should handle
the needs for short-term loans and accept
short-term deposits. Banks also have an
information advantage on the credit-worthiness
of participants.
 Banks do mediate between savers and
borrowers; however, they are heavily regulated.
This creates a distinct cost advantage for
money markets over banks.

4
 The Money Markets Defined:
Cost Advantages
 Reserve requirements create additional expense
for banks that money markets do not have;
 Regulations on the level of interest (set a ceiling on
the rate of interest that banks could pay for fund)
for purpose to reduce the competition among
banks (lessen of Great Depression in 1930s);
 Even today, the cost structure of banks limits their
competitiveness to situations where their
informational advantages outweighs ( 超过 ) their
regulatory costs.

5
 The Purpose of Money
Markets
 Investors in money market find that the MM
Provides a place for warehousing ( 储存 ) surplus
funds for short periods of time;
 Borrowers from money market find that the money
market provides a low-cost source of temporary
funds;
 Corporations and U.S. government use these
markets because the timing of cash inflows and
outflows are not well synchronized.
Money markets provide a way to solve these cash-
timing problems.

6
Who Participates in the Money
Markets?: A Sample from the Wall
Street Journal

7
Who Participates in the Money
Markets?

8
Who Participates in the Money
Markets? (cont.)

9
Who Participates in the Money
Markets? (cont.)

10
 Money Market Instruments
 We will examine each of these in the following
slides:
 Treasury Bills
 Federal Funds
 Repurchase Agreements
 Negotiable Certificates of Deposit
 Commercial Paper
 Banker’s Acceptance
 Eurodollars

11
 Money Market Instruments:
Treasury Bills( 国库券，短期
 债券
T-bills have)91-day, 182-day or
12 month maturities.
 Most money market securities do not pay interest.
Instead, the investor pays in discount.
 Discounting: when an investor pays less for the
security than it will be worth when it matures, and
the increase in price provides a return. This is
common to short-term securities because they
often mature before the issuer can mail out
interest checks.

12
 Money Market Instruments:
Treasury Bills Discounting
 Example
You pay $9850 for a 91-day T-bill. It is worth
$10,000 at maturity. What is its annualized yield?

F  P 365
iyt   (1)
P n

$10,000  $9,850 365

iyt    0.0611  6.11%
$9,850 91

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Risk of Treasury Bill

TBs have virtually zero default because even if

the government ran out of money, it could print
more to redeem them when they mature.
The risk of unexpected changes in inflation is
also low because of the short term to maturity.

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 Money Market Instruments:
Treasury Bill Auctions
 T-bills are auctioned to the dealers
every Thursday;
 In auction, the Treasury may accept both
competitive (not everyone pays the same
price) and noncompetitive bids, the later
pays at the weighted-average price of the
competitive bids.

15
Competitive and
Noncompetitive bids
 Competitive bidders might pay at different
prices if accepted;
 Noncompetitive bidders will pay the weighted

average price.
Case on P145

16
 Money Market Instruments:
Treasury Bill Rates

Figure 9.1 Treasury Bill Interest Rates and the Inflation Rate, Jan.1973–Jan.2004
Note that in several years the inflation rate is higher than T-B interest rate.

17
Money Market Instruments:
Treasury Bill Rates

Clearly, the T-bill is not an investment

to be used for anything but temporary
storage of excess funds, because it
barely keeps up with inflation.

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 Money Market Instruments:
Fed Funds ( 联邦基金 ): why is it
called?
 Fed funds are transferred between financial

institutions, usually for a period of one day;

 Fed funds have nothing to do with Fed;
 The Federal Reserve requires that all banks
must maintain a certain percentage of their total
deposits with the Federal Reserve.
 Banks prefer to borrow fed funds to avoid alert
the Fed to any liquidity problems, to lend fed
funds to earn interest (no interest to keep money
in excess of requirement)
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 Fed Funds
 Fed funds market began in the 1920s; used by
banks to meet short-term needs to meet reserve
requirements.
 Short-term funds transferred (loaned or borrowed)
between financial institutions, usually for a period of
one day;
 Interest rate for borrowing these funds was close to
the rate that the Fed charged on discount loans.
 The Fed cant directly control fed funds rates. It can
and does directly influence them by adjusting
the level of reserves available and the discount
loans;

20
 Money Market Instruments:
Fed Funds Rates

Figure 9.2 Federal Funds and Treasury Bill Interest Rates, January 1990–January 2004
21
 Money Market Instruments:
Fed Funds Rates

 Notice that the two rates track fairly closely.

 It reveals that T-bills and the fed funds are
somewhat substitutable.

22
Money Market Instruments:
Repurchase Agreements ( 回购协
议)
 These work similar to the market for fed
funds, but non-banking institutions can
participate.
 A firm sells Treasury securities, but agrees to
buy them back at a certain date (usually 3–14
days later) for a certain price.

