financial markets - 2500 words
dodo1995
Topic-3TheMoneyMarketSecurities-2.pptxThe Money Market
FINANCIAL MARKETS
Topic 3
RMIT University©
2
Overview: Money Market
Characteristics of Money Market
Participants in Money Market
Pricing of Money Market Instruments
Use of market data and information
Money Market Instruments
Characteristics of the Money Market
Nature of the Market
Borrow and lending for less than 1 year
Buying and selling of financial assets with maturities of less than 1 year
Only debt financial assets are traded in the Money Market
Major types of short-term debt are:
Trade credit, intercompany loans, bank draft, fully drawn advances, commercial bills.
Features of the Market
No physical location
The Money Market is a world-wide communications network and a mechanism which allows short-term debt assets to be created and traded
Over the Counter (OTC) market
There is no central exchange. Market participates must contract directly with another counterparty to complete a transaction
Primarily a wholesale market
The majority of Money Market transactions are of the order of several million dollars in value
Characteristics of the Money Market
Functions of the market
Transfer of funds from surplus economic units to deficit economic units for periods of less than 1 year
Trading of existing money market securities
A mechanism for government to:
Raise short-term funding
Implement monetary policy
“Determinant” of term structure interest rates
Facilitate short-term international trade transactions
Characteristics of the Money Market
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Overview: Money Market
Characteristics of Money Market
Participants in Money Market
Pricing of Money Market Instruments
Use of market data and information
Money Market Instruments
Participants
Money
Market
Commercial banks
Central Bank
Brokers
Finance companies
Corporations
Investment banks
Central banks
Use the money market for:
Raising short-term government funding
Implementing monetary policies (using open market operations to influence the money supply, and hence interest rates, inflation, economic growth, unemployment, etc)
Match borrowers with lenders (buyers with sellers)
Allow for anonymity
Provide a range of financial services
Are paid fees or commissions
Brokers
Corporations
Borrow and lend in the overnight Money Market
Use overdraft facilities
Place short-term deposits and take out short-term loans with banks
Issue commercial bills and promissory notes
Corporations Alternative sources of short-term finance
Trade credit
Using credit terms from suppliers to delay payment of invoices
Accruals
Delaying payment of obligations such as tax and leave entitlements
Factoring / Debt Finance
“Selling” the debts of company’s debtors (account receivables)
How do participants profit?
Borrowers and lenders use the market to borrow and invest respectively.
Only intermediaries profit from their activities in the market, by
Borrowing at a lower rate of interest than that at which they lend
Buying financial assets at a lower price than that at which they sell
How do participants profit?
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Intermediation Management Issues
Liquidity Management – need to match maturity of assets and liabilities
Interest Rate Management – maintain a match between fixed and variable interest rates
Capital Management – Central bank require corporations to maintain minimum ratios of capital to assets.
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Overview: Money Market
Characteristics of Money Market
Participants in Money Market
Pricing of Money Market Instruments
Use of market data and information
Money Market Instruments
Money Market Instruments
Cash products
Discount securities
Cash products
Overnight cash
7-day cash
Overdrafts
Fixed term deposits
Fixed term loans
Cash Products
Overnight cash (11 am cash)
Initial deposit or loan is made overnight
Deposits/withdrawals by 11am the following day, or the loan/deposit is “rolled over” for another day
Interest rate reset daily
Parcels of 5/10 million
Market mainly used by Banks
Cash Products
7-day cash (24 hour cash)
Initial period of deposit/loan is 7 days
After 7 days, deposits/withdrawals require 24 hours notice
Interest rate reset daily after initial 7 day period
Other short-term loans
Committed loans
Uncommitted loans
Bank overdrafts
Customer permitted to overdraw cheque account up to agreed limit
Interest charged daily (compounded daily)
Repayable on demand
Rate higher than fully-drawn loans
Rate usually follows Bank Bill Swap Index (BBSW)
Two-way pricing of cash products
Price-makers (such as banks) will provide both a bid and offer quote
e.g: Overnight cash quote 7.45/60
This means the price maker (bank) will:
(buy) borrow cash at 7.45% or
(sell) lend cash at 7.60%
To deal the price-taker must do the opposite –
(sell) lend cash at 7.45% or
(buy) borrow cash at 7.60%
Two-way pricing and Over the Counter Trading
Price-makers (such as banks) will provide both a bid and offer quote
Price makers decide on rates (special licence), they are usually commercial banks
Price takers do not decide on the rate but can refuse to trade
Two-way pricing and Over the Counter Trading
Bid-Offer Quote:
This is from the price maker’s perspective
Bid is the buying rate of the price maker
Offer is the selling rate of the price maker
Note:
Buying Cash product is borrowing, Selling Cash is lending
Question for discussion
A bank (price maker) quotes 5.70/75
As an investor, what rate would you prefer?
