Tài chính doanh nghiệp - Chapter 6: Money markets

Chapter 6Money MarketsFinancial Markets and Institutions, 7e, Jeff MaduraCopyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.1Chapter OutlineMoney market securitiesInstitutional use of money marketsValuation of money market securitiesRisk of money market securitiesInteraction among money market yieldsGlobalization of money markets2Money Market SecuritiesMoney market securities:Have maturities within one yearAre issued by corporations and governments to obtain short-term fundsAre commonly purchased by corporations and government agencies that have funds available for a short-term periodProvide liquidity to investors3Money Market Securities (cont’d)Treasury bills:Are issued by the U.S. TreasuryAre sold weekly through an auctionHave a par value of $1,000Are attractive to investors because they are backed by the federal government and are free of default riskAre liquidCan be sold in the secondary market through government security dealers4Money Market Securities (cont’d)Treasury bills (cont’d)Investors in Treasury billsDepository institutions because T-bills can be easily liquidatedOther financial institutions in case cash outflows exceed cash inflowsIndividuals with substantial savings for liquidity purposesCorporations to have easy access to funding for unanticipated expenses5Money Market Securities (cont’d)Treasury bills (cont’d)Pricing Treasury billsThe price is dependent on the investor’s required rate of return:Treasury bills do not pay interestTo price a T-bill with a maturity less than one year, the annualized return can be reduced by the fraction of the year in which funds would be invested6Computing the Price of a Treasury Bill A one-year Treasury bill has a par value of $10,000. Investors require a return of 8 percent on the T-bill. What is the price investors would be willing to pay for this T-bill?7Money Market Securities (cont’d)Treasury bills (cont’d)Treasury bill auctionInvestors submit bids on T-bill applications for the maturity of their choiceApplications can be obtained from a Federal Reserve district or branch bankFinancial institutions can submit their bids using the Treasury Automated Auction Processing System (TAAPS-Link)Institutions must set up an account with the TreasuryPayments to the Treasury are withdrawn electronically from the accountPayments received from the Treasury are deposited into the account8Money Market Securities (cont’d)Treasury bills (cont’d)Treasury bill auction (cont’d)Weekly auctions include 13-week and 26-week T-bills4-week T-bills are offered when the Treasury anticipates a short-term cash deficiencyCash management bills are also occasionally offeredInvestors can submit competitive or noncompetitive bidsThe bids of noncompetitive bidders are acceptedThe highest competitive bids are acceptedAny bids below the cutoff are not acceptedSince 1998, the lowest competitive bid is the price applied to all competitive and noncompetitive bids9Money Market Securities (cont’d)Treasury bills (cont’d)Estimating the yieldT-bills are sold at a discount from par valueThe yield is influenced by the difference between the selling price and the purchase priceIf a newly-issued T-bill is purchased and held until maturity, the yield is based on the difference between par value and the purchase price10Money Market Securities (cont’d)Treasury bills (cont’d)Estimating the yield (cont’d)The annualized yield is:Estimating the T-bill discountThe discount represents the percent discount of the purchase price from par value for newly-issued T-bills:11Computing the Yield of a Treasury Bill An investor purchases a 91-day T-bill for $9,782. If the T-bill is held to maturity, what is the yield the investor would earn?12Estimating the T-Bill DiscountUsing the information from the previous example, what is the T-bill discount?13Money Market Securities (cont’d)Commercial paper:Is a short-term debt instrument issued by well-known, creditworthy firmsIs typically unsecuredIs issued to provide liquidity to finance a firm’s investment in inventory and accounts receivableIs an alternative to short-term bank loansHas a minimum denomination of $100,000Has a typical maturity between 20 and 270 daysIs issued by financial institutions such as finance companies and bank holding companiesHas no active secondary marketIs typically not purchased directly by individual investors14Money Market Securities (cont’d)Commercial paper (cont’d)RatingsThe risk of default depends on the issuer’s financial condition and cash flowCommercial paper rating serves as an indicator of the potential risk of defaultCorporations can more easily place commercial paper that is assigned a top-tier ratingJunk commercial paper is rated low or not rated at all15Money Market Securities (cont’d)Commercial paper (cont’d)Volume of commercial paper:Has increased substantially over timeIs commonly reduced during recessionary periodsPlacement Some firms place commercial paper directly with investorsMost firms rely on commercial paper dealers to sell itSome firms (such as finance companies) create in-house departments to place commercial paper16Money Market Securities (cont’d)Commercial paper (cont’d)Backing commercial paperIssuers typically maintain a backup line of creditAllows the company the right to borrow a specified maximum amount of funds over a specified period of timeInvolves a fee in the form of a direct percentage or in the form of required