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Chapter 4:
Learning Objectives

Characteristics of Financial Market Instruments:



Money Market Instruments
Capital Market Instruments
Financial Innovations
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Money Market Instruments

Short-term, low risk financial
instruments
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


Bankers' Acceptance
Certificates of Deposit (CDs)
Commercial Paper
Treasury Bills (T-bills)
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The Money Market
(most important)

Treasury Bills






Bank of Canada
Advances



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Mature 91-365 days
issued by the Federal Govt
large secondary market
rate fluctuates according to
overnight market band
useful indicator of
monetary policy stance
“lender of last resort” loan
access by CPA members
Actively discouraged
source of borrowing
Bank of Canada Advances
4000
3469
3 4 6 9 .0
Millions of dollars
3000
2000
1174
1 1 7 4 .0
1000
952
868 798
9 5 2 .0
8 6 8 .0
7 9 8 .0
485
471
312
4 8 4 .9
4 7 1 .0
3 1 2 .0
545 554
224
131
2 2 4 .0
447
656
561
363
6 5 6 .0
5 4 5 .0
5 6 0 .9
5 5 4 .0
647
535
383
6 4 7 .0
5 3 5 .0
4 4 7 .0
3 6 3 .0
3 8 3 .0
10
1 3 1 .0
0
1 0 .0
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003
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The Operating Band for the Overnight Market
Overnight
Market Rates
Bank Rate
OPERATING
BAND
BOC target rate = mid-point
of range
Rate on +ve balances =
Bank rate less 0.50%
Overdraft
Surplus
ON*=(BRt+Rtsb)/2
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The Money Market (cont’d)


Special Purchase and
Resale
Agreements(SPRA)
FIG4.2
Bankers’ Acceptances
FIG 4.3




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Short-term loan used by
BOC to affect liquidity in
fin. mkts.
Can be implemented at
short notice and has been
used more frequently of
late.
Widely used as a method
of high quality short-term
finance
large and active
secondary mkt.
Financing Through an SPRA
Investment Dealer
Assets
Bank of Canada
Liabilities
Call loan
T-bill
SPRA
Bank
Call loan
BOC Dep.
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Bank deposit
Financing via a Banker’s Acceptance
Importer
Exporter
“Stamped”
Letter of credit
issued
BANKS
Secondary Market
Investment Dealers
Rediscounting
Investors
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The Money Market (cont’d)

Interbank deposits



Eurocurrency
instruments



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growth reflects
globalization and
importance of interbank
transactions
useful as a cash
management tool
offshore financial market in
several centers (London
UK most important)
highly liquid, low tax and
transactions costs
useful guide for int’l int
rate developments
The Money Market [cont’d]

The Large Value Transfer System
(LVTS)




Assists in the operations of the clearing
system
Attempting to reduce systemic risk
Not, strictly speaking, an instrument
Created by the CPA (Canadian payments
Association]
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The Money Market (cont’d)

Special Purchase and
Resale Agreements
(SPRA) FIG4.2 (cont’d)

If participant i’s
LVTS is LVTSi while
participant j’s LVTS
balance are LVTSj
then we would
expect:
LVTSi + LVTSj = 0
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The Capital Market & Derivatives
(most important)

Govt of Canada
bonds
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

Large secondary market
principal source of debt
finance across the term
structure
Main Groups Holding Government Debt
90
80
70
Percent
60
50
Bank of Canada
Nonresidents
Canadian residetns
40
30
20
10
0
1987
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1990
1993
Year
1996
1999
2002
The Capital Market & Derivatives
(most important)

Govt of Canada
bonds




Stocks

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Large secondary market
principal source of debt
finance across the term
structure
newly issued and large
secondary market
private source of debt
Net New Issues of Stocks and Bonds
Millions of dollars (par value)
6000
5000
Stocks
4000
3000
Bonds
2000
1000
0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Year
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The Capital Market & Derivatives
(most important)

Govt of Canada bonds



Stocks




Derivatives
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
large secondary market
principal source of debt
finance across the term
structure
newly issued and large
secondary market
private source of debt
large variety
can be a source of reduced
or increased risk
Summary





Financial Markets can be subdivided into the Money
and Capital Markets
Money Market instruments are short-term in nature
Capital Market instruments are long-term in nature
The principal Money market instruments are T-bills,
Bank of Canada Advances, SPRAs, Banker’s
Acceptances, interbank deposits and the Eurocurrency
market
The principal capital market instruments are Govt
bonds, stocks and derivative products
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