The money market is a component of the financial markets for assets involved in short-term borrowing and lending with

original maturities of one year or shorter time frames. Trading in the money markets involvesTreasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and assetbacked securities.[1] It provides liquidity funding for the global financial system. Contents [hide]

1 Overview 2 Common money market instruments 3 See also 4 References 5 External links [edit]Overview The money market consists of financial institutions and dealers in money or credit who wish to either borrow or lend. Participants borrow and lend for short periods of time, typically up to thirteen months. Money market trades in short-term financial instruments commonly called "paper." This contrasts with the capital market for longer-term funding, which is supplied by bonds and equity. The core of the money market consists of interbank lending--banks borrowing and lending to each other using commercial paper, repurchase agreements and similar instruments. These instruments are often benchmarked to (i.e. priced by reference to) the London Interbank Offered Rate (LIBOR) for the appropriate term and currency. Finance companies, such as GMAC, typically fund themselves by issuing large amounts of asset-backed commercial paper (ABCP) which is secured by the pledge of eligible assets into an ABCP conduit. Examples of eligible assets include auto loans, credit card receivables, residential/commercial mortgage loans, mortgage-backed securities and similar financial assets. Certain large corporations with strong credit ratings, such as General

Electric, issue commercial paper on their own credit. Other large corporations arrange for banks to issue commercial paper on their behalf via commercial paper lines. In the United States, federal, state and local governments all issue paper to meet funding needs. States and local governments issuemunicipal paper, while the US Treasury issues Treasury bills to fund the US public debt. Trading companies often purchase bankers' acceptances to be tendered for payment to overseas suppliers. Retail and institutional money market funds Banks Central banks Cash management programs Arbitrage ABCP conduits, which seek to buy higher yielding paper, while themselves selling cheaper paper. Merchant Banks [edit]Common money market instruments

Certificate of deposit - Time deposits, commonly offered to consumers by banks, thrift institutions, and credit unions. Repurchase agreements - Short-term loansnormally for less than two weeks and frequently for one dayarranged by selling securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. Commercial paper - Unsecured promissory notes with a fixed maturity of one to 270 days; usually sold at a discount from face value. Eurodollar deposit - Deposits made in U.S. dollars at a bank or bank branch located outside the United States. Federal agency short-term securities - (in the U.S.). Short-term securities issued by government sponsored enterprises such as the Farm Credit System, the Federal Home Loan Banks and the Federal National Mortgage Association. Federal funds - (in the U.S.). Interest-bearing deposits held by banks and other depository institutions at the Federal Reserve; these are

immediately available funds that institutions borrow or lend, usually on an overnight basis. They are lent for the federal funds rate. Municipal notes - (in the U.S.). Short-term notes issued by municipalities in anticipation of tax receipts or other revenues. Treasury bills - Short-term debt obligations of a national government that are issued to mature in three to twelve months. For the U.S., see Treasury bills. Money funds - Pooled short maturity, high quality investments which buy money market securities on behalf of retail or institutional investors. Foreign Exchange Swaps - Exchanging a set of currencies in spot date and the reversal of the exchange of currencies at a predetermined time in the future. Short-lived mortgage- and asset-backed securities [edit] Certificate of Deposit A Certificate of Deposit or CD is a time deposit, a financial product commonly offered to consumers by banks, thrift institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually risk-free; they are "money in the bank" (CDs are insured by the FDIC for banks or by the NCUA for credit unions). They are different from savings accounts in that the CD has a specific, fixed term (often three months, six months, or one to five years), and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. Fixed rates are common, but some institutions offer CDs with various forms of variable rates. For example, in mid-2004, interest rates were expected to rise, many banks and credit unions began to offer CDs with a "bump-up" feature. These allow for a single readjustment of the interest rate, at a time of the consumer's

choosing, during the term of the CD. Sometimes, CDs that are indexed to the stock market, the bond market, or other indices are introduced. A few general guidelines for interest rates are:

A larger principal should receive a higher interest rate, but may not. A longer term will usually receive a higher interest rate, except in the case of an inverted yield curve (i.e. preceding a recession) Smaller institutions tend to offer higher interest rates than larger ones. Personal CD accounts generally receive higher interest rates than business CD accounts. Banks and credit unions that are not insured by the FDIC or NCUA generally offer higher interest rates.

[edit]How CDs work CDs typically require a minimum deposit, and may offer higher rates for larger deposits. In the US, the best rates are generally offered on "Jumbo CDs" with minimum deposits of $100,000. However there are also institutions that do the opposite and offer lower rates for their "Jumbo CDs". The consumer who opens a CD may receive a passbook or paper certificate. It is now common for a CD to consist simply of a book entry and an item shown in the consumer's periodic bank statements; that is, there is usually no "certificate" as such. [edit]Closing a CD Withdrawals before maturity are usually subject to a substantial penalty. For a five-year CD, this is often the loss of six months' interest. These penalties ensure that it is generally not in a holder's best interest to withdraw the money before maturityunless the holder has another investment with significantly higher return or has a serious need for the money.Banks will charge a penalty fee if the money is withdrawn from the CD before it matures. Commonly, institutions mail a notice to the CD holder shortly before the CD matures requesting directions. The notice usually offers the choice of withdrawing the principal and accumulated interest or "rolling it over" (depositing it into a new CD). Generally, a "window" is allowed after maturity where the CD holder can cash in the CD without penalty. In the absence of such directions, it is common for the institution to roll over the CD automatically, once again tying up the money for a period of time (though the CD holder may be able to specify at the time the CD is opened not to roll over the CD).

