MONEY

MARKETS
“I always knew I was
going to be rich. I
don’t think I ever
doubted it for a
minute.”
-Warren Buffet
1. There is no active secondary
market for commercial paper.
 Money Markets
▫ Usually sold in large denominations (1,000,000 or
more)
▫ Mature in one year or less from their issue date,
although most mature in less than 120 days
▫ Money market instruments characterized by:
- Low liquidity risk
- Low Default risk
▫ Does not occupy one particular geographic location or
trading floor
EXAMPLES of MONEY MARKET
INSTRUMENTS
▫ Treasury bills —short-term obligations issued by the
government.
▫ Federal funds —short-term funds transferred between
financial institutions usually for no more than one day.
▫ Repurchase agreements —agreements involving the sale
of securities by one party to another with a promise to
repurchase the securities at a specified date and price.
 EXAMPLES of MONEY MARKET
INSTRUMENTS
▫ Commercial paper —short-term unsecured promissory
notes issued by a company to raise short-term cash.
▫ Negotiable certificates of deposit —bank-issued time
deposit that specifies an interest rate and maturity date and
is negotiable (saleable on a secondary market).
▫ Banker’s acceptances —time drafts payable to a seller of
goods, with payment guaranteed by a bank.
Additional Details
• Bid - the discount yield on the T-bill given the
current selling price available to T-bill holders
(i.e., the price dealers are willing to pay T-bill
holders to purchase their T-bills for them)
• Ask - the discount yield based on the current
purchase price set by dealers that is available to
investors (i.e., potential T-bill buyers) and is
calculated from the settlement date, two days
after the quote date
Additional Details
• federal funds purchased - asset of the
institution that borrows fed funds incurs a
liability on its balance sheet
• federal funds sold - liabilitiy of the
institution that lends the fed funds records an
asset
• federal funds rate - overnight (or one day)
interest rate for borrowing fed funds
Additional Details
• reverse repurchase agreement
(reverse repo)- an agreement involving the
purchase (buying) of securities by one party from
another with the promise to sell them back at a
given date in the future
Additional Details
• Commercial paper - generally held by investors from
the time of issue until maturity and are usually
unsecured
• letter of credit - backs up
• commercial paper, serves as credit standing in lieu of
the credit ratings made by independent credit rating
firms
Additional Details
• bearer instrument — a CD is a bearer
instrument, whoever holds the CD when it matures
receives the principal and interest. A negotiable CD
can be traded any number of times in secondary
markets; therefore, the original buyer is not
necessarily the owner at maturity
Additional Details
• Time drafts — issued by a banks, it indicate
orders for the bank to pay a specified amount of
money to the bearer of the time draft on a given date.
Market Participants
• Time drafts — issued by a banks, it indicate
orders for the bank to pay a specified amount of
money to the bearer of the time draft on a given date.
Comparing Money Market Securities: Money Market Securities and
Their Depth
Money Market Securities and Their Markets
FORMULA &
PROBLEMS
EAR, Discount Yields, Bond Equivalent Yields,
Single Payment Yield, Money Market Price
Bond Equivalent Yield & Discount Yield
-quoted nominal, or stated, yield on a security
.

ibey = [(Pf - P0)/P0](365/h)

vs.
idy = [(Pf - P0 )/Pf ](360/h)
.
where
Pf = Face value
P0 = Purchase price of the security
h = Number of days until maturity
Bond Equivalent Yield & Discount Yield
.
.

ibey = [(Pf - P0)/P0](365/h)

vs.
idy = [(Pf - P0 )/Pf ](360/h)
.
EXAMPLE:
You can purchase a P100,000 T-Bill for 98% of
its face value. This T-Bill will mature 95 days
from maturity. The BEY and the DY are:
Effective Annual Return

Suppose you can invest in a money market

security that matures in 75 days and offers a
7 percent nominal annual interest rate (i.e.,
bond equivalent yield). The effective annual
interest return on this security is:
Bond Equivalent Yield

You can purchase a P1 million Treasury

bill that is currently selling on a discount
basis (i.e., with no explicit interest
payments) at 97½ percent of its face
value. The T-bill is 140 days from
maturity. What are the DY, BEY and EAR
DY and BEY for Treasury Bill
BEY and DY for Treasury Bill
.

ibey = [(Pf - P0)/P0](365/h) vs. idy = [(Pf - P0 )/Pf ](360/h)

You purchase the T-bill maturing on Nov 18, 2019 for

P9,993.793. The T-bill matures 133 days after the
settlement date, July 9, 2019, and has a face value of
P10,000.
1. The T-bill’s asked discount yield is reported as:
BEY and DY for Treasury Bill
.
.
ibey = [(Pf - P0)/P0](365/h) vs. idy = [(Pf - P0 )/Pf ](360/h)
.

From the data from WSJ, the asked (or discount) yield
on the T-bill maturing on September 23, 2010 (or 77
days from the settlement date, July 9, 2010), is 0.158
percent. The T-bill price for these T-bills is calculated
as:
or using the asked yield (or the bond equivalent yield)
on the T-bill, 0.160 percent:
EXAMPLE
▫ If the 175 days Treasurybill have the maturity of one
year with the value of $8000 and face value is $10000
then reported discount yield is:
▫ How about the bond equivalent yield.
▫ What about the EAR
▫ You pay $996.73 for a 28-day T-bill. It is worth $1,000 at
maturity.
▫ What is its discount rate?
▫ What is its annualized yield?
▫ What is its EAR?
 ASSIGNMENT:
Discuss in 2-3 sentences:
- Why repo transactions require a
securities “haircut”
-Imporatance of money market
END