Money Market (MM)
• MM is where organizations go to adjust their liquidity.
• Market is a collection of dealers that specialize in one or
more MM instruments.
• Liquidity is stored in the MM by investing in MM
securities (lending). Liquidity is purchased in the MM
by selling MM securities (borrowing).
• Ideal place for temporary investments.
1
Properties of a Good MM Instrument
• low default risk.
• short maturity (to have low price risk).
• high marketability (typically facilitated by
standardized features).
Sold in large denominations ($1 million is a tiny trade),
per-dollar transaction costs thus kept low.
2
Typical MM Instruments
typical maturities
U.S. Treasury Bills
Repurchase agreements
13 and 26 weeks
1 to 14 days
Commercial paper
30 to 180 days
Negotiable CDs
12 to 180 days
Fed Funds
Banker’s acceptances
1 to 7 days
30 to 180 days
3
Auctioning New T-Bills
• Weekly auction by U.S. Treasury of 13-week, and 26week bills. Other bills (e.g., 1-day, 4-week, 52-week) sold
on an as announced basis.
• Sold at a discount basis.
• Sold in multiples of $100.
• $100 million is not a large institutional purchase.
• All winning bidders pay same price which is the price of
the lowest successful bid. Thursday/Monday/Thursday
schedule.
4
For Instance, This Past Week’s Schedule
• Thursday (Oct 29), Treasury Department announced
sale of $26 billion of 26-week T-bills, that were
auctioned off on Monday (Nov 2).
• On auction dates, noncompetitive tenders due by 11:00
am, competitive tenders due by 11:30 am.
• Results of auction announced minutes later.
• Bills issued and payments made on Thursday (Nov 5).
5
http://www.treasurydirect.gov/instit/annceresult/press/preanre/2015/A_20151029_1.pdf
6
http://www.treasurydirect.gov/instit/annceresult/annceresult.htm
7
http://www.treasurydirect.gov/instit/annceresult/press/preanre/2015
Bid-to-Cover Ratio = 9.74/26.0 = 3.75
8
CUSIP Number
Committee on Uniform Security Identification Procedures
A 9-digit alphanumeric identifier, such as
00817Y 10 8
Uniquely identifies each U.S. and Canadian security.
CUSIP system, operated by Standard & Poor’s, but owned
by American Bankers Association, is designed to facilitate
bookkeeping and the settlement of trades.
First 6-characters identify “issuer”
Next two identify the “issue”
Last is a “check digit”
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Competitive Bids
•
Competitive bidders (dealers and large banks) specify
• quantity
• discount rate willing to accept (in multiples of
.005%)
•
Treasury Dept. ranks bids according to bank discount
rate, then allocates down the list.
•
Bid-to-Cover Ratio signals how easy it is for US Gov’t
to borrow money.
•
No more than 35% of an issue can be sold to any
competitive bidder to ensure a competitive secondary
market.
10
Noncompetitive Bids

Small part of offering, all noncompetitive bids
accepted.

Noncompetitive bidders (individuals and small banks)
specify only quantity
•
$5 million max per noncompetitive bidder.
• receive the “High Rate” of accepted competitive bid
tenders
• Can buy online. Set up TreasuryDirect account (with
bank routing number & bank account number).
Treasury electronically debits your bank account at
beginning & credits it at end.
• Interest on US Treasuries taxed as ordinary income at
the federal level, but not taxed at the state level.
11
Example 1: Overview
offering
competitive ($49.5 B total)
$15.9 B
accepted
$18 B
Tenders with lowest
discount rate bids
accepted
noncompetitive
$2.1 B
$33.6 B
rejected
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Example 1: Auction Process
Offering Amount
$18.0 billion
Competitive tenders
$2.5 billion 3.880%
Noncompetitive tenders
$2.1 billion
$5.0 billion
3.895
$6.0 billion
3.910
Competitive tenders
$49.5 billion
$2.0 billion
3.930
High Rate (highest accepted rate)
3.945%
$4.5 billion
3.945
$9.0 billion
4.290
$11.0 billion
4.305
$9.5 billion
4.315
Bid-to-Cover Ratio
(49.5 + 2.1)/18 = 2.87
Competitive tenders Allocated at High rate
.4/4.5 = 8.89%
Median Rate (of accepted competitive tenders)
3.910%
Low Rate
3.880%
13
Secondary Market for T-Bills
discount rates
investment rate
• Bid & Asked are bank discount rates. Bid applies when customer
sells, Asked applies when customer buys.
• Asked Yield is bond equivalent rate.
14
Discount Rate
• The (bank) discount rate yd is given by:
Pf  P0  360 
yd 


