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Calculate the bond equivalent yield for a 180-day T-bill that is purchased at a 6% "ask"
rate. If the bill has a face value of $10,000, calculate its price.
First, calculate the price of the T-bill,
YD = (F - P) * 100% * (360/D) = (100 - P) * 100% * (360/180) = 6%,
where YD is the discount yield (6%).
P = F - (F * YD * D/360) = 100 - (100 * 0.06 * 180/360) = 97 per 100 of face value
Second, calculate the bond equivalent yield,
YBE = (F - P) * 100% * (365/D) = (100 - 97) * 100% * (365/180) = 6.27%
2. What are the characteristics of money market instruments? Why must a financial claim
possess these characteristics to function as a money market instrument?
The three fundamental characteristics of money market instruments are: (a) low default risk, (b)
short-term to maturity, and (c) high marketability. These characteristics give money market
instruments their characteristic of being low risk.
3. What types of firms issue commercial paper? What are the characteristics critical to being
able to issue commercial paper?
Large high-rated businesses issue commercial paper as an inexpensive source of short-term
borrowing. Commercial paper is an alternative to prime rate borrowing from a commercial
bank and, typically, the rates are lower than rates charged by banks.
Most investors, an in attempt to protect their principal, only want paper rated high by rating
agencies. Rating agencies will quickly write down or remove their ratings for commercial paper
if the financial conditions of a company decrease. The number companies issuing commercial
paper in the economic boom of the late 1990's, shrunk considerably by 2001 as rating agencies
pulled their commercial paper ratings.
4. Suppose Fargood Corporation engages in a repurchase agreement with The National Bank
of Nebraska. In the agreement, Fargood sells $9,987,950 worth of Treasury securities to
the bank and agrees to repurchase the securities in 30 days for $10,000,000.
a. Is this transaction a loan, and if so, who is the borrower and who is the lender?
Defend your answer.
In this case, the transaction is a reverse repurchase agreement (reverse repo) for the
bank. It agrees to purchase securities under agreement to resell. The bank is buying
(investment of funds) the Treasuries owned by Fargood (liquidity provided; funds gained for
period of reverse repo). Technically, it is not a loan, but a purchase (by the bank) with
agreement to resell, but the effect is the same as a loan to a customer.
b. Is the loan collateralized? What is the Collateral? Who holds the collateral during
the term of the agreement?

The bank or offsite depository would hold the securities during the contract period. It
technically a purchase/sale, but is a type of short-term collateralized loan.
c. What interest rate (or yield) is earned by the lender?
The annualized yield to the bank (cost to Fargood) would be
YREPO = (PREPO - P0) * 100% * (360/D) = ($10,000,000 - $9,987,950) * 100% * (360/30)
= 1.45%

Describe in what ways commercial banks participate in the money markets.

Banks play three important roles in the money market.
First, they borrow in the money market to fund their loan portfolios and to acquire funds to
satisfy noninterest-bearing reserve requirements at Federal Reserve Banks. Banks are the major
participants in the market for federal funds, which are very short-termchiefly overnight
loans of immediately available money; that is, funds that can be transferred between banks
within a single business day. The funds market efficiently distributes reserves throughout the
banking system. The borrowing and lending of reserves takes place at a competitively
determined interest rate known as the federal funds rate. Banks and other depository institutions
can also borrow on a short-term basis at the Federal Reserve discount window and pay a rate of
interest set by the Federal Reserve called the discount rate. A bank's decision to borrow at the
discount window depends on the relation of the discount rate to the federal funds rate, as well as
on the administrative arrangements surrounding the use of the window.
Banks also borrow funds in the money market for longer periods by issuing large negotiable
certificates of deposit (CDs) and by acquiring funds in the Eurodollar market. A large
denomination CD is a certificate issued by a bank as evidence that a certain amount of money
has been deposited for a period of time usually ranging from one to six monthsand will be
redeemed with interest at maturity. Eurodollars are dollar-denominated deposit liabilities of
banks located outside the United States (or of International Banking Facilities in the United
States). They can be either large CDs or nonnegotiable time deposits. U.S. banks raise funds in
the Eurodollar market through their overseas branches and subsidiaries.
A final way banks raise funds in the money market is through repurchase agreements (RPs). An
RP is a sale of securities with a simultaneous agreement by the seller to repurchase them at a
later date. (For the lenderthat is, the buyer of the securities in such a transactionthe
agreement is often called a reverse RP.) In effect this agreement (when properly executed) is a
short-term collateralized loan. Most RPs involve U.S. government securities or securities issued
by government-sponsored enterprises. Banks are active participants on the borrowing side of the
RP market.
A second important role of banks in the money market is as dealers in the market for over-thecounter interest rate derivatives, which has grown rapidly in recent years. Over-the-counter
interest rate derivatives set terms for the exchange of cash payments based on subsequent
changes in market interest rates. For example, in an interest rate swap, the parties to the
agreement exchange cash payments to one another based on movements in specified market
interest rates. Banks frequently act as middleman in swap transactions by serving as a
counterparty to both sides of the transaction.
A third role of banks in the money market is to provide, in exchange for fees, commitments that

help insure that investors in money market securities will be paid on a timely basis. One type of
commitment is a backup line of credit to issuers of money market securities, which is typically
dependent on the financial condition of the issuer and can be withdrawn if that condition
deteriorates. Another type of commitment is a credit enhancementgenerally in the form of a
letter of creditthat guarantees that the bank will redeem a security upon maturity if the issuer
does not. Backup lines of credit and letters of credit are widely used by commercial paper
issuers and by issuers of municipal securities.
6. How and why do bankers acceptances frequently arise in
international trade transactions?
Solution: Often when people trade across borders, they trust the guarantee
of an international bank more than they trust an importers
agreement to pay them in the future. Thus, exporters often ask
importers to obtain a letter of credit from a well-known bank that
will agree to pay the importers obligation. When the exporter
complies with all terms of the transaction, the bank accepts the
obligation to make payment to complete the transaction if the
importer does not. Because the banks credit is good, the bankers
acceptance can be sold easily in the money markets and when it
comes due; the bank will pay, if necessary, if the importer does not.
7. The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-days
commercial paper. What is the expected 91-day commercial paper rate 91 days from
$100,000 P

F 98,284.73 365

100,000 99,019.87 365

3.97%. The 91-day rate in 91-days is expected to be 3.97%.