[edit]CD refinance In the U.S. insured CDs are required by the Truth in Savings Regulation DD to state at the time of account opening the penalty for early withdrawal. These penalties cannot be revised by the depository prior to maturity.[citation needed] The penalty for early withdrawal is the deterrent to allowing depositors to take advantage of subsequent enhanced investment opportunities during the term of the CD. In rising interest rate environments the penalty may be insufficient to discourage depositors from redeeming their deposit and reinvesting the proceeds after paying the applicable early withdrawal penalty. The added interest from the new higher yielding CD may more than offset the cost of the early withdrawal penalty. [edit]Ladders While longer investment terms yield higher interest rates, longer terms also may result in a loss of opportunity to lock in higher interest rates in a rising-rate economy. A common mitigation strategy for this opportunity cost is the "CD ladder" strategy. In the ladder strategies, the investor distributes the deposits over a period of several years with the goal of having all one's money deposited at the longest term (and therefore the higher rate), but in a way that part of it matures annually. In this way, the depositor reaps the benefits of the longest-term rates while retaining the option to re-invest or withdraw the money in shorter-term intervals. For example, an investor beginning a three-year ladder strategy would start by depositing equal amounts of money each into a 3-year CD, 2-year CD, and 1-year CD. From this point on, a CD will reach maturity every year, at which time the investor would re-invest at a 3-year term. After two years of this cycle, the investor would have all money deposited at a three-year rate, yet have one-third of the deposits mature every year (which can then be reinvested, augmented, or withdrawn). The responsibility for maintaining the ladder falls on the depositor, not the financial institution. Because the ladder does not depend on the financial institution, depositors are free to distribute a ladder strategy across more than one bank, which can be advantageous as smaller banks may not offer the longer terms found at some larger banks. Although laddering is most common with CDs, this strategy may be employed on any time deposit account with similar terms. [edit]Deposit insurance In the US, the amount of insurance coverage varies depending on how accounts for an individual or family are structured at the institution. The level of insurance is governed

by complex FDIC and NCUA rules, available in FDIC and NCUA booklets or online. The standard insurance coverage is currently $250,000 per owner or depositor for single accounts or $250,000 per co-owner for joint accounts. Some institutions use a private insurance company instead of, or in addition to, the Federally backed FDIC or NCUA deposit insurance. Institutions often stop using private supplemental insurance when they find that few customers have a high enough balance level to justify the additional cost. The Certificate of Deposit Account Registry Service program allows investors to keep up to $50 million invested in CDs managed through one bank with full FDIC insurance.[1] However rates will likely not be the highest available. [edit]Terms and conditions There are many variations in the terms and conditions for CDs. In the US, the federally required "Truth in Savings" booklet, or other disclosure document that gives the terms of the CD, must be made available before the purchase. Employees of the institution are generally not familiar with this information; only the written document carries legal weight. If the original issuing institution has merged with another institution, or if the CD is closed early by the purchaser, or there is some other issue, the purchaser will need to refer to the terms and conditions document to ensure that the withdrawal is processed following the original terms of the contract.

The CD may be callable. The terms may state that the bank or credit union can close the CD before the term ends. Payment of interest. Interest may be paid out as it is accrued or it may accumulate in the CD. Interest calculation. The CD may start earning interest from the date of deposit or from the start of the next month or quarter. Right to delay withdrawals. Institutions generally have the right to delay withdrawals for a specified period to stop a bank run. Withdrawal of principal. May be at the discretion of the financial institution. Withdrawal of principal below a certain minimumor any withdrawal of principal at allmay require closure of the entire CD. A US Individual Retirement Account CD may allow withdrawal of IRA Required Minimum Distributions without a withdrawal penalty.

Withdrawal of interest. May be limited to the most recent interest payment or allow for withdrawal of accumulated total interest since the CD was opened. Interest may be calculated to date of withdrawal or through the end of the last month or last quarter. Penalty for early withdrawal. May be measured in months of interest, may be calculated to be equal to the institution's current cost of replacing the money, or may use another formula. May or may not reduce the principalfor example, if principal is withdrawn three months after opening a CD with a six-month penalty. Fees. A fee may be specified for withdrawal or closure or for providing a certified check. Automatic renewal. The institution may or may not commit to sending a notice

before automatic rollover at CD maturity. The institution may specify a grace period before automatically rolling over the CD to a new CD at maturity. Be careful as some otherwise respectable banks have been known to renew at scandalously low rates.[2] [edit]Other similar products This section does not cite any references or sources. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged andremoved. (March 2009) This article has described the familiar FDIC-insured or NCUA-insured CDs which are usually purchased by consumers directly from banks or credit unions. There are also "certificates of deposit" issued by various entities that do not carry insurance. [edit]Callable CDs A callable CD is similar to a traditional CD, except that the bank reserves the right to "call" the investment. After the initial non-callable period, the bank can buy (call) back the CD. Callable CDs pay a premium interest rate. Banks manage their interest rate risk by selling callable CDs. On the call date, the banks determine if it is cheaper to replace the investment or leave it outstanding. This is similar torefinancing a mortgage. [edit]Brokered CDs Many brokerage firms known as "deposit brokers" offer CDs. These brokerage firms can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain number of deposits to the institution. Unlike traditional bank CDs, brokered CDs are sometimes held by a group of unrelated investors. Instead of owning the entire CD, each investor owns a piece. If several