compensating balancesEstimating the yieldThe yield on commercial paper is slightly higher than on a T-billThe nominal return is the difference between the price paid and the par value17Estimating the Commercial Paper YieldAn investor purchases 120-day commercial paper with a par value of $300,000 for a price of $289,000. What is the annualized commercial paper yield?18Money Market Securities (cont’d)Commercial paper (cont’d)The commercial paper yield curve:Illustrates the yield offered on commercial paper at various maturitiesIs typically established for a maturity range from 0 to 90 daysIs important because it may influence the maturity that is used by firms that issue CPIs similar to the short-term range of the Treasury yield curveIs affected by short-term interest rate expectationsIs similar to the yield curve on other money market instruments19Money Market Securities (cont’d)Negotiable certificates of deposit (NCDs):Are issued by large commercial banks and other depository institutions as a short-term source of fundsHave a minimum denomination of $100,000Are often purchased by nonfinancial corporationsAre sometimes purchased by money market fundsHave a typical maturity between two weeks and one yearHave a secondary market20Money Market Securities (cont’d)Negotiable certificates of deposit (NCDs) (cont’d)PlacementDirectlyThrough a correspondent institution Through securities dealersPremiumNCDs offer a premium above the T-bill yield to compensate for less liquidity and safetyPremiums are generally higher during recessionary periods21Money Market Securities (cont’d)Negotiable certificates of deposit (NCDs) (cont’d)YieldNCDs provide a return in the form of interest and the difference between the price at which the NCD was redeemed or sold and the purchase priceIf investors purchase a NCD and hold it until maturity, their annualized yield is the interest rate22Money Market Securities (cont’d)Repurchase agreementsOne party sells securities to another with an agreement to repurchase them at a specified date and priceEssentially a loan backed by securitiesA reverse repo refers to the purchase of securities by one party from another with an agreement to sell themBank, S&Ls, and money market funds often participate in reposTransactions amounts are usually for $10 million or moreCommon maturities are from 1 day to 15 days and for one, three, and six monthsThere is no secondary market for repos23Money Market Securities (cont’d)Repurchase agreements (cont’d)PlacementRepo transactions are negotiated through a telecommunications network with dealers and repo brokersWhen a borrowing firm can find a counterparty to a repo transaction, it avoids the transaction feeSome companies use in-house departmentsEstimating the yieldThe repo yield is determined by the difference between the initial selling price and the repurchase price, annualized with a 360-day year24Estimating the Repo YieldAn investor initially purchased securities at a price of $9,913,314, with an agreement to sell them back at a price of $10,000,000 at the end of a 90-day period. What is the repo rate?25Money Market Securities (cont’d)Federal fundsThe federal funds market allows depository institutions to lend or borrow short-term funds from each other at the federal funds rateThe rate is influenced by the supply and demand for funds in the federal funds marketThe Fed adjusts the amount of funds in depository institutions to influence the rateAll firms monitor the fed funds rate because the Fed manipulates it to affect economic conditionsThe fed funds rate is typically slightly higher than the T-bill rate26Money Market Securities (cont’d)Federal funds (cont’d)Two depository institutions communicate directly through a communications network or through a federal funds brokerThe lending institution instructs its Fed district bank to debit its reserve account and to credit the borrowing institution’s reserve account by the amount of the loanCommercial banks are the most active participants in the federal funds marketMost loan transactions are or $5 million or more and usually have one- to seven-day maturities27Money Market Securities (cont’d)Banker’s acceptances:Indicate that a bank accepts responsibility for a future paymentsAre commonly used for international trade transactionsAn unknown importer’s bank may serve as the guarantorExporters frequently sell an acceptance before the payment dateHave a return equal to the difference between the discounted price paid and the amount to be received in the futureHave an active secondary market facilitated by dealers28Money Market Securities (cont’d)Banker’s acceptances (cont’d)Steps involved in banker’s acceptancesFirst, the U.S. importer places a purchase order for goodsThe importer asks its bank to issue a letter of credit (L/C) on its behalfRepresents a commitment by that bank to back the payment owed to the foreign exporterThe L/C is presented to the exporter’s bankThe exporter sends the goods to the importer and the shipping documents to its bankThe shipping documents are passed along to the importer’s bank29Sequence of Steps in the Creation of A Banker’s AcceptanceImporterExporterAmerican Bank(Importer’s Bank)Japanese Bank(Exporter’s Bank)1Purchase Order5Shipment of Goods2L/C Application3L/C7Shipping Documents& Time Draft Accepted4L/C Notification6Shipping Documents & Time Draft30Institutional Use of Money MarketsFinancial institutions purchase money market securities to earn a