The Money Market and MoneyMarket Instruments 1 Week

The Money Market and Money-Market Instruments (1) Week 10 – October 26, 2005 J. K. Dietrich - FBE 524 - Fall, 2005

Overview of Money Market J. K. Dietrich - FBE 524 - Fall, 2005

Money Market Participants u Financial Institutions – Commercial banks – Money market mutual funds – Futures exchanges – Brokers and dealers – Federal Reserve u Purpose u Primary – – Sectors U. S. Government Municipal Government Corporations Foreign counterparts of the money market is to allocate money at a price for market participants who need it to pay for things J. K. Dietrich - FBE 524 - Fall, 2005

Treasury Bills u Maturities of 91 days (13 -week) and 182 days (26 -week) -- older one-year cancelled. u Bills are quoted on a 360 -day discounted basis, so that a 4% ask price corresponds to or 99% of face value (e. g. $10, 000 face value costs $9, 900, 000. u Bills are in book-entry form J. K. Dietrich - FBE 524 - Fall, 2005

Bill auctions u Tenders are announced, usually on Tuesdays u Auctions are conducted by Federal Reserve on Mondays, with competitive and noncompetitive tenders due by 1: 30 pm EST u Competitive tenders are arranged in ascending order of price (descending in discount) and highest bids are taken until tender is filled at lowest winning price (uniform-price auctions since Nov. 1998) J. K. Dietrich - FBE 524 - Fall, 2005

Converting discount rate to yields u Convert Bill discounts to yields using: where discount is in percent, or u This can also be expressed where discount is in decimal form J. K. Dietrich - FBE 524 - Fall, 2005

Example of converting discounts u 27 -day T-Bill quoted at 1. 62% ask (on October 17, 2002): u Using simplified equation (Rose): J. K. Dietrich - FBE 524 - Fall, 2005

History of Money Market Rates J. K. Dietrich - FBE 524 - Fall, 2005

Sources of money market rates u Weekly auction results in Tuesday’s Wall Street Journal in “Credit Markets” – Bid types and amounts – Rates and yields u “Money Rates” daily in Journal – Interpretation of rates requires caution – Rates change constantly u Daily and weekly H 15 Fed release J. K. Dietrich - FBE 524 - Fall, 2005

Money market rates u Fed funds quoted on annualized overnight rate u Certificates of deposit quoted on 360 -day basis with interest added to principal u Treasury bills, commercial paper, and bankers’ acceptances are quoted on a bankers’ discount basis u Discount rate and prime rate are posted rates, not market rates J. K. Dietrich - FBE 524 - Fall, 2005

Interpreting money market rates u T-Bill auction rate doesn’t change until a new auction occurs, this is a primary market u A 30 -day bill was a 91 -day bill 61 days ago or a 182 -day bill 152 days ago – Trading in bills occurs in secondary market u CDs have issue rate in the primary market but negotiable CDs trade in secondary market u Market rates set in secondary markets J. K. Dietrich - FBE 524 - Fall, 2005

Money Market Rates since 1960 J. K. Dietrich - FBE 524 - Fall, 2005

Money Market Rates since 1990 J. K. Dietrich - FBE 524 - Fall, 2005

Primary Dealers u Market makers in U. S. Treasury debt – Quote a price for all issues – Bid on tenders – Participate in Federal Reserve Bank of New York go rounds – Report to Federal Reserve u Limited number of large money-center banks and investment banks, and now foreign banks J. K. Dietrich - FBE 524 - Fall, 2005

Repo Market Federal Reserve Assets U. S. Notes Commercial Bank Liabilities Assets Reserves Cash Liabilities Reserves Deposits U. S. Notes Repo • Repurchase u Securities Dealer Assets U. S. Notes Liabilities Repo Cash agreements are a way for dealers to finance their inventories of securities u Market is also open to corporations with excess cash through Fed wire J. K. Dietrich - FBE 524 - Fall, 2005

Repos and Reverse-Repos u Repurchase agreements are widely used by corporate treasurers and other institutional investors u Repos and reverses may be overnight or term repos for time periods up to months u For some (like Orange County), reverse repos were a way of leveraging a portfolio u Effect of terrorist attack on repo market J. K. Dietrich - FBE 524 - Fall, 2005

Repos and Reverse Repos J. K. Dietrich - FBE 524 - Fall, 2005

Certificates of Deposit u. Large deposits (>$100, 000) u. No reserve requirements (currently) u. Development of the market in 1960’s – Citibank – “Credit Crunches” of 1966 and 1969 u. Interest l 960’s J. K. Dietrich - FBE 524 - Fall, 2005 rates and Regulation Q in the

Next time u Read Chapter 18 of text, concentrating on gaining a basic idea of money market instruments u Take a quick look at Instruments of the Money Market referenced in the “Data Sources” section of the class website u Bring a Wall Street Journal for next Tuesday or Wednesday to class J. K. Dietrich - FBE 524 - Fall, 2005