investors own the CD, the deposit broker may not list each person's name in the title but the account records should reflect that the broker is merely acting as an agent (e.g., "XYZ Brokerage as Custodian for Customers"). This ensures that each portion of the CD qualifies for up to $100,000 of FDIC coverage. In some cases, the deposit broker may advertise that the CD does not have a prepayment penalty for early withdrawal. In those cases, the deposit broker will instead try to resell the CD if the investor wants to redeem it before maturity. If interest rates have fallen since the CD was purchased, and demand is high, he/she may be able to sell the CD for a profit. But if interest rates have risen, there may be less demand for such lower-yielding CD, which means that he/she may have to sell the CD at a discount and lose some of the investors original deposit. Deposit brokers do not have to go through any licensing or certification procedures, and no state or federal agency licenses, examines, or approves them. In the event of bank failure, FDIC insurance applies but may be more difficult to realize. Direct deposit CDs are often allowed to mature at the original rate by the acquiring bank, but brokered accounts usually stop paying interest immediately. Brokered depositors may not be timely notified. Further, the FDIC will pay claims on direct deposits within 710 days, brokered CD claims may take 3060 days. Additionally, the FDIC may require that brokered depositors prove they do not hold simultaneous direct and brokered deposits which exceed FDIC limits. [edit]Bump-up CDs A Bump Up CD allows the account holder the option to increase the interest rate once during the term of the CD. Upon request, the bank will bump up the interest rate on the certificate of deposit to a higher rate being offered by the issuing bank on that CD (or a comparable term CD). The rate change does not change the original maturity date of the CD. [edit]Liquid CDs This type of CD is generally a fixed rate certificate of deposit, which allows you to withdraw a portion of the original deposit during the term without paying a penalty. There will be some limits on when you can take the money out, the amount that can be withdrawn and how many separate withdrawals you can make from the CD.

[edit]Step-up CD or step-down CDs These can also be called a flex CD and can be confused with a Bump Up CD. Certificates of deposit with a step up or down feature have a fixed interest rate for a period of time, usually one year and then the interest rate automatically rises up to a predetermined rate or is lowered to a predetermined rate. [edit]Variable-rate CDs Unlike traditional CD's that pay a fixed rate of interest, a variable rate CD or index based CD is tied to the outcome of a market index. The interest you earn at maturity is based on the percentage gain (or loss) from the Initial Index to the final Index value. These certificates of deposit can be tied to a bond or stock index or a reference rate like the Treasury bills, Prime Rate or the Consumer Price Index. [edit]Add-on CDs These are fixed or variable rate CDs to which you can make additional deposits. There can be restrictions, such as a minimum deposit that can be made to the account., [edit]Zero-coupon CD These certificates of deposit are issued at a substantial discount from the face amount of the CD. Typically the maturity terms are much longer, 15 to 20 years, which results in the discounted price. Zero coupon CDs do not pay interest until the maturity date. [edit]Criticism CD interest rates closely track inflation.[3] For example, in one situation interest rates may be 15% and inflation may be 15%, and in another situation interest rates may be 2% and inflation may be 2%. Of course, these factors cancel out, so the real interest rate is the same in both cases. In this situation, it is a misinterpretation that the interest is an increase in value. However, to keep the same value the rate of withdrawal must be the same as the real rate of return, in this case, zero. People may also think that the higher-rate situation is "better," when the real rate of return is actually the same. Also, the above does not include taxes.[4] When taxes are considered, the higher-rate situation above is worse, with a lower (more negative) real return, although the beforetax real rates of return are identical. The after-inflation, after-tax return is what's important.

Ric Edelman writes, "You don't make any money in bank accounts (in real economic terms), simply because you're not supposed to.";[5] on the other hand, bank accounts and CDs are fine for holding cash for a short amount of time. However Mr. Edelman's opinions may apply only to "average" CD interest rates. In reality, some banks pay much lower than average rates while others pay much higher rates (differences of 100% are not unusual, e.g., 2.50% vs 5.00%).[6] In the United States, depositors can take advantage of the best FDIC-insured rates without increasing their risk.[7] Furthermore, a long-term CD might have a high nominal interest ratewith a relatively low real interest rate due to high inflation at the time of purchase (as indicated above); however inflation rates often change rapidly and the final real interest rate could be significantly higher than riskier investments.[8] Finally, Mr. Edelman's statement that "CD interest rates closely track inflation" is not necessarily true. For example, during a credit crunchbanks are in dire need of funds and CD interest rate increases may not track inflation.[9] A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price will be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan while the settlement date of the forward contract is the maturity date of the loan. Contents [hide]