return and maintain adequate liquidityInstitutions issue money market securities when experiencing a temporary shortage of cashMoney market securities enhance liquidity:Newly-issued securities generate cashInstitutions that previously purchased securities will generate cash upon liquidationMost institutions hold either securities that have very active secondary markets or securities with short-term maturities31Institutional Use of Money Markets (cont’d)Financial institutions with uncertain cash in- and outflows maintain additional money market securitiesInstitutions that purchase securities act as a creditor to the initial issuerSome institutions issue their own money market instruments to obtain cashMany money market transaction involve two financial institutions32Valuation of Money Market SecuritiesFor money market securities making no interest payments, the value reflects the present value of a future lump-sum paymentThe discount rate is the required rate of return by investors33Valuation of Money Market Securities (cont’d)Explaining money market price movementsThe price of a noninterest-paying money market security is:A change in the price can be modeled as:34Valuation of Money Market Securities (cont’d)Explaining money market price movements (cont’d)Impact of September 11The weak economy combined with this event caused investors to transfer funds into money market securitiesThe additional demand placed upward pressure on their price and downward pressure on their yieldsThe Fed added liquidity to the banking system and reduced the federal funds rate35Valuation of Money Market Securities (cont’d)Indicators of future money market security pricesEconomic growth is monitored since it signals changes in short-term interest rates and the required return from investing in money market securitiesEmploymentGDPRetail salesIndustrial productionConsumer confidenceIndicators of inflation36Risk of Money Market SecuritiesBecause of the short maturity, money market securities are generally not subject to interest rate risk, but they are subject to default riskInvestors commonly invest in securities that offer a slightly higher yield than T-bills and are very unlikely to defaultAlthough investors can assess economic and firm-specific conditions to determine credit risk, information about the issuer’s financial condition is limitedMeasuring riskMoney market participants can use sensitivity analysis to determine how the value of money market securities may change in response to a change in interest rates37Interaction Among Money Market YieldsMoney market instruments are substitutes for each otherMarket forces will correct disparities in yield and the yields among securities tend to be similarIn periods of heightened uncertainty, investors tend to shift from risky money market securities to TreasuriesFlight to qualityCreates a greater differential between yields38Globalization of Money MarketsInterest rate differentials occur because geographic markets are somewhat segmentedInterest rates have become more highly correlated:Conversion to the euroThe flow of funds between countries has increased because of:Tax differencesSpeculation on exchange rate movementsA reduction in government barriersEurodollar deposits, Euronotes, and Euro-commercial paper are widely traded in international money markets39Globalization of Money Markets (cont’d)Eurodollar deposits and EuronotesEurodollar certificates of deposit are U.S. dollar deposits in non-U.S. banksHave increased because of increasing international trade and historical U.S. interest rate ceilingsIn the Eurodollar market, banks channel deposited funds to other firms that need to borrow them in the form of Eurodollar loansTypical transactions are $1 million or moreEurodollar CDs are not subject to reserve requirementsInterest rates are attractive for both depositors and borrowersRates offered on Eurodollar deposits are slightly higher than NCD rates40Globalization of Money Markets (cont’d)Eurodollar deposits and Euronotes (cont’d)Investors in fixed-rate Eurodollar CDs are adversely affected by rising market ratesIssuers of fixed-rate Eurodollar CDs are adversely affected by declining ratesEurodollar-floating-rate CDs (FRCDs) periodically adjust to LIBORThe Eurocurrency market is made up of Eurobanks that accept large deposits and provide large loans in foreign currenciesLoans in the Eurocredit market have longer maturities than loans in the Eurocurrency marketShort-term Euronotes are issued in bearer form with maturities of one, three, and six months41Globalization of Money Markets (cont’d)Euro-commercial paper (Euro-CP):Is issued without the backing of a banking syndicateHas maturities tailored to satisfy investorsHas a secondary market run by CP dealersHas a rate 50 to 100 basis points above LIBORIs sold by dealers at a transaction cost between 5 and 10 basis points of the face value42Globalization of Money Markets (cont’d)Performance of foreign money market securitiesMeasured by the effective yield (adjusted for the exchange rateDepends on:The yield earned on the money market security in the foreign currencyThe exchange rate effect43Computing the Effective YieldA U.S. investor buys euros for $1.15 and invests in a one-year European security with a yield of 8 percent. After one year, the investor converts the proceeds from the investment back to dollars at the spot rate of $1.16 per euro. What is the effective yield earned by the investor?44