Money Market

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Money market chapter 10

Need for money markets








It is required by both the government and business institutions mainly because the inflow and outflow of cash is not in harmony with each other. The Government receives revenue when taxes are due but it has to make payments throughout the year Even business institutions may make credit sales and require excess cash for short term Financial institutions usually never like to keep idle funds

Goals of Money Market Investors





Safety Liquidity Speed

Risks faced



   

Market risk Reinvestment risk Default risk Inflation risk Currency risk Political risk

Money market maturities


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Original maturity (maturity mentioned in the instrument) Actual maturity (time left to retirement) The Actual maturity decreases every day but the original maturity stays the same

Money market characteristics





 



Investors are very sensitive. Easy to sell instruments Trade is usually completed in seconds or minutes via phone or computer network There is no centralized trading area Payment is made instantaneously This market is dominated by small number of large financial institutions

Money Market Instruments
Ch 11 + 12

1. Treasury Bills







These are direct obligations of the Government who issues these instruments Mostly having maturities like 3 month, 6 month, 9 month and maximum 1 year. These are different from treasury bonds. This instrument can be Regular series bills or irregular series bills (can be strip bill or cash management bill)

1. Treasury bills (cont..)






These bills are sold using the auction technique A T.Bill does not specifically carry an interest rate. The are sold at discount and redeemable at par. DR = [(par value – purchase price)/Par ] * [360/number of days to maturity]

2. Demand Loans






Demand loans are issued by one bank to another. A demand loan is a short term loan and can be called back any time the bank needs cash. This is callable in short notice and the maturity is not fixed. For the issuing Bank such loans are considered less risky since they get back the cash/loan almost immediately

3. Repurchase Agreements
Under this agreement, the dealer sells securities to a lender but makes a commitment to buy back the securities at a later date at fixed price plus interest.  RPS can be term RPs or Continuing Contracts) RP interest income = Amt of loan * Current RP rate * (no: of days loaned / 360 days)


4. Federal Funds








The name federal fund came about because early in the development of the market the principal source of immediately available money was the reserve balance. These instruments are mainly to sort out the legal reserves. The processing is fast and happens by either direct book keeping or wire transfer. The rate on this instrument is highly volatile and depends on the money market interest rate

5. Negotiable Certificate of Deposits






Also known in short as CD is an interest bearing receipt for funds left with depository institutions for a set period of time. These instruments are sold a number of times before reaching maturity. If the denomination and total amount of a CD is large interest is fixed on negotiable terms

5. Negotiable Certificate of Deposits
Funds owed = Amt *[1+ (n/360)*i] where Amt is the amount provided and I is interest If a 6 month Tk 100,000 CD has 7.5 % interest then it would receive: Tk 100000* (1+ 180/360*0.075) = Tk103,750 In secondary market DR = [(par – purchase price)/Par]* 360/n Where n is days left to maturity If a 6 month CD of 7.5% interest is sold in 3 months for 98,200 then DR = [(100000-98200)/100000]*(360/90) = 7.2 %

6. Commercial Paper






It is one of the oldest of all money instruments These instruments are issued by well known companies that are financially strong and carry high credit rating. It is mainly issued to meet current transactions. The 2 major types are direct paper

6. Commercial Paper






The 2 major types of Commercial paper are direct paper and dealer paper Direct paper is issued by large financial companies that deal directly with the investor thus the term direct paper is used. Dealer paper also known as industrial paper is issued by security dealers on behalf of their corporate customers.

7. Banker’s Acceptance




 



It is a time draft drawn on a bank by an exporter or an importer to pay for merchandise or to buy foreign currencies. If the bank honors the draft it will stamp accepted Maturity ranges from 30 to 270 days This way the risk of default is avoided for a certain amount of cost borne by the exporter. These instruments can also be discounted before maturity

8. Euro currency deposit


The Eurocurrency markets are one of the truly significant innovations in international finance of the past 50 years. These markets have provided a foundation for a series of innovations in both the structure of and choices in financing the MNE.





Eurocurrencies are domestic currencies of one country on deposit in a
second country. A Eurocurrency deposit is a short-term fixed-rate time deposit denominated in a currency other than the local currency (e.g., U.S. dollars deposited in a London bank). Any convertible currency can exist in “Euro” form (not to be confused with the European currency called the euro). These markets serve two valuable purposes:  Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity  The Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs (including imports and exports)







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