1 Structure and terminology 2 Types of repo and related products o 2.1 Due bill/hold in-custody repo o 2.2 Tri-party repo o 2.3 Whole loan repo o 2.4 Equity repo o 2.5 Sell/buy backs and buy/sell backs

o o

2.6 Securities lending 2.7 Reverse Repo 3.1 United States Federal Reserve use of repos

3 Uses
o

4 Risks 5 History o 5.1 Market size 6 See also 7 Notes and references 8 External links

[edit] Structure and terminology A repo is economically similar to a secured loan, with the buyer (effectively the lender or investor) receiving securities as collateral to protect him against default by the seller. The party who initially sells the securities is effectively the borrower. Almost any security may be employed in a repo, though highly liquid securities are preferred as they are more easily disposed of in the event of a default and, more importantly, they can be easily obtained in the open market where the buyer has created a short position in the repo security by a reverse repo and market sale; by the same token, illiquid securities are discouraged. Treasury or Government bills, corporate and Treasury/Government bonds, and stocks may all be used as "collateral" in a repo transaction. Unlike a secured loan, however, legal title to the securities passes from the seller to the buyer. Coupons (interest payable to the owner of the securities) falling due while the repo buyer owns the securities) are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the legal ownership of the collateral rests with the buyer during the repo agreement. The agreement might instead provide that the buyer receives the coupon, with the cash payable on repurchase being adjusted to compensate, though this is more typical of sell/buybacks. Although the transaction is similar to a loan, and its economic effect is similar to a loan, the terminology differs from that applying to loans: the seller legally repurchases the securities from the buyer at the end of the loan term. However a key aspect of repos is that they are legally recognised as a single transaction (important in the event of counterparty insolvency) and not as a disposal and a repurchase for tax purposes. The following table summarizes the terminology: Repo Reverse repo

Borrower Lender Participant Seller Buyer Cash receiver Cash provider

Near leg Sells securities Buys securities Far leg Buys securities Sells securities

[edit] Types of repo and related products There are three types of repo maturities: overnight, term, and open repo. Overnight refers to a one-day maturity transaction. Term refers to a repo with a specified end date. Open simply has no end date. Although repos are typically short-term, it is not unusual to see repos with a maturity as long as two years. Repo transactions occur in three forms: specified delivery, tri-party, and held in custody. The third form is quite rare in developing markets primarily due to risks. The first form requires the delivery of a prespecified bond at the onset, and at maturity of the contractual period. Tri-party essentially is a basket form of transaction, and allows for a wider range of instruments in the basket or pool. Tri-party utilizes a tri-party clearing agent or bank and is a more efficient form of repo transaction. [edit] Due bill/hold in-custody repo In a due bill repo, the collateral pledged by the (cash) borrower is not actually delivered to the cash lender. Rather, it is placed in an internal account ("held in custody") by the borrower, for the lender, throughout the duration of the trade. This has become less common as the repo market has grown, particularly owing to the creation of centralized counterparties. Due to the high risk to the cash lender, these are generally only transacted with large, financially stable institutions. [edit] Tri-party repo The distinguishing feature of a tri-party repo is that a custodian bank or international clearing organization, the tri-party agent, acts as an intermediary between the two parties to the repo. The tri-party agent is responsible for the administration of the transaction including collateral allocation, marking to market, and substitution of collateral. In the US, the two principal tri-party agents are The Bank of New York Mellon and JP Morgan Chase. The size of the US tri-party repo market peaked in 2008 before the worst effects of the crisis at approximately $2.8 trillion and by mid 2010 was about $1.6 trillion. [1] As tri-party agents administer hundreds of billions of US$ of collateral, they have the scale to subscribe to multiple data feeds to maximise the universe of coverage. As part of a tri-party agreement the three parties to the agreement, the triparty agent, the repo buyer and the repo seller agree to a collateral management service agreement which includes an "eligible collateral profile". It is this "eligible collateral profile" that enables the repo buyer to define their risk appetite in respect of the collateral that they are prepared to hold against their cash. For example a more risk averse repo buyer may wish to only hold "on-the-run" government bonds as collateral. In the event of a liquidation event of the repo seller the collateral is highly liquid thus enabling the repo buyer to sell the collateral quickly. A less risk averse repo buyer may be prepared to take non investment grade bonds or equities as

collateral, these may be less liquid and may suffer a higher price volatility in the event of a repo seller default, making it more difficult for the repo buyer to sell the collateral and recover their cash. The tri-party agents are able to offer sophisticated collateral eligibility filters which allow the repo buyer to create these "eligible collateral profiles" which can systemically generate collateral pools which reflect the buyer's risk appetite.[2] Collateral eligibility criteria could include asset type, issuer, currency, domicile, credit rating, maturity, index, issue size, average daily traded volume, etc. Both the lender (repo buyer) and borrower (repo seller) of cash enter into these transactions to avoid the administrative burden of bi-lateral repos. In addition, because the collateral is being held by an agent, counterparty risk is reduced. A tri-party repo may be seen as the outgrowth of the due bill repo, in which the collateral is held by a neutral third party. [edit] Whole loan repo A whole loan repo is a form of repo where the transaction is collateralized by a loan or other form of obligation (e.g. mortgage receivables) rather than a security. [edit] Equity repo The underlying security for many repo transactions is in the form of government or corporate bonds. Equity repos are simply repos on equity securities such as common (or ordinary) shares. Some complications can arise because of greater complexity in the tax rules for dividends as opposed to coupons. [edit] Sell/buy backs and buy/sell backs A sell/buy back is the spot sale and a forward repurchase of a security. It is two distinct outright cash market trades, one for forward settlement. The forward price is set relative to the spot price to yield a market rate of return. The basic motivation of sell/buy backs is generally the same as for a classic repo, i.e. attempting to benefit from the lower financing rates generally available for collateralized as opposed to non-secured borrowing. The economics of the transaction are also similar with the interest on the cash borrowed through the sell/buy back being implicit in the difference between the sale price and the purchase price. There are a number of differences between the two structures. A repo is technically a single transaction whereas a sell/buy back is a pair of transactions (a sell and a buy). A sell/buy back does not require any special legal documentation while a repo generally requires a master agreement to be in place between the buyer and seller (typically the SIFMA/ICMA commissioned Global Master Repo Agreement (GMRA)). For this reason there is an associated increase in risk compared to repo. Should the counterparty default, the lack of agreement may lessen legal standing in retrieving collateral. Any coupon payment on the underlying security during the life of the sell/buy back will generally be passed back to the seller of the security by adjusting the cash paid at the termination of the sell/buy back. In a repo, the coupon will be passed on immediately to the seller of the security. A buy/sell back is the equivalent of a "reverse repo".

