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2. Primary Market – market that absorbs the issues and enabling borrowers to
raise new funds.
4. Derivatives Market – market for financial contracts whose values are derived
from the underling money market instruments.
INTERBANK MARKET
- is a market which involves bank borrowing and lending of any funds in
reserve accounts at the central bank.
- Interbank Market is defined mainly in terms of participants, while other
markets are defined in terms of instruments issued and traded. Therefore,
there is a considerable overlap between these segments. Interbank market is
referred mainly as the market for very short deposits and loans (overnight or
up to two weeks). Nearly, all types of money market instruments can be
traded in interbank market.
- in the US, the interbank market is the federal funds market, in which
involves the borrowing and lending any funds in reserve accounts at the
Federal Reserved Bank.
INTERBANK MARKET
Major Characteristics of interbank market:
• the transfer of immediately available funds
• Short time horizons
• Unsecured transfers
Individual banks have a possibility to invest or lend surplus funds and have a source of
borrowing when their reserves are low, so they manage their reserves position and fund
their assets portfolio by trading at the interbank market.
It is used by all types of banks, involved in loans for very short periods, from overnight
to 14 days mostly.
If the bank borrows in the interbank market, it is said to be a funds buyer.
And if the bank lends immediately available reserve accounts, it is said to be a seller.
PRIMARY MARKET
• In secondary markets, investors exchange with each other rather than with the issuing entity.
• Secondary Market is a market where securities are offered to the general public after being
offered in the primary market. These securities are usually listed on the Stock Exchange.
2. Money market instruments have low default risk; the risk of late
or nonpayment of principal and/or interest is generally small.
- are the characteristic to the secured and the unsecured segments of the
money markets.
- in the secure REPO markets, this counterparty credit risk is mitigated as the
bank that provides liquidity that receives collateral in return.
MONEY MARKET INTEREST
RATES AND YIELDS
Short- term money market instruments have different
interest rate and yield quoting conventions.
The yield on short- term money market instruments is often
calculated using simple interest as opposed to compound
interest, and as a result is not directly comparable with the
yields to maturity.
MONEY MARKET INTEREST RATES
AND YIELDS
1. Rate on discount basis/ discount yield
id = (Pf – P0) 360
Pf n
n = Number of days of the until maturity
Pf = face value
P0 = purchase price of the security
Example:
A 90- days US Dollar Treasury bill is issued at 99% of its par value. It will be
redeemed at its par value (100%) 90 days after the issuance. It is traded on a
discount basis.
MONEY MARKET INTEREST RATES
AND YIELDS
2. Add- on rate
y = (Pf – P0) 360
P0 n
Example:
Assume Php 990,000 is lent for 90 days period at the add- on rate. The par
value is Php 1 million.
MONEY MARKET INTEREST RATES
AND YIELDS
3. Bond- equivalent yield
Example:
A 90- days US Dollar Treasury bill is issued at 99% of its par value. It will be
redeemed at its par value (100%) 90 days after the issuance.
MONEY MARKET INTEREST RATES
AND YIELDS
y= (PAR / P) - 1
Example:
A 90- days US Dollar Treasury bill is issued at 99% of its par value. It will be
redeemed at its par value (100%) 90 days after the issuance.
MONEY MARKET INTEREST RATES
AND YIELDS
•5. Semiannual yield to maturity
y= 2 * (PAR / P) - 2
Example:
A 90- days US Dollar Treasury bill is issued at 99% of its par value. It will be
redeemed at its par value (100%) 90 days after the issuance.
MONEY MARKET INTEREST RATES
AND YIELDS
6. Effective Annual Return
EAR = (1 + ibe
365/n ) -1
Example:
Suppose you can invest in a money market security that
matures in 75 days and offers a 7 percent nominal interest rate
(i.e., bond equivalent yield).
MONEY MARKET INSTRUMENT
1. Treasury Bills
Treasury bills are short- term money market instruments issued by
government and backed by the government. Therefore, market participant view
these government securities as have a little or even no risk.
A typical life to maturity is from 4 weeks to 12 months.
T- Bills do not have specified coupon. They are in effect of zero- coupon
instruments and are issued at a discount to their par or nominal value.
T- Bills are typically issued at only certain maturities dependent upon the
government budget deficit financing requirement.
Large volumes of Treasury securities have to be sold each year to cover the
annual deficit, as well as the maturing Treasury securities, that were issued in the
past. The mix of Treasury offerings determines the maturity structure of the
government’s debt.
TREASURY BILLS: Price of a
Treasury Bill
Price of a Treasury bill
-is the price that an investor willing to pay for a particular maturity Treasury
security, depending upon the investor’s required return on it.
- the price is determined as the present value of the future cash flows to be
received.
- since the T- Bills does not pay interest, investors will pay a price for a one- year
security that will ensure that the amount they receive 1 year later will generate the
desired return.
TREASURY BILLS: Price of a
Treasury Bill
P0 = Pf
(1 + d)
Pf = face value/ par value
d = Yield or rate of return
Example:
Assume that the investor requires a 5% annualized return on a 1
year Treasury bill with Php 100,00 par value. He will be willing to pay
the price.
TREASURY BILLS: Price of a
Treasury Bill
On a discount rate basis:
P0 = Pf * [1- (d * n / 360)]
Number of days of the investment
Yield or rate of return
Example:
Assume that the investor requires a 8% annualized return on a 91-
day Treasury bill with a Php 100,000 par value.
TREASURY BILLS: Yield of a
Treasury Bill
Example:
Suppose that you purchase the T-bill maturing on October 24, 2013,
for $9,000. The T-bill mature 123 days after the settlement date, June
23, 2013, and has a face value of $10,000.
