MONEY MARKETS

• The purpose of money markets

• Money markets segments and participants
• Money market instruments
• Money market rates and yields
MONEY MARKET SECURITIES
Money market securities are debt securities with a maturity of
one year or less. They are issued in the primary market through
a telecommunication network by the Treasury corporations, and
financial intermediaries that wish to obtain short-term financing.

Money market securities are commonly purchased by

households, corporations (including financial institutions), and
Government agencies that have funds available for a short-
term period. Because money market securities have a short-
term maturity and can typically be sold in the secondary market,
they provide liquidity to investors. most firms and financial
institutions maintain some holdings of money market securities
for this reason.
 The role of money markets
The purpose of money markets is facilitate the transfer of
short-term funds from agents with excess funds (corporations,
financial institutions, individuals, government) to those market
participants who lack funds for short-term needs.

• Fund raising;
• Cash management;
• Risk management;
• Speculation or position financing;
• Signaling;
• Providing access to information on prices.
Money market segments
• Interbank market, where banks and non-deposit financial
institutions settle contracts with each other and with
central bank, involving temporary liquidity surpluses and
deficits.
• Primary market, which is absorbing the issues and
enabling borrowers to raise new funds.
• Secondary market for different short-term securities,
which redistributes the ownership, ensures liquidity, and
as a result, increases the supply of lending and reduces
its price.
• Derivatives market – market for financial contracts
whose values are derived from the underlying money
market instruments.
The more popular money market securities are

. Treasury bills
. Commercial paper
· Negotiable certificates of deposit
. Repurchase agreements
. Federal funds
· Banker's acceptances
 Treasury bills
Treasury Bills are one of the safest money market instruments
as they are issued by Central Government. They are zero-risk
instruments, and hence returns are not that attractive. T-Bills are
circulated by both primary as well as the secondary markets.
They come with the maturities of 3-month, 6-month and 1-year.

Investors in Treasury bills

Depository institutions commonly invest in T -bills so that they
call retain a portion of their funds in assets that can easily be
liquidated if they suddenly need to accommodate deposit
withdrawal. Other financial institutions also invest in T -bills in
the event that they need cash because cash outflows exceed
cash inflows. Individuals with substantial savings invest in T
-bills for liquidity purposes.
Pricing of Treasury Bills
Pricing Treasury Bills As mentioned) T -bills do not pay
interest, but are priced at a discount from their par value.
That price is determined as the present value of the future
cash flows to be received.

If investors require a 7 percent annualized return on a one-

year T-bill with a $10,000 par value, the price that they are
willing to pay is

P = $10.000/1.07
= $9,345.79
Treasury Bill Auction
Estimating the Yield
T -bills do not offer coupon payments but are sold at a discount from
par value. Their yield is influenced by the difference between the selling
price and the purchase price. If an investor purchases a newly issued T
-bill and holds it until maturity, the return is based on the difference
between the par value and the purchase price. If the T -bill is sold prior
to maturity, the return is based on the difference between the price for
which the bill was sold in the secondary market and the purchase price.
The annualized yield from investing in a T-bill (YT) can be determined
as
Commercial Papers (CPs)
Commercial Paper is the short term unsecured promissory
note issued by corporates and financial institutions at a
discounted value on face value. They come with fixed
maturity period ranging from 1 day to 270 days. These are
issued for the purpose of financing of accounts receivables,
inventories and meeting short term liabilities.

BB Guidelines
 Estimating the Yield
Like T -bills, commercial paper does not pay interest) but 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.

If an investor purchases 30-day commercial paper with a par value of

$1,000,000 for a price of $ 990,OOO, the yield (Ycp) is
Certificate of Deposits (CDs)
Certificate of Deposit is like a promissory note issued by a
bank in form of a certificate entitling the bearer to receive
interest. It is similar to bank term deposit account. The
certificate bears the maturity date, fixed rate of interest
and the value. These certificates are available in the
tenure of 3 months to 5 years. The returns on certificate of
deposits are higher than T-Bills because they carry higher
level of risk.
An investor purchased an NCD a year ago in the secondary
market for $970,000. He redeems it today upon maturity
and receives $1,000,000. He also receives interest of
$40,000. His annualized yield (Y NCD ) on this investment
is
An investor purchased an NCD a year ago in the secondary
market for $970,000. He redeems it today upon maturity
and receives $1,000,000. He also receives interest of
$40,000. His annualized yield (Y NCD ) on this investment
is
 Repurchase Agreements (Repo)
Repurchase Agreements which are also called as Repo or
Reverse Repo are short term loans that buyers and sellers agree
upon for selling and repurchasing. Repo or Reverse Repo
transactions can be done only between the parties approved by
central bank and allowed only between central bank-approved
securities such as state and central government securities, T-
Bills, PSU bonds and corporate bonds
An investor initially purchased securities at a price (PP) of $9,852,217, with an
agreement to sell them back at a price (SP of $10,000,000 at the end of a 50-
day period. The yield (or repo rate) on the repurchase agreement is
Federal Funds.
The federal funds market enables depository institutions to
lend or borrow short-term funds from each other at the so-
called federal funds rate. This rate is charged on federal
funds transactions, and it is influenced by the supply of and
demand for funds in the federal funds market.

Commercial banks are the most active participants in the

federal funds market. Federal funds brokers serve as
financial intermediaries in the market, matching up
institutions that wish to sell (lend) funds with those that
wish to purchase (borrow) them.
Banker's Acceptance
• A banker’s acceptance indicates that a bank accepts
responsibility for a future payment. Banker’s acceptances
are commonly used for international trade transactions. An
exporter that is sending goods to an importer whose credit
rating is not known will often prefer that a bank act as a
guarantor. The bank therefore facilitates the transaction by
stamping ACCEPTED on a draft, which obligates
payment at a specified point in time. In turn, the importer
will pay the bank what is owed to the exporter along with a
fee to the bank for guaranteeing the payment.
 VALUATION OF MONEY MARKET SECURITIES
• The market price of money market securities (Pm) should equal the present
value of their future cash flows. Since money market securities normally do
not make periodic interest payments, their cash flows are in the form of one
lump-sum payment of principal. Therefore, the market price of a money
market security can be determined as
Framework for Pricing Money Market Securities
Details of coupon rates offered on Treasury bills in the last three years