[edit] Securities lending In securities lending, the purpose is to temporarily obtain the security for other purposes, such as covering short positions or for use in complex financial structures. Securities are generally lent out for a fee and securities lending trades are governed by different types of legal agreements than repos. Repos have traditionally been used as a form of collateralized loan and have been treated as such for tax purposes. Modern Repo agreements, however, often allow the cash lender to sell the security provided as collateral and substitute an equivalent security at repurchase.[3] In this way the cash lender acts as a security borrower and the Repo agreement can be used to take a short position in the security very much like a security loan might be used.[4] [edit] Reverse Repo A reverse repo is simply the same repurchase agreement from the buyer's viewpoint, not the seller's. Hence, the seller executing the transaction would describe it as a "repo", while the buyer in the same transaction would describe it a "reverse repo". So "repo" and "reverse repo" are exactly the same kind of transaction, just described from opposite viewpoints. The term "reverse repo and sale" is commonly used to describe the creation of a short position in a debt instrument where the buyer in the repo transaction immediately sells the security provided by the seller on the open market. On the settlement date of the repo, the buyer acquires the relevant security on the open market and delivers it to the seller. In such a short transaction the seller is wagering that the relevant security will decline in value between the date of the repo and the settlement date. [edit] Uses For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral. Market liquidity for repos is good, and rates are competitive for investors. Money Funds are large buyers of Repurchase Agreements. For traders in trading firms, repos are used to finance long positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities. In addition to using repo as a funding vehicle, repo traders "make markets". These traders have been traditionally known as "matched-book repo traders". The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management.

[edit] United States Federal Reserve use of repos Repurchase agreements when transacted by the Federal Open Market Committee of the Federal Reserve in open market operations adds reserves to the banking system and then after a specified period of time withdraws them; reverse repos initially drain reserves and later add them back. This tool can also be used to stabilize interest rates, and the Federal Reserve has used it to adjust the Federal funds rate to match the target rate.[5] Under a repurchase agreement ("RP" or "repo"), the Federal Reserve (Fed) buys U.S. Treasury securities, U.S. agency securities, or mortgage-backed securitiesfrom a primary dealer who agrees to buy them back, typically within one to seven days; a reverse repo is the opposite. Thus the Fed describes these transactions from the counterparty's viewpoint rather than from their own viewpoint. If the Federal Reserve is one of the transacting parties, the RP is called a "system repo", but if they are trading on behalf of a customer (e.g. a foreign central bank) it is called a "customer repo". Until 2003 the Fed did not use the term "reverse repo"which it believed implied that it was borrowing money (counter to its charter)but used the term "matched sale" instead. [edit] Risks While classic repos are generally credit-risk mitigated instruments, there are residual credit risks. Though it is essentially a collateralized transaction, the seller may fail to repurchase the securities sold at the maturity date. In other words, the repo seller defaults on his obligation. Consequently, the buyer may keep the security, and liquidate the security in order to recover the cash lent. The security, however, may have lost value since the outset of the transaction as the security is subject to market movements. To mitigate this risk, repos often are over-collateralized as well as being subject to daily mark-to-market margining. Conversely, if the value of the security rises there is a credit risk for the borrower in that the creditor may not sell them back. If this is expected to happen then the borrower may negotiate a repo which is undercollateralized. [6] Credit risk associated with repo is subject to many factors: term of repo, liquidity of security, the strength of the counterparties involved, etc. Repo transactions came into focus within the financial press due to the technicalities of settlements following the collapse of Refco. Occasionally, a party involved in a repo transaction may not have a specific bond at the end of the repo contract. This may cause a string of failures from one party to the next, for as long as different parties have transacted for the same underlying instrument. The focus of the media attention centers on attempts to mitigate these failures. [edit] History In the US, Repos have been used from as early as 1917 when war time taxes made older forms of lending less attractive. At first Repos were used just by the Federal reserve to lend to other banks, but the practice soon spread to other market participants. The use of Repos expanded in

the 1920s, fell away through theGreat depression and WWII , then expanded once again in the 1950s, enjoying rapid growth in the 1970s and 1980s in part due to computer technology. [6] [edit] Market size The US Federal Reserve and the European Repo Council (a body of the International Capital Market Association) both try to estimate the size of their respective repo markets. At the end of 2004, the U.S. repo market reached US$5 trillion. The European repo market has experienced consistent growth over the past five years, from 1.9 billion in 2001 to 6.4 trillion by the end of 2006, and is expected to continue significant growth due to Basel II, according to a 2007 Celent report entitled The European Repo Market.[7] Especially in the US and to a lesser degree in Europe, the repo market contracted in 2008 as a result of the financial crisis. But by mid 2010 the market had largely recovered and at least in Europe had grown to exceed its pre-crisis peak. [1] Other countries including Chile, India, Japan, Mexico, Hungary, Russia, China, and Taiwan, have their own repo markets, though activity varies by country, and no global survey or report has been compiled. In the global money market, commercial paper is an unsecured promissory note with a fixed maturity of 1 to 270 days. Commercial Paper is a money-market security issued (sold) by large banks and corporations to get money to meet short term debt obligations (for example, payroll), and is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than bonds. Typically, the longer the maturity on a note, the higher theinterest rate the issuing institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates.[1] Contents [hide]

