Money Market Instruments

1. Money Market Instruments

2. Money Market Instruments • money market instruments are defined as debt instruments with a maturity of one year or less. Money Markets serve important functions: • Transfer Funds (savers to borrowers) • Serves as a pricing benchmark • Facilitates monetary policy by allowing the FRB to control inflation by buying and selling money market instruments

3. Types of Instruments • Method of payment of interest • Interest bearing vs. Discount Instruments • Currency Denominations • US Dollar vs. Non-USD Instruments • Issuance Market • United States vs. the “Euro” Markets • Structure • Fixed-Rate vs. Floating-Rate • Nationality of Borrower • Domestic vs. Foreign

4. Interest-Bearing vs. Discount Instruments • Interest-Bearing • Referred to as Coupon Bearing • The investor pays face value and at maturity received face value plus interest. • Discount Instruments • Purchased at a discount from face value; upon maturity the investor receives full face value rather than interest.

5. Types of Interest-Bearing Instruments • Negotiable Certificates of Deposits (CDs) • Issued by banks to raise short-term money. • Negotiable CDs are issued as securities (versus CDs which are a form of deposit at retail banks). • No deposit insurance. • Typical maturity one to twelve months.

6. Types of Interest-Bearing Instruments • Three Types of CDs issued in USD: • Domestic CD: issued by a US bank in the US for local markets. • Foreign or Yankee CD: issued by a foreign bank in the US. • Eurodollar CD: issued by a large US or foreign bank in the “Euro” market (an off-shore market primarily located in London).

7. Types of Interest-Bearing Instruments • Floating-Rate CD: securities issued with a 3 to 5 year maturity have coupons that change (or float) based on a spread over a benchmarked reference rate.

8. Types of Interest-Bearing Instruments • Federal Funds Market • Controlled by the Federal Reserve. • Provides overnight liquidity solutions. • The Fed requires that all depositories keep “reserves” on-hand in their Federal Reserve account. • Non-Collateralized.

9. Types of Interest-Bearing Instruments • Repurchase Agreements • Institutions can also borrow/invest using repurchase argeements or in the repo market. • Typically overnight investments • Collateralized.

10. Types of Interest-Bearing Instruments • Interbank Markets • Bank-to-Bank borrowing. • Highly developed interbank market within the Euro market. • LIBOR: London Interbank Offered Rate • Unregulated Market (since it is off-shore).

11. Types of Discount Instruments • Treasury Bills • US government issues: • Three- and six-month T-Bills weekly • Twelve month T-Bills monthly • Three-month bill is known as the “risk-free” rate. • Issued through an auction processes: • Competitive bid (indicates price bidder is willing to pay). • Non-Competitive bid (indicates the average price bidders are willing to pay).

12. Types of Discount Instruments • Commercial Paper • Short-term debt instrument issued by corporations. • Issued on a discount basis in maturities ranging from one to 270 days. • Securities in this maturity range are exempt from SEC registration requirements. • Global CP markets.

13. Types of Discount Instruments • Bankers Acceptances • Form of short-term bank borrowing created by facilitating import/export transactions. • Bank provides a letter of credit to an exporter • LC guarantees payment at the end of a set periods for goods that they have exported. • Bank sells this commitment in the money market (making it into a security) and creating a bankers acceptance.

14. Types of Discount Instruments LC LC Exporter Bank Importer LC guarantees payment to Exporter Bank assumes risk from Importer Goods received Payment Rec’d Payment Rec’d