23
Money Market Instruments:
Repurchase Agreements
 This set-up makes a repo (repurchase agreement)
agreements essentially a short-term collateralized
loan ( 抵押贷款 ).
 Securities dealers use the repo to manage their
liquidity and to take advantage of anticipated
changes in interest rate.
 This is one market the Fed may use to conduct its
monetary policy, whereby the Fed purchases/sells
Treasury securities in the repo market.

24
Money Market Instruments: Negotiable
Certificates of Deposit ( 可转让存单 )

 Negotiate: 议付、转让
 A bank-issued security that documents a deposit and
specifies the interest rate and the maturity date
 CD is a term security ( 定期证券 ) as opposite to a
demand deposit （活期存款）
 CD is a bearer instrument, and can be bought and
sold until maturity
 Denominations range from $100,000 to $10 million

25
Money Market Instruments:
Negotiable CD Rates
• The rates paid on negotiable CDs are negotiated
between the bank and the customers.
• They are similar to the rate paid on other money market
instruments because the level of risk is relatively low.
• Large money center banks can offer rates a little lower
than other banks because many investors believe that
the government would never allow one of the nation’s
largest banks to fail.

26
Money Market Instruments:
Negotiable CD Rates

Figure 9.3 Interest Rates on Negotiable Certificates of Deposit

and on Treasury Bills, 1990–2004.
27
 Money Market Instruments:
Commercial Paper （商业票据）
 Unsecured promissory notes, issued by
corporations, that mature in no more than
270 days.
 Because these securities are unsecured, only
the largest and most creditworthy
corporations issue commercial paper.

28
Money Market Instruments:
Commercial Paper （商业票据）

 Nonbank corporations use commercial paper

extensively to finance the loans that they extend to
their customers.
--- eg. General Motors Acceptance Corporation borrows
money by issuing commercial paper and uses the
money to make loans to consumers buying General
Motor cars.

29
 Money Market Instruments:
Commercial Paper
 Most issuers of commercial paper back up their paper with
a line of credit( 信贷额度 ) at a bank. This means that in the
event the issuer cannot pay off or roll over the maturing
paper, the bank will lend the firm funds for this purpose.
 The bank charges a fee of 0.5%-1% for this commitment.
Issuers are willing to pay the fee because they are able to
save more than this in lowered interest cost by this line.
 Although the two track closely in terms of movements,
notice that difference between the two remains roughly 200
basis points.

30
Money Market Instruments:
Commercial Paper Rates

Figure 9.4 Return on Commercial Paper and the Prime Rate, 1990–January 2004
31
Money Market Instruments:
Commercial Paper Volume

Figure 9.5 Volume of Commercial Paper Outstanding

32
 Money Market
Instruments: Commercial
•
Paper
Commercial banks were the original purchasers of
commercial paper. Today, the market has greatly
expanded to include large insurance companies,
nonfinancial businesses, bank trust department, and
government pension funds.
• Commercial papers attract them for the relatively
low default risk, short maturity, and high yields they
offer.

33
 Money Market Instruments:
Banker’s Acceptances （银行承兑
汇票）
 An order to pay a specified amount to the
bearer on a given date if specified conditions
have been met, usually delivery of promised
goods.
 These are often used when buyers / sellers of
expensive goods live in different countries.

34
 Steps for using banker’s
acceptance
 Steps for using banker’s acceptance is as
shown on page 154.

35
 Process of a Typical Foreign Trade Transaction
(usance L/C)
Purchase(order
一笔典型的国际贸易交易过程 远期信用证方式）
1 采购订单
Importer Exporter
Shipment of goods
进口方 5 货物运输 出口方
（ Carrier 承运人）
Signed promissory note
for face value of B/A

Shipping documents
Shipping documents

Money Market
B/A 面值的本票
L/C application

Payment face B/A

discounted value
Investor

L/C notification

and time draft

B/A

Payment
资本市场投资者

of B/A
A
B/
12 e
lu
PV

Va
e 15
c
13 Fa16 B/A B/A presented at maturity
2 10 11 14
4 6 9
Letter of Credit
3 信用证
Importer’s Bank Shipping Documents and time draft Exporter’s Bank
进口方银行
7 accepted 装箱单和远期汇票承兑
出口方银行
8 Payment-discounted value of
B/A
 Process of Other Foreign Trade Transaction
（ Sight L/C ）
其它国际贸易交易过程（即期信用证）
Purchase order
1 采购订单
Importer Exporter
Shipment of goods
进口方 5 货物运输 出口方
（ Carrier 承运人）

Shipping documents
Shipping documents

11
L/C application

and signt draft

Payment 付款

L/C notification

Payment 付款
2 8 9
4 6
Sight Letter of
3 Credit 即期信用证
Shipping Documents and sight draft
Importer’s Bank 7 装箱单和即期汇票 Exporter’s Bank
进口方银行 出口方银行
Payment 付款 10
 Banker’s Acceptances:
Advantages
1. Exporter is paid immediately
2. Exporter can be shielded from foreign
exchange risk by future FX agreements
3. Exporter does not have to assess the
financial security of the importer, importer’s
bank guarantees payment
4. Crucial to international trade

38
Secondary Market for Banker’s
Acceptances
 Because banker’s acceptance are payable to
bearer, they can be bought and sold until
they mature.
 Interest rates on banker’s acceptance are low
because the default risk is low. The reason is
that only large money center banks are
involved in this market.