1 Overview 2 History 3 Issuance 4 Line of credit

5 Commercial Paper Yields 6 Defaults 7 See also 8 References 9 External links Overview

U.S. Commercial Paper types outstanding at end of each year 2001 to 2007

Total U.S. CP outstanding each week. Note the Federal reserve changes its methods of calculation As defined by American law, commercial paper is a financial instrument that matures before nine months (270 days), and is only used to fund operating expenses or current assets (e.g., inventoriesand receivables) and not used for financing fixed assets, such asland, buildings, or machinery.[2] By meeting these qualifications it may be issued without U.S. federal government regulation, that is, it need not be registered with the U.S. Securities and Exchange Commission.[3] Commercial paper is a type

of negotiable instrument, where the legal rights and obligations of involved parties are governed by Articles Three and Four of the Uniform Commercial Code, a set of nonfederal business laws adopted by all 50 U.S. States except Louisiana.[4] At the end of 2009, more than 1,700 companies in the United Statesissue commercial paper. As of 2008 October 31, the U.S. Federal Reserve reported seasonally adjusted figures for the end of 2007: there was $1.7807 trillion (short-scale, or 1,780,700,000,000) in total outstanding commercial paper; $801.3 billion was "asset backed"and $979.4 billion was not; $162.7 billion of the latter was issued by nonfinancial corporations, and $816.7 billion was issued by financial corporations.[5] History Commercial paper, in the form of promissory notes issued by corporations, have existed since at least the 19th century. For instance, Marcus Goldman, founder of Goldman Sachs, got his start trading commercial paper in New York in 1869. [6] Issuance There are two methods of issuing paper. The issuer can market the securities directly to a buy and hold investor such as most money market funds. Alternatively, it can sell the paper to a dealer, who then sells the paper in the market. The dealer market for commercial paper involves large securities firms and subsidiaries of bank holding companies. Most of these firms also are dealers in US Treasury securities. Direct issuers of commercial paper usually are financial companies that have frequent and sizable borrowing needs and find it more economical to sell paper without the use of an intermediary. In the United States, direct issuers save a dealer fee of approximately 5 basis points, or 0.05% annualized, which translates to $50,000 on every $100 million outstanding. This saving compensates for the cost of maintaining a permanent sales staff to market the paper. Dealer fees tend to be lower outside the United States. Line of credit Commercial paper is a lower cost alternative to a line of credit with a bank. Once a business becomes established, and builds a highcredit rating, it is often cheaper to draw on a commercial paper than on a bank line of credit. Nevertheless, many companies still maintain bank lines of credit as a "backup". Banks often charge fees for the amount of the line of the credit that does not have a balance. While these fees may seem like pure profit for banks, in some cases companies in serious trouble may not be able to repay

the loan resulting in a loss for the banks. Advantage of commercial paper:

High credit ratings fetch a lower cost of capital. Wide range of maturity provide more flexibility. It does not create any lien on asset of the company. Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

Its usage is limited to only blue chip companies. Issuances of Commercial Paper bring down the bank credit limits. A high degree of control is exercised on issue of Commercial Paper.

Stand-by credit may become necessary Commercial Paper Yields Like Treasury Bills, yields on commercial paper are quoted on a discount basisthe discount return to commercial paper holders is the annualized percentage difference between the price paid for the paper and the par value using a 360-day year. Specifically: icp(dy) = [(Pf - P0)/Pf] x (360/h) and when converted to a bond equivalent yield: icp(bey) = [(Pf - P0)/P0] x (365/h) Defaults Defaults on high quality commercial paper are rare, and cause concern when they occur.[7] Notable examples include:

On June 21, 1970, Penn Central defaulted on a debt of $77.1 million The Federal Reserve intervened and cut Penn Central's bond rating from BBB to Bb.[8] This placed a substantial burden on clients of the issuing dealer for Penn Centrals commercial paper, Goldman Sachs.

On January 31, 1997, Mercury Finance, a major automotive lender, defaulted on a debt of $17 million, rising to $315 million. Effects were small, partly because default occurred during a robust economy. [7]

On September 15, 2008, Lehman Brothers caused two money funds to break the buck, and led to Fed intervention in money market funds.