TREASURY BILLS: Yield of a
Treasury Bill Asked Bond
Equivalent Yield
iT-bill,be = (Pf – P0) 365
P0 n
Finally, the EAR on the T-bill is calculated as:
EAR = (1 + iT-
bill,be
365/n
) -1
MONEY MARKET INSTRUMENTS
2. Repurchase Agreements
Repurchase Agreements (REPO)
- is an agreement to buy any securities from a seller with the agreement that they will repurchased ate
some specified date and price in the future.
- it is a fully collateralized loan in which the collateral consists of marketable securities.
- it is arranged either directly between two parties or with the help of brokers and dealers.
Reverse REPO
-purchase of securities by one party from anther with the agreement to sell them.
Open REPO
- is a REPO agreement with no set of maturity date, but renewed each day upon agreement of both
counterparties.
Overnight Repo
- is a REPO with one day maturity.
Term REPO
REPURCHASE AGREEMENTS
The participants of REPO transactions are banks, money market
funds, non- financial institutions.
In REPO, the seller is the equivalent of the borrower and the buyer is
the lender.
The repurchase price is higher than the initial sale price, and the
difference in price constitutes the return to the lender.
REPURCHASE AGREEMENT:
Yield of a Repurchase Agreement
irepo,sp = (Pf – P0) 360
P0 n
Pf = Repurchase price of the securities (equals the selling price plus interest paid on the repurchase
agreement)
Example:
Suppose a bank enters a reverse repurchase agreement in which it agrees
to buy fed funds from one of its correspondents banks at a price of
$1,000,000, with the promise to sell these funds back at a price of $1,001,000
($1,000,000 plus interest of $1,000) after five days.
COMMERCIAL PAPERS
P0 = Pf * [1 – (d * n / 360)]
Example:
A 30- day Commercial paper with Php 10 million par value yields
4.75.
COMMERCIAL PAPERS: Yield of
Commercial Paper
icp,d = (Pf – P0) 360
Pf n
Example:
Suppose an investor purchases 30-day commercial paper with a
par value of $1,000,000 for a price of $990,000
CERTIFICATES OF DEPOSIT
Certificate of Deposit (CD) states that a deposit has been made with a bank for a
fixed period of time, at the end of which it will be repaired with interest rate.
An institution is said to “issue” a CD when it accepts a deposit and to “hold” a CD
when it itself make a deposit or buys a certificate in the secondary market.
[Advantage of the depositor]: the certificate can be tradable.
[Advantage of the bank]: it has the use of a deposit for a fixed period but because
of the flexibility given to the lender, at a slightly lower price than it would have had to
pay for a normal time deposit.
The minimum denomination ca be 100,000 USD but the issue can be as large as 1
million USD.
The maturities of CDs usually range from 2 weeks to 1 year.
CERTIFICATES OF DEPOSIT
Negotiable certificates of deposit
- is a bank-issued time deposit that specifies an interest rate and maturity date
and is negotiable in the secondary market.
- a bearer instrument, whoever holds the CD when it matures receives the
principal and interest.
- are the certificates that are issued by the large commercial banks and other
depository institutions as a short- term source of funds.
- it must be priced offering a premium above government securities to
compensate for less liquidity and safety.
- the premiums are generally higher during the recessionary periods.
- negotiable CDs are priced on a yield basis.
CERTIFICATES OF DEPOSIT
icd,sp = (Pf – P0) 360
P0 n
Example:
A 3- months CD fro Php 100,000 at 6% that matures in 73
days. It is currently trading at Php 99,000.
CERTIFICATES OF DEPOSIT
P0 = Pf / [1- (i *n / 360)]
Short- term interest rate
Example:
Find the price of a 3- months Php 150,000 CD, 4%, if it has
36 days to maturity and short- term interest rates are 4%.
INTERBANK MARKET LOANS
The interbank interest rates and interest rates in the traditional market are
interconnected. If the banks are short of liquidity, they will lend less to both
markets and will cause interest rates to rise. When Central bank provides funds to
the discount market, less attractive terms are offered by banks. So, they may
choose other markets to invest and will cause the drop in interest rates.
Interbank rates are generally slightly higher and more volatile that interest
rates in the traditional market. In periods of great shortage f liquidity, the eeds of
banks which do not have sufficient funds to meet the central bank requirements
drive up the overnight rates significantly.
INTERBANK MARKET LOANS
Two types of interbank transactions:
• Ultimate borrowers- are companies and government with a financial deficit which need
to borrow.
• Government- they plays the important role as money market participant, in which they
issues money market securities and use the proceeds to finance state budget deficits.
• Central bank- employs money markets to execute monetary policy. Through monetary
intervention means and by fixing the terms at which banks are provided with money,
central banks ensure economy’s supply with liquidity.
Money Market Participants
• Large non- financial corporations- they issues money market securities and use the proceeds
to support their current operations or to expand their activities through investments.
• Credit institutions- they issue money market securities to finance loans to households and
corporations. These institutions rely on the money market for the management of their short-
term liquidity positions and for the fulfillment of their minimum reserve requirements.
The issuance of money market securities allow market participants to increase their
expenditures and finance economic growth.
Money market securities are purchased mainly by corporations, financial intermediaries
and government that have funds available for a short- term period. Individuals (households)
plays a limited role in the market by investing indirectly through money market funds.
Money Market Participants
• The U.S Treasury
• The Federal Reserve
• Commercial Banks
• Money Market Mutual Funds
• Brokers and Dealers
• Corporations
• Other Financial Institutions
• Individuals