Pf  n 
where Pf is face value
P0 is discounted price (today’s price)
n is calendar days to maturity
• Solving for P0 we have
P0  Pf 
Pf n yd
360
15
Bond Equivalent Rate
•
Bond equivalent rate ybe is given by
ybe 
Pf  P0  365 


P0  n 
(note 365 annualizer and discounted price is in
denominator)
•
Solving for P0 we have
Pf
P0 
ybe n 

1



365 

•
Bond equivalent yields are reported to facilitate
comparison against other debt instruments.
16
Example 2: Using Bank Discount Rate
Consider a $1,000 T-bill that matures in 133 days whose
Bid and Asked quotes are 4.96 and 4.92, respectively. If
selling, would get
P0  Pf 
Pf n yd
360
1000(133)(.0496)
 1000 
360
 $981.67566
If buying, would cost
P0  Pf 
Pf n yd
360
1000(133)(.0492)
 1000 
360
 $981.82333
17
Example 3: Using Bond Equivalent Rate
Bond Equivalent Rate is same as Investment Rate as on
slides 7 & 17.
Suppose you are contemplating a $1,000 T-bill that
matures in 67 days whose Asked Yield is 5.23. How much
would it cost?
Pf
P0 
ybe n 

1



365 

1000

 .0523(67) 
1 

365 

 $990.49101
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Fed Funds
• Unsecured loans between banks.
• Overnight interest rate called the fed funds rate.
• Term “fed funds” is misleading.
• Typically done in units of $1 million.
• Yields on fed funds assume 360-day year. Conversion
to bond equivalent yield is as follows.
 365 
ybe  y ff 

 360 
19
Commercial Paper
• Review slides 14-17 of Module 2.3.
• Compete head-to-head against T-bills. Consequently,
sold at discount, and quoted using bank discount rate
Pf  P0  360 
ycp 


Pf  n 
• There is a secondary market.
• Virtually impossible to sell without backup line of
credit and a P-1 or A-1 rating.
20
Federal Agencies (GSEs)
Agencies created by Congress for public policy reasons to
assure availability of capital in areas of the economy where
credit might otherwise be insufficient or too costly. Mostly
in
• Home mortgages
• Agriculture
GSEs often provide loan guarantees and conduct
securitizations. Obtain the money they need by issuing
agency securities.
Such agency securities qualify as legal instruments to be
held by banks, insurance companies, and pension funds.
21
Government Sponsored Enterprises
• Agency (i.e, GSE) debt perceived to have only slightly
greater default risk than US Treasuries.
• Marketability very good.
• (Fannie Mae) Federal National Mortgage Association
(Freddie Mac) Federal Home Loan Mortgage Association
• (Ginnie Mae) Government National Mortgage Association
• See list of GSEs on p. 214.
22
Retail Certificates of Deposit
• Issued by banks to finance their business activities.
• Not negotiable – no secondary market, can only be
sold back to issuing bank early, with penalty.
• Issued at face value with interest as an “add on”.
• Interest based on a 365 day year.
• Can be in any denomination.
• FDIC insured up to standard amounts.
• Banks typically use standard maturities such as 0.5,
1.0, 1.5, 2.0 and 5.0 years.
23
Negotiable Certificates of Deposit
• Large-denomination CDs issued by well-known
banks are negotiable (exists a secondary market for
them).
• Issued at face value with interest as an “add on”.
• Stated interest computed on a 360-day year (like Fed
Funds).
• Interest rates on negotiable CDs are higher than on
T-Bills because of higher credit risk and lower
marketability.
•
Purchased mainly by corporate businesses.
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