Treasury bills (or T-Bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity. Many regard Treasury bills as the least risky investment available to U.S. investors. Regular weekly T-Bills are commonly issued with maturity dates of 28 days (or 4 weeks, about a month), 91 days (or 13 weeks, about 3 months), 182 days (or 26 weeks, about 6 months), and 364 days (or 52 weeks, about 1 year). Treasury bills are sold by single-price auctionsheld weekly. Offering amounts for 13-week and 26-week bills are announced each Thursday for auction, usually at 11:30 a.m., on the following Monday and settlement, or issuance, on Thursday. Offering amounts for 4-week bills are announced on Monday for auction the next day, Tuesday, usually at 11:30 a.m., and issuance on Thursday. Offering amounts for 52-week bills are announced every fourth Thursday for auction the next Tuesday, usually at 11:30 am, and issuance on Thursday. Purchase orders at TreasuryDirect must be entered before 11:00 on the Monday of the auction. The minimum purchase, effective April 7, 2008, is $100. (This amount formerly had been $1,000.) Mature T-bills are also redeemed on each Thursday. Banks and financial institutions, especially primary dealers, are the largest purchasers of T-bills.

Like other securities, individual issues of T-bills are identified with a unique CUSIP number. The 13-week bill issued three months after a 26-week bill is considered a re-opening of the 26-week bill and is given the same CUSIP number. The 4-week bill issued two months after that and maturing on the same day is also considered a re-opening of the 26-week bill and shares the same CUSIP number. For example, the 26-week bill issued on March 22, 2007, and maturing on September 20, 2007, has the same CUSIP number (912795A27) as the 13-week bill issued on June 21, 2007, and maturing on September 20, 2007, and as the 4-week bill issued on August 23, 2007 that matures on September 20, 2007.

During periods when Treasury cash balances are particularly low, the Treasury may sell cash management bills (or CMBs). These are sold at a discount and by auction just like weekly Treasury bills. They differ in that they are irregular in

amount, term (often less than 21 days), and day of the week for auction, issuance, and maturity. When CMBs mature on the same day as a regular weekly bill, usually Thursday, they are said to be on-cycle. The CMB is considered another reopening of the bill and has the same CUSIP. When CMBs mature on any other day, they are off-cycle and have a different CUSIP number.

Treasury bills are quoted for purchase and sale in the secondary market on an annualized discount percentage, or basis. With the advent of TreasuryDirect, individuals can now purchase T-Bills online and have funds withdrawn from and deposited directly to their personal bank account and earn higher interest rates on their savings.

General calculation for the discount yield for Treasury bills is

[edit]Treasury note This is the modern usage of "Treasury Note" in the U.S., for the earlier meanings see Treasury Note (disambiguation). Treasury notes (or T-Notes) mature in one to ten years. They have a coupon payment every six months, and are commonly issued with maturities dates between 1 to 10 years, with denominations of $1,000. In the basic transaction, one buys a "$1,000" T-Note for say, $950, collects interest over 10 years of say, 3% per year, which comes to $30 yearly, and at the end of the 10 years cashes it in for $1000. So, $950 over the course of 10 years becomes $1300.

T-Notes and T-Bonds are quoted on the secondary market at percentage of par in thirty-seconds of a point (n/32 of a point, where n = 1,2,3,...). Thus, for example, a quote of 95:07 on a note indicates that it is trading at a discount: $952.19 (i.e., 95 + 7/32%) for a $1,000 bond. (Several different notations may be used for bond price quotes. The example of 95 and 7/32 points may be written as 95:07, or 95-07, or 95'07, or decimalized as 95.21875.) Other notation includes a +, which indicates 1/64 points and a third digit may be specified to represent 1/256 points. Examples include 95:07+ which equates to (95 + 7/32 + 1/64) and 95:073 which equates to (95 + 7/32 + 3/256). Notation such as 95:073+ is unusual and not typically used.

The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government bond market and is used to convey the market's take on longer-term macroeconomic expectations. [edit]Treasury bond "U.S. Bonds" redirects here. For the singer/performer, see Gary U.S. Bonds. Treasury bonds (T-Bonds, or the long bond) have the longest maturity, from twenty years to thirty years. They have a coupon paymentevery six months like T-Notes, and are commonly issued with maturity of thirty years. The secondary market is highly liquid, so the yield on the most recent T-Bond offering was commonly used as a proxy for long-term interest rates in general.[citation needed] This role has largely been taken over by the 10-year note, as the size and frequency of long-term bond issues declined significantly in the 1990s and early 2000s.[citation needed]

The U.S. Federal government suspended issuing the well-known 30-year Treasury bonds (often called long-bonds) for a four and a half year period starting October 31, 2001 and concluding February 2006.[6] As the U.S. government used its budget surpluses to pay down the Federal debt in the late 1990s,[7] the 10-year Treasury note began to replace the 30-year Treasury bond as the general, most-followed metric of the U.S. bond market. However, because of demand from pension funds and large, long-term institutional investors, along with a need to diversify the Treasury's liabilities - and also because the flatter yield curve meant that the opportunity cost of selling long-dated debt had dropped - the 30-year Treasury bond was re-introduced in February 2006 and is now issued quarterly.[8] This brought the U.S. in line withJapan and European governments issuing longer-dated maturities amid growing global demand from pension funds.[citation needed]

[edit]TIPS Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation. TIPS are currently offered in 5-year, 10-year and 30-year maturities.[9]

[edit]Top Foreign holders of U.S. Treasuries As of December 2010: Holder $US billion

1. China

1160.1

2. Japan

882.3

3 United Kingdom

272.1

4. Oil Exporters

211.9

5. Brazil

186.1

6. Carib Bnkng Ctrs

168.6

7. Taiwan

155.1

8. Russia

151.0

9. Hong Kong

134.2

10. Switzerland

107.0

11. Luxembourg

86.4

12. Canada

76.8

13. Singapore

72.9

14. Germany

60.5

Luxembourg holds with approximately 500,000 inhabitants $172,800 per capita of U.S. Treasury securities. In comparison, Germany holds only $747 per capita. Source: The United States Treasury[10] [edit]Created by the Financial Industry [edit]STRIPS Separate Trading of Registered Interest and Principal Securities (or STRIPS) are T-Notes, T-Bonds and TIPS whose interest and principal portions of the security have been separated, or "stripped"; these may then be sold separately (in units of $1000 face value) in the secondary market. The name derives from the days before computerization, when paper bonds were physically traded; traders would literally tear the interest coupons off of paper securities for separate resale.

