Professional Documents
Culture Documents
FIN ZG 512
• Money markets
• Treasury Bills
• Commercial Paper
• Certificates of Deposit
• Bankers Acceptance
• Repurchase Agreement
3
Money Markets - Introduction
4
US Treasury Bills
5
US T-bills- Pricing
Bid and offers on T-bills are quoted in a unique manner
Unlike medium or long term bonds T-bills are quoted on a
bank discount basis not on the usual price/ PV basis
The yield on a bank discount basis is calculated as
follows:
(D) or (Face Value Price) 360
yd x 100%
Face Value (t) or Days to Maturity
Example: Calculate the yield on a T bill with 100 days to
maturity and face value of $100,000 and selling at
$98,888.89.
(1,111.11) 360
yd x 100% 4%
100,000 (100) or Days to Maturity
6
US T-bills- Pricing
However, the yield calculated (in prior slide) is not a
meaningful measure primarily because it is based on the
“Face Value” and not on the “Price” or the actual amount
invested.
Additionally it is calculated on a 360 day basis whereas
bond yields are calculated on a 365 day basis.
But by convention this is the method followed in this
market
But to make it comparable to other MM securities there is
a measure called MM Equivalent yield which is computed
as follows:
360xyd
MM _ Equivalent_ Yield
360 - t( y d )
7
US T-bills- Pricing
Alternately, given the yield we can compute the Price of T-
bill as follows
Since D = Face Value – Price Price = Face Value - D
Where D is calculated as follows:
t
D y d xFaceValuex
360
Example: Calculate the Price of a T bill with 200 days to
maturity and face value of $100,000 if the Yield on a bank
discount basis is quoted as 5%.
200
D 5% x100,000x $2,777.78
360
Hence, Price = $100,000 - $2,777.78 = $97,222.22
8
Commercial Paper
Short term – up to 270 days, but majority are of 90 days
maturity
They are unsecured and issued in large denominations of
$100,000 or higher
They are issued by high-quality borrowers and represent the
obligation of the borrowing entity
It is a wholesale market dominated by institutional investors
with very few individual investors
These instruments are sold at a discount from par
While both financial institutions as well as other corporations
issue CP, the majority of the CP issues are from the former
They are sold either directly or via a dealer and backed by
bank lines of credit
9
Certificates of Deposit (CD)
Certificates of Deposit are issued by banks to raise money to fund their business
activities
10
Certificates of Deposit (CD)
Development of the CD Market
Issued by Citibank in 1961.
With a view towards offsetting declining demand deposits as a source of
funds for business expansion
Consequently CD yields are higher than yield on Treasury securities (of similar
maturity) because CDs are exposed to credit risk of the issuer. Additionally CDs
are a little less liquid compared to Treasury securities
Particularly during a crisis situation (like the 2008 financial crisis) the spread
widens because of “flight to quality”, wherein a majority of investors shift their
funds to high quality government issued debt (with little risk)
11
Bankers Acceptance (BA)
Bankers Acceptance are used to facilitate international trade.
They are called as such because a bank “accepts” the
responsibility to repay a loan to the holder of the BA
document in case the debtor fails to perform
These are also sold on a discount basis similar to T-Bills and
CP
BA’s are time drafts or pay orders with the objective of a
future payment
Drafts are drawn on and/or accepted by commercial bank.
Direct liability of bank.
There is an active secondary market comprising of dealers
for Bankers Acceptance
Discounted in market to reflect yield.
Standard maturities of 30, 60, 90, or maximum of 180 days
12
Genesis of a Bankers Acceptance (BA)
13
Repurchase Agreement (Repo)
A repo is a lending transaction where the borrower uses a security as a
collateral for borrowing
The difference between the repurchase price and the sale price
represents the cost of borrowing
Overnight repos (most popular) are for one day and other repos (>1 day)
are called term repos
Parties to a Repo are exposed to credit risk limited by posted margin and
marking to market of securities
14
Repurchase Agreement (Repo)
Bank Financing -- Source of funds
Security sold under agreement to repurchase at given price in future.
Way to include corporate business in Federal Funds market (due to
attractive yields)
This yield is referred to as the Fed Funds Rate and is the reference rate
for determination of all other money market rates
This rate is subject to the Federal Reserve’s monetary policy and hence
exhibits wide range of variability over time
16