Fe442 Slides Ch. 5

Front 1

Money Market Definition

Back 1

Associated withthe issuance and trading of ST (<1 yr.) debt obligations of large corporations, FI's and governments

Front 2

Who can borrow in the Money Markets

Back 2

Only high quality entities and individual issues are large

Front 3

Investors in Money Market Instruments

Back 3

Include corporations and FI's who have idle cash but are restricted to a ST investment horizon

Front 4

Essential function of MM's

Back 4

serve to allocate the nation's supply of liquid funds among major ST lender and borrowers

Front 5

Treasury Bills

Back 5

ST obligations issued by the US government

Front 6

Federal Funds

Back 6

ST funds transferred between financial institutions usually for no more than a day

Front 7

Repurchase Agreements

Back 7

AKA Repo's, egreement involving the sale of securities between parties with a promise to repurchase the security at a specific date and price

Front 8

Commercial Paper

Back 8

ST unsecured promissory notes issued by a company to raise ST cash

Front 9

Negotiable Certificates of Deposit

Back 9

negotiable bank-issued time deposit with specified interest rate and maturity

Front 10

Banker Acceptances

Back 10

time draft payable to seller of goods, with payment guaranteed by bank

Front 11

Who issues T-Bills, and why?

Back 11

Issued by US goernment to cover government budget deficits and to refinance maturing debt

Front 12

What are Tbill maturities

Back 12

Standard Original Maturities of 13, 26, or 52 weeks

Front 13

T-Bill Denominations

Back 13

Denominations are $1000 but typical round lot is $5M

Front 14

Auction process for T-Bills

Back 14

1. Amount of new 13 and 26 week T-bills offered announced weekly
2. Bids submitted by government securities dealers, financial and non-financial corporations and individuals
3. Individual competetive bidders limited to 35% total issue size, can submit more than one bid, allocations made beginning with highest bidder

Front 15

Secondary Markets for T-Bills

Back 15

-The largest of any US money market security
-Approx. 30 financial institutions "make" a market in T-Bills by buying and selling securities for their own accounts and by trading for their customers, including depository institutions, insurance companies, pension funds, etc.
-T bills are the FOMC (Federal Open Market Committee)'s instrument of choice for its open market operations

Front 16

TBill Rates and Yield

Back 16

-No interest paid on Tbills (coupon rate is zero), issued at a discount from their par (or face) value
-Tbill rates quoted in the WSJ

Front 17

Discount Yield

Back 17

the price the dealers are willing to pay TBill holders to purchase their T-bills for (from?) them

Front 18

Asked

Back 18

The discount yield based on the current purchase price set by dealers that is available to investors

Front 19

Spread

Back 19

The percentage difference in the ask and bid yield, part of transaction cost, the profit for the dealers

Front 20

Calculating Tbill Yields from Discount Rates

Back 20

i>tbill(discount yield) = (face value - purchase price)/Face value x 360/(number of days until t-bill matures)

Front 21

Another Federal Funds Definition

Back 21

Short term funds transferred between FI's, usually for a period of one day

Front 22

Federal Funds Rate

Back 22

-The interest rate for borrowing fed funds
-A focus or target rate in the conduct of monetary policy

Front 23

Federal Funds Yield

Back 23

-Single-payment loans - they pay interest only once, at maturity
-Fed fund transactions take the form of short term (mostly overnight) unsecured loans

Front 24

Trading in the Fed Funds Market

Back 24

-Commercial banks conduct the majority of transactions in the fed funds market
-Banks with excess reserves lend fed funds, while banks with deficient reserves borrow fed funds
-Fed funds transactions can be initiated by either the lending or borrowing institution or handled through a broker

Front 25

Repurchase Agreement Definition II: Attack of the Clones

Back 25

An agreement involving the sale of securities by one party to another with a promise to repurchase the securities at a specified price on a specified date

Front 26

"Essentially" Def. of Fed Fund

Back 26

A collateralized fed funds loan with collateral in the form of securities (e.g. T-bills and Fannie Mae securities)

Front 27

Reverse Repo Agreement

Back 27

involves the purchase of securities between parties with the promise to sell them back at a given date in the future

Front 28

Trading Process for Repurchase Agreements

Back 28

-Arranged either directly between two parties or with the help of brokers and dealers
-The repo buyer arranges to purchase T-bills from the repo seller with an agreement that the seller will repurchase the T-bills within a stated period of time

Front 29

Commercial Paper Another Definition

Back 29

An unsecured ST promissory note issued by a corporation to raise ST cash, often to finance working cap. requirements
-The largest (in terms of dollar value) of the money market instruements