39
Comparing Money Market
Securities : A comparison of
rates

Figure 9.6 Interest Rates on Money Market Securities, 1990-2004

40
 Comparing Money Market
Securities : A comparison of
rates
 The most feature of the graph is that all of the
money market instruments appear to move
very closely together over time.
 This is because all have very low risk and a
short term, and they have so many of the
same risk and term characteristics which
makes them be close substitutes.

41
Comparing Money Market
Securities: Money Market
Securities and Their Depth

42
Money Market Instruments:
Eurodollars （欧洲美元）
 Eurodollars represent Dollar denominated
deposits held in foreign banks.
 The market is essential since many foreign
contracts call for payment is U.S. dollars due
to the stability of the dollar, relative to other
currencies.

43
Money Market Instruments:
Eurodollars
 The Eurodollar market has continued to grow rapidly
because depositors receive a higher rate of return
on a dollar deposit in the Eurodollar market than in
the domestic market.
 Multinational banks are not subject to the same
regulations restricting U.S. banks and they are
willing to accept narrower spreads between the
interest paid on deposits and the interest earned on
loans.

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 A major risk Eurobank face in accepting
Eurodeposits and in extending Eurocredits is
interest rate risk resulting from a mismatch in the
maturities of the deposits and credits.
 Forward Rate Agreements
 An interbank contract that involves two
parties, a buyer and a seller. 0 1 2 3 4 5 6
 The buyer of FRA pays the interest at Sell a 3 against 6
Agreement Rate ( 合同利率 ), and the seller of FRA
FRA pays the interest at the future Settlement
Rate( 参考利率 ).
 Thus, the buyer agrees to pay the seller the
rate difference on a notational amount if interest
rates fall below an agreement rate.
 The seller agrees to pay the buyer the rate
difference if interest rates increase above the
agreement rate.
Forward Rate Agreements:
Example
 A three against nine FRA is on a six-month

interest rate for a six-month period beginning

three months from now.

0 1 2 3 4 5 6 7 8 9

Agreement FRA period

period (6 months)
(3 months)

Cash Settlement
 Settling a FRA
At the end of the agreement period, the loser pays the
winner an amount equal to the difference between the
settlement rate and the agreement rate, sized according
to the length of the agreement period and the notational
amount.
days
Notational Amount × (SR – AR) ×
360
days
1 + SR ×
360
Note: Since the difference of the interest is paid at the agreement
date, the gain or loss of a FRA should be discounted to the agreement
date.
上面计算现值天数的方法是按欧洲货币法，
即把基础天数固定为 360 天，生息天数按日
历。在国际货币市场上欧洲货币法适用范围
广。

49
Setting a FRA
Dealer quotes a rate of 4% on this instrument and end user agrees. He is
hoping that rates will increase.
Expiration is in 90 days.

The notional amount is $ 5 million.

The underlying interest rate is the 180 LIBOR time deposit.

In 90 days the 180-day LIBOR is at 5%. That 5% interest will be paid 180

days later.


So: 5,000,000 x ((0.05 - 0.04) (180/360)) = $ 47,600

1 + 0.05 (180/360)
Because rates increased, the long party or the end user will receive $47,600

from the short party or the dealer.

50
 A question:
 Consider a bank that has three-month Eurodollar
loan of $3,000,000 against an offsetting six-month
Eurodollar deposit. The bank’s concern is that three-
month LIBOR will fall below expectations and the
Eurocredit is rolled over at the new lower base rate,
making the six-month deposit unprofitable. To protect
itself, what should it do?

Sell a $3,000,000 “three against six FRA”.

中国人民银行发布公告（ [2007] 第 20 号），推出
远期利率协议业务（ Forward Rate Agreement ）
。
Chapter Summary

 The Money Markets Defined

 Short-term instruments
 Most have a low default probability
 The Purpose of Money Markets
 Used to “warehouse” funds
 Returns are low because of low risk and
high liquidity

53
Chapter Summary (cont.)

 Who Participates in Money Markets?

 U.S. Treasury
 Commercial banks
 Businesses
 Individuals (through mutual funds)
 Money Market Instruments
 Include T-bills, fed funds, etc.

54
Chapter Summary (cont.)
 Comparing Money Market Securities
 Issuers range from the US government to banks
to large corporations
 Mature in as little as 1 day to as long as 1 year
 The secondary market liquidity
varies substantially

55
Group work
 Chinese money market
 Please include the following points:
1) Participants
2) Size
3) Instruments
4) Market function
5) Regulation institutions and main regulation aspects
6) Shortages

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