The government does not directly issue STRIPS; they are formed by investment banks or brokerage firms, but the government does register STRIPS in its bookentry system. They cannot be bought through TreasuryDirect, but only through a broker. STRIPS are used by the Treasury and split into individual principal and interest payments, which get resold in the form of zero-coupon bonds. Because they then pay no interest, there is not any interest to re-invest, and so there is no reinvestment risk with STRIPS. edit]Nonmarketable securities [edit]Zero-Percent Certificate of Indebtedness The "Certificate of Indebtedness" is a Treasury security that does not earn any interest and has no fixed maturity. It can only be held in a TreasuryDirect account and bought or sold directly through the Treasury.

It is intended to be used as a source of funds for traditional Treasury security purchases. Purchases and redemptions can be made at any time.[citation needed] [edit]Government Account Series Government Account Series Treasuries are the principal form of intragovernmental debt holdings.[11] Surpluses from the Social Security Trust Fund are invested in this type of security.[citation needed] [edit]U.S. Savings Bonds Savings bonds were created to finance World War I, and were originally called Liberty Bonds. In 2002, the Treasury Department started changing the savings bond program by lowering interest rates and closing its marketing offices.[12] As of January 2011, Treasury stopped mailing paper bonds through payroll deduction programs in favor of individuals buying bonds online. Banks continue to sell paper bonds. [edit]Series EE Series EE bonds are issued at 50% of their face value (paper bonds only, bonds purchased online are sold at face value) and reach maturity 20 years from issuance though they continue to earn interest for a total of 30 years. Interest is added to the bond monthly and paid when the holder cashes the bond. For bonds issued before May 2005 the rate of interest is recomputed every six months at 90% of the average five-year Treasury yield for the preceding six months. Bonds issued in May 2005 or later pay a fixed interest rate for the life of the bond (0.6% in February 2011). At 0.6%, a $200 bond purchased for $100 would be worth less than $113 just before 20 years, but will be adjusted to $200 at 20 years (giving it an effective rate of 3.5%) then continue to earn the fixed rate for 10 more years. In the space of a decade, interest dropped from well over 5% to 0.7% for new bonds in 2009.[13] Interest is taxable at the federal level only. Investors can elect to defer taxation until the bond ceases to pay interest (30 years after issuance) or until it is redeemed. Series EE bonds are designed for individual investors, sold at a discount, and redeemed at an amount that includes the interest income. Hence,

while interest is calculated monthly, the interest on a Series EE bond is not paid until redemption. All Series I Savings Bonds and Series EE Savings Bonds issued in May 1997 or later increase in value monthly. All other Savings Bonds, including Series HH bonds issued after May 1997, pay interest on a six-month cycle. These bonds should be cashed near the beginning of their month of issue or of the month exactly six months later. [edit]Series HH Series HH bonds are sold at a discount and mature at face value. Unlike T-Bonds (Treasury Bonds) and agency issues, Series HH bonds are nonmarketable. They also pay interest semi-annually, as do most bonds. Issuance of Series HH bonds stopped as of August 31, 2004, but there are still many yet that have not matured.[14][15] [edit]Series I Series I bonds are issued at face value and have a variable yield based on inflation. The interest rate consists of two components: the first is a fixed rate which will remain constant over the life of the bond and the second is a variable rate reset every six months from the time the bond is purchased based on the current inflation rate. New rates go into effect on May 1 and November 1 of every year.[16] The fixed rate is determined by the Treasury Department; the variable component is based on the Consumer Price Index from a six month period ending one month prior to the reset time. Interest accrues monthly, in full, on the first day of the month (i.e., a Savings Bond will have the same value on July 1 as on July 31, but on August 1 its value will increase for the August interest accrual). Like EE bonds, I-bonds are issued to individuals with a limit of $5,000 per person (by Social Security number) per year.[17] A person may purchase the limit of both paper and electronic bonds for a total of $10,000 per year. Redeeming the bonds before five years will incur a penalty of three months of interest.[18] The fixed portion of the rate has varied from as much as 3.6% to 0% (0% in February 2011 while the inflation portion was 0.74% per year). During times of deflation (during part of 2009), the negative inflation portion can wipe out the return of the fixed portion, but the combined rate cannot go below 0% and the bond will not lose value.[19]

Besides being available for purchase at financial institutions and online, tax payers may purchase I-bonds using a portion of their 2010 tax refund via IRS Form 8888 Allocation of Refund. Bonds purchased using Form 8888 are issued as paper bonds and mailed to the address listed on the tax return. Tax payers may purchase bonds for themselves or other persons such as children or grandchildren. The remainder of the tax payer's refund may be received by direct deposit or check.