09_MONEY MARKET

Chapter9TheMoneyMarketsNowthat’salot!Inits2006annualreport,Microsoftlisted$27billioninshort-termsecuritiesonitsbalancesheet.Thisisessentiallycash,butMicrosoftdoesnotkeepthisinitslocalbank.Butwhere?Thisis,ofcourse,thistopicofchapter9–MoneyMarkets.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-2ChapterPreview•Wereviewthemoneymarketsandthesecuritiesthataretradedthere.Inaddition,wediscusswhythemoneymarketsareimportantinourfinancialsystem.Topicsinclude:–TheMoneyMarketsDefined–ThePurposeofMoneyMarkets–WhoParticipatesinMoneyMarkets?–MoneyMarketInstruments–ComparingMoneyMarketSecuritiesCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-3TheMoneyMarketsDefinedTheterm“moneymarket”isamisnomer.Money(currency)isnotactuallytradedinthemoneymarkets.Thesecuritiesinthemoneymarketareshorttermwithhighliquidity;therefore,theyareclosetobeingmoney.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-4TheMoneyMarketsDefined•MoneyMarketsDefined1.Moneymarketsecuritiesareusuallysoldinlargedenominations($1,000,000ormore)2.Theyhavelowdefaultrisk3.TheymatureinoneyearorlessfromtheirissuedateCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-5TheMoneyMarketsDefined:WhyDoWeNeedMoneyMarkets?Intheory,thebankingindustryshouldhandletheneedsforshort-termloansandacceptshort-termdeposits.Banksalsohaveaninformationadvantageonthecredit-worthinessofparticipants.Banksdomediatebetweensaversandborrowers;however,theyareheavilyregulated.Thiscreatesadistinctcostadvantageformoneymarketsoverbanks.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-6TheMoneyMarketsDefined:CostAdvantages•Reserverequirementscreateadditionalexpenseforbanksthatmoneymarketsdonothave•Regulationsonthelevelofinterestbankscouldofferdepositorsleadtoasignificantgrowthinmoneymarkets,especiallyinthe1970sand1980s.Wheninterestratesrose,depositorsmovedtheirmoneyfrombankstomoneymarketstoearnahigherinterestrate.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-7TheMoneyMarketsDefined:CostAdvantages•Eventoday,thecoststructureofbankslimitstheircompetitivenesstosituationswheretheirinformationaladvantagesoutweighstheirregulatorycosts.•Figure1showsthatlimitsoninterestbankscouldofferwasnotrelevantuntilthe1950s.Butinthedecadesthatfollowed,theproblembecameapparent.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-83-monthT-billratesandInterestRateCeilingsCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-9ThePurposeofMoneyMarkets•InvestorsinMoneyMarket:Providesaplaceforwarehousingsurplusfundsforshortperiodsoftime•Borrowersfrommoneymarketprovidelow-costsourceoftemporaryfundsCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-10ThePurposeofMoneyMarkets•CorporationsandU.S.governmentusethesemarketsbecausethetimingofcashinflowsandoutflowsarenotwellsynchronized.Moneymarketsprovideawaytosolvethesecash-timingproblems.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-11WhoParticipatesintheMoneyMarkets?•Wewilldiscuss,inturn,eachofthemajorborrowersandlendersinthemoneymarket.•Beforewedothat,let’sexaminesomeofthecurrentratesofferedintheU.S.moneymarkets.Someoftheserateshavebeendiscussedinpreviouschapters.Otherrateswillbeexploredthroughoutthischapter.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-12WhoParticipatesintheMoneyMarkets?:ASamplefromtheWallStreetJournalCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-13WhoParticipatesintheMoneyMarkets?MoneyMarketInstruments•Wewillexamineeachoftheseinthefollowingslides:–TreasuryBills–FederalFunds–RepurchaseAgreements–NegotiableCertificatesofDepositCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-15MoneyMarketInstruments(cont.)•Wewillexamineeachoftheseinthefollowingslides(continued):–CommercialPaper–Banker’sAcceptance–EurodollarsCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-16MoneyMarketInstruments:TreasuryBills•T-billshave28-daymaturitiesthrough12-monthmaturities.•Discounting:Whenaninvestorpayslessforthesecuritythanitwillbeworthwhenitmatures,andtheincreaseinpriceprovidesareturn.Thisiscommontoshort-termsecuritiesbecausetheyoftenmaturebeforetheissuercanmailoutinterestchecks.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-17MoneyMarketInstruments:TreasuryBillsDiscountingExample•Youpay$996.37fora28-dayT-bill.Itisworth$1,000atmaturity.Whatisitsannualizedyield?%76.42836637.99673.996000,1xiytCopyright©2009PearsonPrenticeHall.Allrightsreserved.9-18iytFPP365n(1)MoneyMarketInstruments:TreasuryBillAuctions•T-billsareauctionedtothedealerseveryThursday.•TheTreasurymayacceptbothcompetitiveandnoncompetitivebids,andthepriceeveryonepaysisthehighestyieldpaidtoanyacceptedbid.Copyright©2009PearsonPrenticeHall.Allrightsreserved.9-19MoneyMarketInstruments:TreasuryBillAuctionsExampleTheTreasuryauctioned$2.5billionparvalue91-dayT-bills,thefollowingbidswerereceived:BidderBidAmountBidPrice1$500million$0.99402$750million$0.99013$1.5billion$0.99254$1billion$0.99365$600million$0.9939TheTreasuryalsoreceived$750millioninnoncompetitivebids.WhowillreceiveT-bills,whatquantity,andatwhatprice?Copyright©2009PearsonPrenticeHall.Allrightsrese