Front 30

General Denominations of Commercial Paper

Back 30

Generally sold in denom.'s of $100,000, $250,000, and $1M with maturities of 1-270 days (if maturity is greater than 270 days then SEC requires registration)

Front 31

Secondary market of Commercial Paper

Back 31

Generally held until maturity so there is not an active secondary market

Front 32

Trading Process for Commercial Paper

Back 32

-CP's are sold either directly to investors (25%) or indirectly through brokers and dealers such as investment banks or major bank subsidiaries
-Selling through brokers is more expensive for issuer due to underwriting costs

Front 33

Negotiable Certificates of Deposit Definition Again

Back 33

A bank-isssued time deposit that specifies an interest rate and maturity date and is negotiable in the secondary market

Front 34

Neg. CD's are bearer instruments -- what does that mean?

Back 34

Whoever holds the CD when it matures receives the principal and interest

Front 35

Denominations of Neg. CD's

Back 35

Range form $100,000 to $10M, $1M being the most common

Front 36

Who often purchases Neg. CD's

Back 36

Often purchased by money market mutual funds with pools of funds from individual investors

Front 37

Trading Process for Negotiable CD's

Back 37

-Banks issung NCDs post daily rates for the more popular maturities and subject to funding needs, tries to sell to investors who are likely to hold them as investments rather than sell them to the secondary market
-In some cases, the bank and investor negotiate the size, rate, and maturity

Front 38

NCD Secondary Market

Back 38

Consists of a linked network of approximately 15 brokers and allows investors to buy existing CD's rather than new issues

Front 39

More info on Banker's Acceptances

Back 39

-A time draft payable to a seller of goods with payment guaranteed by a bank
-Arise form international trade transactions and are used to finance trade in goods that have yet to be shipped froma foreign exporter (seller) to a domestic importer (buyer)
--Foreign exporters prefer that banks act as guarantors for payment before sending goods to importer

Front 40

T Bills Principal Facts

Back 40

Issuer: US Treasury

Investor: FRS, Comm. Banks, Brokers and dealers, Other FIs, Coprorations

Front 41

Federal Funds Principal Facts

Back 41

Issuer: Commercial Banks

Investors: Commercial Banks

Front 42

Repurchase Agreements Principal Facts

Back 42

Issuer: FRS, Commercial Banks, Brokers and dealers, Other FI's

Investors: FRS, Commercial Banks, Brokers and Dealers, Other FI's, corps

Front 43

Commercial Paper Principal Facts

Back 43

Issuer: Commercial Banks, Other FI's, Corporations

Investor: Brokers and Dealers, corporations

Front 44

Negotiable CD's Principal Facts

Back 44

Issuer: Commercial Banks

Investor: Brokers and dealers, corporations, other FI's

Front 45

Banker's Acceptances

Back 45

Issuer: Commercial Banks

Investors: Commercial Banks, corporations, brokers and dealers

Front 46

Bonds Definition

Back 46

A promise to make periodic coupon payments and to repay principal at maturity; breech of this promise is an event of default

Front 47

Maturities of bonds and their market classification

Back 47

Carry original maturities of greater than one year so bonds are instruments of the capital markets

Front 48

Issuers of Bonds

Back 48

Corporations and Government units

Front 49

Five Characteristic of Treasury notes and Bonds

Back 49

1. T-notes and T-bonds issued by the US Treasury to finance the national debt and toehr federal government expenditures
2. Backed by the full faith and credit of the US government and are default risk free
3. Pay relatively low rates of interest (yields to maturity)
4. Given their longer maturity, not entirely risk free due to interest rate fluctuations
5. Pay coupon interest (semi annually)

Front 50

Treasury Strips (4 characteristics)

Back 50

1. Treasury security in which the individual interest payments are separated from the principal payment
2. Effectively creates sets of securities -- one for each semiannual interest payment and one for the final principal payment
3. Often referred to as "treasury zero coupon bonds"
4. Created by the US treasury in response to seperate trading of treasury security principal and interest developed by securities firms; only available through FI's and government securities brokers

Front 51

Primary Market in Treasury Notes and Bonds

Back 51

Similar to the primary market T-bill sales, the Treasury sells T-notes and bonds through competitive and noncompetitive auctions

Front 52

Secondary Market in Treasury Notes and bonds

Back 52

-Most secondary market trading occurs directly through brokers and dealers
-WSJ shows full list of Treasury securities that trade daily

Front 53

Definition of Muni bonds

Back 53

Securities issued by state and local governments to fund either temporary imbalances between operating expenditures and receipts or to finance LT capital outlays for activities such as school construction, public utility construciton, or transport systems

Front 54

Source of repayment for munis

Back 54

Tax receipts or revenues generated

Front 55

Why are munis attractive and to whom

Back 55

Attractive to household investors b/c interest (but not cap gains) are tax exempt

