Asset classes and financial instruments - The money market

Question

What are treasury bills (T-bills)?

Answer 1

T-bills represent the simplest form of borrowing: The government raises money by selling bills to the public. Investors buy the bills at a discount from the stated maturity value. At the bill’s maturity, the holder receives from the government a payment equal to the face value of the bill. The difference between the purchase price and ultimate maturity value constitutes the investor’s earnings.
T-bills are issued with initial maturities of 4, 13, 26, or 52 weeks. T-bills are highly liquid.

Answer 2

The bid price is the slightly lower price you would receive if you wanted to sell a bill to a dealer.

Answer 3

This is because prices and yields are inversely related.

Answer 4

This means that the bill’s discount from its maturity or face value is “annualized” based on a 360-day year, and then reported as a percentage of face value.
It is flawed for at least two reasons. First, it assumes that the year has only 360 days. Second, it computes the yield as a fraction of par value rather than of the price the investor paid to acquire the bill

Answer 5

The T-bill return over a year. This is under the column asked yield.

Answer 6

A certificate of deposit, or CD, is a time deposit with a bank. Time deposits may not be withdrawn on demand. The bank pays interest and principal to the depositor only at the end of the fixed term of the CD.

Answer 7

Large, well-known companies often issue their own short-term unsecured debt notes rather than borrow directly from banks. Very often, commercial paper is backed by a bank line of credit, which gives the borrower access to cash that can be used (if needed) to pay off the paper at maturity. Commercial paper maturities range up to 270 days.

Answer 8

A banker’s acceptance starts as an order to a bank by a bank’s customer to pay a sum of money at a future date, typically within 6 months. At this stage, it is similar to a postdated check. When the bank endorses the order for payment as “accepted,” it assumes respon- sibility for ultimate payment to the holder of the acceptance. At this point, the acceptance may be traded in secondary markets like any other claim on the bank.

Answer 9

A Eurodollar CD resembles a domestic bank CD except that it is the liability of a non-U.S. branch of a bank, typically a London branch. The advantage of Eurodollar CDs over Eurodollar time deposits is that the holder can sell the asset to realize its cash value before maturity. Eurodollar CDs are considered less liquid and riskier than domestic CDs, however, and thus offer higher yields.

Answer 10

They are dollar denominated bonds outside the U.S., although bonds are not a money market investment because of their long maturities.

Answer 11

The dealer sells government securi- ties to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. The increase in the price is the overnight interest. The dealer thus takes out a 1-day loan from the investor, and the securities serve as collateral. Repos are considered very safe in terms of credit risk because the loans are backed by the government securities.

Answer 12

In the federal funds market, banks with excess funds lend to those with a shortage. These loans, which are usually overnight transactions, are arranged at a rate of interest called the federal funds rate. The fed funds rate is simply the rate of interest on very short-term loans among financial institutions. While most investors cannot participate in this market, the fed funds rate commands great interest as a key barometer of mon- etary policy.

Answer 13

Individuals who buy stocks on margin borrow part of the funds to pay for the stocks from their broker. The broker in turn may borrow the funds from a bank, agreeing to repay the bank immediately (on call) if the bank requests it. The rate paid on such loans is usually about 1% higher than the rate on short-term T-bills.

Answer 14

The London Interbank Offered Rate (LIBOR) is the rate at which large banks in London are willing to lend money among themselves. This rate, which is quoted on dollar- denominated loans, has become the premier short-term interest rate quoted in the European money market, and it serves as a reference rate for a wide range of transactions.

Answer 15

A term repo is essentially an identical transaction, except that the term of the implicit loan can be 30 days or more. A reverse repo is the mirror image of a repo. Here, the dealer finds an investor holding government securities and buys them, agreeing to sell them back at a specified higher price on a future date.

Answer 16

1. Treasury Bills
2. Certificate of deposit
3. Commercial paper (unsecured, like bank credit)
4. Bankers acceptance (postdated check)
5. Eurodollars
6. Repurchase agreements
7. Federal funds
8. LIBOR

Answer 17

1. Treasury notes & bonds
2. TIPS
3. Federal agency debt
4. International bonds
5. Municipal bonds
6. Corporate bonds (secured, unsecured debentures & senior/subordinated)
7. Mortgages & MBS

Answer 18

Capital markets (assets with >1 year maturity)
1. Equity
2. Bonds

Asset classes and financial instruments - The money market

18 important questions on Asset classes and financial instruments - The money market

What are treasury bills (T-bills)?

What is the bi price?

Why is the bid yield higher than the ask yield?

What is the bank discount method and why is it flawed?

What is the treasury bill's bond equivalent yield?

What is a certificate of deposit?

What is commercial paper?

What is a bankers acceptance?

What are Eurodollar CD's?

What are Eurodollar bonds?

What is a repurchase agreement?

What is the federal funds rate?

What is a broker's call?

What is the London Interbank Offered Rate (LIBOR)?

What is a term repo and reverse repo?

Name three financial products traded in money markets

Name (at least) three financial products traded in bond markets

Name (at least) three financial products traded in capital markets

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Asset classes and financial instruments - The money market

18 important questions on Asset classes and financial instruments - The money market

What are treasury bills (T-bills)?

What is the bi price?

Why is the bid yield higher than the ask yield?

What is the bank discount method and why is it flawed?

What is the treasury bill's bond equivalent yield?

What is a certificate of deposit?

What is commercial paper?

What is a bankers acceptance?

What are Eurodollar CD's?

What are Eurodollar bonds?

What is a repurchase agreement?

What is the federal funds rate?

What is a broker's call?

What is the London Interbank Offered Rate (LIBOR)?

What is a term repo and reverse repo?

Name three financial products traded in money markets

Name (at least) three financial products traded in bond markets

Name (at least) three financial products traded in capital markets

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