Part IV

Financial Markets

Chapter Eight
The Money Markets

The Money Markets

Money Markets Defined
1. Money market securities are usually sold in large
denominations
2. They have low default risk
3. They mature in one year or less from their issue date

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Purpose of Money Markets

Investors in Money Market: Provides a place for
warehousing surplus funds for short periods of time
Borrowers from money market provide low-cost
source of temporary funds

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Interest Rates Available on Several Money

Market Instruments

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Participants in Money Markets

U.S. Treasury Department

Federal Reserve System

Commercial Banks

Businesses

Investment and Securities Firms

Individuals
(mostly through money market mutual funds)
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Money Market Instruments

Treasury Bills
Federal Funds
Repurchase Agreements
Negotiable Certificates of Deposit
Commercial Paper
Bankers Acceptance
Eurodollars
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Treasury Bills
1. Short-term borrowings of the federal government
2. Usually sold at discount

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Discounting Example
You pay $9850 for a 91-day T-bill. It is worth
$10,000 at maturity. What is its annualized yield?

F P 365
iyt

P
n

(1)

$10,000 $9,850 365

iyt

0.0611 6.11%
$9,850
91
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Results of a Treasury Auction

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Slide 811

Figure 8-1: Treasury Bill Interest Rate

and the Inflation Rate, January 1973January 2002

Current inflation statistics

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ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt Slide 812

Federal Funds
Short-term funds transferred (loaned or
borrowed) between financial institutions,
usually for a period of one day

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Slide 813

Federal Funds

Figure 8.2: Federal Funds and Treasury Bill Interest Rates, January 1990January 2002

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Negotiable Certificates of Deposit

A bank-issued security that documents a
deposit and specifies the interest rate and the
maturity date
Denominations range from $100,000
to $10 million

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Slide 815

Negotiable Certificates of Deposit

Comparing Interest on CDs and T-bills

Figure 8.3: Interest Rates on Negotiable Certificates of Deposit and on Treasury Bills,
January 1990January 2002

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Commercial Paper
Unsecured promissory notes, issued by
corporations, that mature in no more than
270 days

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Commercial Paper
Comparing Interest on Commercial Paper to Bank Prime Rate

Figure 8.4: Return on Commercial Paper and the Prime Rate, January 1990January 2002

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Bankers Acceptances
An order to pay a specified amount
to the bearer on a given date if specified
conditions have been met, usually delivery
of promised goods

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Advantages to Bankers Acceptances

1. Exporter paid immediately
2. Exporter shielded from foreign exchange risk
3. Exporter does not have to assess the financial
security of the importer
4. Importers bank guarantees payment
5. Crucial to international trade
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Slide 820

Eurodollars
Dollar denominated deposits held
in foreign banks

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Slide 821

Eurodollars
London interbank bid rate (LIBID)
The rate paid by banks buying funds

London interbank offer rate (LIBOR)

The rate offered for sale of the funds

Time deposits with fixed maturities

Largest short term security in the world

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Figure 8-6: Interest Rates on Money Market

Securities, 19902002

Interest rates on money market instruments

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http://www.federalreserve.gov/releases

Slide 823

Money Market Securities and Their Depth

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Money Market Mutual Funds

Open-end investment funds that invest only in short-term securities

No fee for purchasing or redeeming shares
Minimum initial investment of $500 to $20,000
Check-writing privileges
No fee for writing checks
No minimum check amount

Earn 0.5% to 1% higher return than interest earned

on money in the bank
Low risk of default, low rate of risk
Popular to small investors

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Slide 825

Growth
in Money
Market
Mutual
Funds

Figure 8.7:
Net Assets of
Money Market
Mutual Funds,
19752000

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Slide 826

Money Market
Fund Assets

Figure 8.8:
Average Distribution
of Money Market
Fund Assets, 2001

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Slide 827