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CHAPTER 6

CHAPTER 6. Money Markets. CHAPTER 6 OVERVIEW. This chapter will: A. Provide a background on the most popular money market securities B. Explain how money markets are used by institutional investors C. Explain the valuation and risk of money market securities. A. Money Market Securities.

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CHAPTER 6

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  1. CHAPTER 6 Money Markets

  2. CHAPTER 6 OVERVIEW This chapter will: A. Provide a background on the most popular money market securities B. Explain how money markets are used by institutional investors C. Explain the valuation and risk of money market securities

  3. A. Money Market Securities • Debt securities with a maturity of one year or less.

  4. Exhibit 6.1 How Money Markets Facilitate the Flow of Funds

  5. A. Money Market Securities 1. Treasury Bills a. Issued on a weekly basis with 4-week, 13-week, and 26 week maturities; on a monthly basis with a 1-year maturity. b. Minimum par value: $1,000 c. Treasury Bill Auction

  6. Pricing Treasury Bill - present value of the future cash flows • If investors require a 7 % annualized return on a one-year T-bill with a $10,000 par value, what is the price they are willing to pay? • P=10,000/1.07=9,345.79

  7. Pricing Treasury Bill - present value of the future cash flows • If investors require a 6% annualized return on a 6-month T-bill, what is the price that they are willing to pay? • P=10,000/1.03=9,708.74

  8. Estimating the Yield • The annualized yield from investing in a T-bill equals • sp: selling price • pp: purchase price • N: number of days of the investment

  9. Estimating the Yield • An investor purchases a T-bill with 182-day maturity and $10,000 par value for $9,600. What is the yield if this T-bill is held to maturity?

  10. Estimating the Yield • An investor purchased a T-bill with 182-day maturity and $10,000 par value for $9,600. After 120 days the T-bill was sold at $9,820. What is the yield for the 120-day holding period?

  11. A. Money Market Securities 2. Commercial Paper- short-term debt instrument issued by firms. a. maturity: 1- 270 days. b. Estimating the Yield: sold at discount

  12. Estimating the Yield • If an investor purchases 30-day commercial paper with a par value of $1,000,000 for $990,000, what is the yield?

  13. A. Money Market Securities 3. Negotiable Certificates of Deposit (NCDs) - certificates issued by large commercial banks and other depository institutions a. maturity: 2 weeks – 1 year b. Yield

  14. Estimating the Yield • An investor purchased an NCD a year ago for $970,000. He redeems it today upon maturity and receives $1,000,000. He also receives interest of $40,000. what is his annualized yield on this investment?

  15. A. Money Market Securities 4. Repurchase Agreements repo vs. reverse repo 5. Federal Funds 6. Banker’s Acceptances stamping “Accepted” on a draft

  16. Exhibit 6.4 Summary of Commonly Issued Money Market Securities

  17. Exhibit 6.5 Institutional Use of Money Markets

  18. B. Valuation and Risk of Money Market Securities 1. Money Market Price Movements Market price should equal the present value of the future cash flows discounted at the required return which is composed of the short-term risk-free interest rate plus the risk premium

  19. B. Valuation and Risk of Money Market Securities 2. Efficiency of Money Market Securities a. in general, these markets are perceived to be efficient b. most are subject to large trading volumes

  20. B. Valuation and Risk of Money Market Securities 3. Risk of Money Market Securities a. Credit risk b. Interest rate risk

  21. C. Globalization of Money Markets 1. Eurodollar Deposits 2. Euro-Commercial Paper 3. LIBOR

  22. Summary • 1. The main money market securities. • 2. Financial institutions participation in money markets. • 3. The price of a money market securities represents the present value of future cash flows. • 4. Homework Assignment 4: problems 1,3,4,5,6,7,9.

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