Front 56

After tax (equivalent tax exempt) rate of return on a taxable bond

Back 56

After tax raate of return = before tax rate x (1-income tax rate of the marginal bond holder)

Front 57

Types of muni bonds

Back 57

1. General Obligation bonds
2. Revenue bonds

Front 58

General Obligation Bonds

Back 58

Bonds backed by the full faith and credit of the issuer

Front 59

Revenue Bonds

Back 59

Bonds sold to finance a specific revenue generating project and are backed by cash flows from that project

Front 60

Primary Market Placement Choices for Munis

Back 60

1. General Public Offering
2. Rule 144A Placement

Front 61

General Public Offering Munis

Back 61

-underwriter is selected either by negotiation or by competitive bidding
-the underwriter offers the bonds to the general public

Front 62

Rule 144A Placement Munis

Back 62

Bonds are sold on a semi-private basis to qualified investors (generally FI's)

Front 63

Contracting choices with the underwriter for munis

Back 63

1. Firm commitment underwriting
2. Best efforts underwriting

Front 64

Firm Commitment Underwriting

Back 64

The issuer of securities in which the investment bank guarantees the corp. a price for newly issued securities by buying the whole issue at a fixed price from the corporate issuer than seeks to resell to suppliers of funds (investors) at a higher price

Front 65

Best Efforts underwriting

Back 65

The issue of securities in which the underwriter does not guarantee a price to the issuer and acts more as a placing or distribution agent, bank acts as agent on a fee basis related to its success in placing the issue

Front 66

Secondary Market for munis

Back 66

Secondary market is thin (i.e. are relatively infrequent) due to a lack of information on bond issuers, who are generally much smaller than corporate bond issuers

Front 67

Corporate Bonds Definition

Back 67

All LT bonds issued by corporations

Front 68

Denominations of corp bonds

Back 68

Min. denom. publicly traded corp. bonds is $1,000

Front 69

Other (2) characteristics of Corporate bonds

Back 69

-Generally pay interest semi-annually
-Bind indenture: legal contract that specifies the rights and obligations of the bond issuer and the bond holder

Front 70

Types (4) of corporate bonds

Back 70

1. mortgage bonds
2. equipment trust certificates
3. debentures
4. subordinated debentures
5. convertible bonds
6. stock warrant
7. callable bonds
8. sinking fund bonds

Front 71

Mortgage bonds

Back 71

Issued to finance specific projects whcih are pledged collateral

Front 72

Equipment Trust Certificates

Back 72

bonds collateralized with tangible non-real estate property

Front 73

Debentures

Back 73

Backed solely by the general credit of the issuing firm and unsecured by specific assets or collateral

Front 74

Subordinated debentures

Back 74

unsecured debentures that are junior in their rights to mortgage bonds and regular debentures

Front 75

Convertible bonds

Back 75

may be exchanged for another security of the issuing firm at the discretion of the bond holder

Front 76

stock warrant

Back 76

give the bond holder an opportunity to purchase common stock at a specified price up to a specified date

Front 77

callable bonds

Back 77

allow the issuer to force the bond holder to sell the bond back to the issuer at a price above the par value (call price)

Front 78

Sinking Fund Bonds

Back 78

Bonds that include a requirement that the issuer retire a certain amount of the bond issue each year

Front 79

Primary Markets for corp bonds

Back 79

Primary sales of corp bonds occur through either a public sale (issue) or a private placement similar to muni bonds

Front 80

Secondary markets for corp bonds

Back 80

1. The exchange market (e.g. the NYSE)
2. The over the counter (OTC) market

-OTC electronic market dominates trading in corp bonds

Front 81

Bond ratings (4) characteristics
[Bond credit ratings on slides 19 and 20]

Back 81

1. Bonds are rated by the issuer's default risk
2. Large bond investors, traders and managers evaluate default risk by analyzing the issuer's financial ratios and security prices
3. Two major bond rating agencies are Moody's and Standard and Poor's (S&P)
4. Bonds Assigned A letter grade based on perceived probability of issuer default

Front 82

Bond Market Indexes

Back 82

-Managed by major investment banks
-Reflect both the monthly capital gain and loss on bonds plus any interest (coupon) income earned
-Changes in values of the broad market indexes can be used by bond traders to evaluate changes in the investment attractiveness of bonds of different types and maturities

Front 83

Bond Market Participants

Back 83

-The major issuers of debt market securities are federal, state, and local governments and corporations
-The major purchasers of capital market securities are households, businesses, government units and foreign investors
-Businesses and financial firms (e.g. banks, insurance companies, mutual funds) are the major suppliers of funds for all three types of bonds