Chapter 5 - Money Markets

Question 1

Money Markets

Answer 1

refers to the global market place for short-term financial instruments that are highly liquid.

Have a maturity of one year or less

usually debt instruments

Question 2

Broker Dealer

Answer 2

an entity that trades securities for its own account or on behalf of its customers
Broker: when executing trades on behalf of a customer
Dealer: when executing trades for its own account

Question 3

Street Name (holding securities)

Answer 3

securities are held in the broker’s name on behalf of the broker’s account. Holding securities in the street name does not affect the rights of the actual owner. allows investors to stay anonymous

Question 4

Ask price

Answer 4

the price at which the dealer will sell a security

Question 5

bid price

Answer 5

the price at which the dealer with buy a security

Question 6

spread

Answer 6

difference between the ask and bid prices

this is the dealers profit

Question 7

Central Securities Depositories (CSDs)

Answer 7

companies that hold securities to enable book-entry transfer of securities

may provide trade matching along with clearing and settlement

E.g. Depository trust company

Question 8

Book-entry Security

Answer 8

Book-entry securities are investments such as stocks and bonds whose ownership is recorded electronically. Book-entry securities eliminate the need to issue paper certificates of ownership. Ownership of securities is never physically transferred when they are bought or sold; accounting entries are merely changed in the books of the commercial financial institutions where investors maintain accounts. (INVESTOPEDIA)

Question 9

Default/ Credit Risk

Answer 9

The likelihood that the payments owed to creditors will not be made under the original loan terms

higher yields are required on more risky instruments to compensate buyers for the risk

Default risk is asses by credit rating agencies Moody’s, S&P, Fitch

Question 10

Liquidity Risk

Answer 10

the likelihood that a security cannot be sold quickly without incurring a substantial loss in value.

primary determinants of liquidity are marketability and maturity

Question 11

Interest Rate Risk

Answer 11

involves the uncertainty associated with future interest rate levels

two components: reinvestment risk and price risk

Question 12

Reinvestment Risk

Answer 12

results from the potential for lower interest rates in the future. After IR drop the proceeds from maturing investments will be reinvested at a lower rate

Question 13

Price Risk

Answer 13

the potential for an increase in interest rates

refers to changes in interest rates having an adverse impact on the value of a security

Securities with longer maturities have increased price risk as their market values are more responsive to changes in IR

Question 14

FX Risk

Answer 14

Arises when investors purchase securities in other currencies. There is a risk that the return on the securities will be lower once the investment is converted back sometime in the future

Question 15

Commercial Paper (CP)

Answer 15

tradable promissory not that represents an unsecured obligation or debt to the issuer

maturity can be overnight to 270 days for publicly traded CP and 397 days for private placement

does not pay interest, instead it is issued at a discount and the facevalue is paid at maturity. thus yield is influenced by the difference between the purchase price and the face value

investment grade CP is highly liquid

Question 16

Asset Backed Commercial Paper (ABCP)

Answer 16

Secured against specific assets, usually short-term trade receivables from a single company or range of companies

issued through a sponsoring financial institution refereed to as a conduit, rather than the actual company

can be single seller seller (backed by assets of a single institution) or multi seller (backed by assets purchased from a number of issuers

advantage: secured
disadvantage: complex and hard to value, market is smaller and less liquid

Question 17

Bank Obligations

Answer 17

the way in which banks raise funds in the money markets

1) time deposits
2) banker’s acceptance
3) Repo Agreements

Question 18

Time Deposits

Answer 18

Savings accounts, CDs, Negotiable CDS

Question 19

Negotiable CD

Answer 19

large-value time deposits issued by banks and other financial institutions that are bought and sold on the open market.

usually traded in multiples of 100,000 or more

Question 20

Certificate of Deposit Account Registry Service (CDARS)

Answer 20

a private service that makes it possible to receive full FDIC insurance coverage on amounts up to $50 m by distributing the funds among CDs issued by a network of banks

Question 21

Eurodollars

Answer 21

US denominated deposits held in financial institutions outside the US

a way for non US banks and foreign branches of US banks to raise funds in the global money market

may be issued as negotiable eurodollar CDs or as time deposits

higher rate or returns than regular CDs due to limited regs

Question 22

Yankee CDs

Answer 22

USD denominated CDs sold by US branches of non-US Banks

usually sold through the NY branches and carry a min invest of 100k

higher rates of return than reg CDs

Question 23

Banker’s Acceptance (BA)

Answer 23

a time draft that is issued by a purchaser of goods to pay a supplier that has been accepted by the bank on which the draft is drawn. constitutes the bank’s unconditional promise to pay the draft at maturity

Question 24

Government Paper

Answer 24

National, State, and Local government agencies raise funds in the money market by issuing short-term promissory notes,

Question 25

Treasury Bills (T Bills)

Answer 25

money market instruments that are sold at a discount to their par value at maturity

auctions held and bids accepted starting with the highest bid (aka lowest yield) and going down to lowest price to sell entire issue. bidder is guaranteed the desired amount of T bills at the average price

Question 26

Floating Rate Notes (FRNS)

Answer 26

way to raise short term funds

typically have maturities as one year or longer

pay a regular coupon along with the promised return of their face value at maturity

rate if interest resets periodically based on LIBOR or EURibor

min and max coupon rates

Question 27

Repurchase Agreements (REPOs)

Answer 27

a bank or securities dealer sells government securities it owns to an investor and agrees to repurchase them at a later date at a slightly higher price

short term borrowing agreement

negotiated between two parties so maturity and yield can be tailored (however yield is generally determined by the market repo rates)

generally over collateralized

Question 28

Reverse REPO

Answer 28

when you buy a security with the promise to sell it back at a later date (the buyer in the repor agreement)

short term investing agreement

Question 29

Tri-Party Repo

Answer 29

when the collateral for a repo agreement is held by a broker dealer and funds are exchanged through that party

Question 30

Money market funds (MMF)

Answer 30

Commingled pools of money market securities

MMFs are typically held by financial institutions and investors purchase an ownership interest in the fund

Usually contain a dollar weighted average portfolio maturity of 60 days or less

More stable in times of interest rate volatility

Question 31

Net asset value (NAV)

Answer 31

A value the represents the price per share of a mutual fund or an exchange traded fund.

Calculated As The total value of all securities or assets in the fund less liabilities divided by the number of out standing shares

Question 32

Commercial book-entry system (CBES)

Answer 32

A multi tiered automated system for purchasing, holding, and transferring marketable securities

Operated by the us treasury

Question 33

Indirect holding

Answer 33

When an investor purchases securities through a broker, dealer or financial institution the securities are held on the book-entry system of that firm. This is called indirect holding

Question 34

Depository trust and clearing corporation (DTCC)

Answer 34

Owned by member financial institutions, is is a corporation that works through its subsidiaries, to provide clearing, settlement and information services for equities, corporate and municipal bonds etc

Operates on an at-cost basis