At what rate will the bank borrow?
At what rate do you deal at?
5.75
5.70
5.70
Question for discussion
You would like to borrow $5,000,000 overnight
You receive the following quotes:
Bank A 5.82/85
Bank B 5.75/80
Bank C 5.75/77
Which bank do you choose?
At what rate do you deal at?
Bank C
5.77
How much interest do you pay?
Discount Securities
Bills of Exchange
Commercial bills
Non-bank bills
Bank Accepted Bills (BAB)
Bank Endorsed Bills (BEB)
Trade Bills
Promissory Notes
Treasury Notes
Certificates of Deposits (CD)
Repurchase Agreements (Repos)
Some Common Products:
Discount Securities
Investor pays a discounted price when buying the security and receives the full value at maturity
Bills of Exchange / Commercial Bills
Bills of Exchange can be used to:
Facilitate international trade (trade bills)
Raise finance (accommodation bills or commercial bills)
Definition of a Bill of Exchange:
“An unconditional order in writing addressed by one person to another, signed by the person to whom it is addressed to pay on demand or at a fixed or determined future time a sum certain in money to or to the order of a specified person(s).”
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Bills of Exchange: Categorisation
Trade Bills: issues to finance specific trade transaction.
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Commercial Bills
Usually involve 3 parties:
Drawer (borrower)
Acceptor/Drawee/Guarantor
Discounter (lender)
If the bill is sold in the secondary market, it must be endorsed, which incurs a “contingent liability”
Commercial Bills
Borrower
Issuer of bill
Lender
Receiver of bill
Commercial Bills
Features
Terms 7 - 180 days
Traded on yields
$5 - $10 million parcels
2-way pricing
Extra fees apply to borrowers
Promissory Notes
Also known as P-Notes or Commercial Paper
Essentially an IOU
Only issued by large companies with excellent credit ratings
No contingent liability when sold
Higher yields than BABs
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Treasury Notes
Essentially Promissory Notes issued by the government to raise short-term finance
Issued weekly by tender with Maturities 5, 13 or 26 weeks
Active secondary market amongst commercial banks
Extremely liquid instruments. Can be used for Prime Asset Ratio purposes.
Bought and sold by Central Bank in the secondary market (open market operations)
Lower yields than BABs
Certificates of Deposit
Essentially Promissory Notes issued by banks
Maturities 90 - 180 days
Yields the same as BABs
Trade in the secondary market
Minimum denomination $50,000
Repurchase Agreements
An agreement under which a financial asset is sold and then repurchased at a later date at an agreed price
Effectively a short-term loan using the asset as security - title is transfer.
Buy a repo: lend cash - buy at a discount a security now and sell it back at a predetermine date.
Sell a repo: Borrow cash- sell at a discount a security now and buy it back at a predetermine date.
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Overview: Money Market
Characteristics of Money Market
Participants in Money Market
Pricing of Money Market Instruments
Use of market data and information
Money Market Instruments
Pricing a discount security
PV= Present value of the security
FV=Future value of the security
y = yield p.a
t = time to maturity in years
From topic 2 the formula pricing discount security:
Question for discussion
A bank offers to sell a $1,000,000 bank bill today to your company at 7.55% for 180 days.
How much would you invest today?
How much do you receive in 180 days?
Two-way pricing of discount securities
A price maker will always lend at a higher rate of interest than they will borrow - the opposite applies to price takers
Buy a commercial bill = lending money
Selling a commercial bill = borrowing money
E.g Bank bill quote 7.65/60
Note: Cash products work the opposite way!
Buying Cash product is borrowing, Selling Cash is lending
Two-way pricing of discount securities
Price-makers (such as banks) will provide both a bid and offer quote
Eg: Bank bill quote 7.65/60
This means the price maker (bank) will
buy the bill at a yield of 7.65% or
sell the bill at 7.60%
The price-taker must do the opposite
sell the bill at a yield of 7.65% or
buy the bill at a yield of 7.60%
Questions for discussion
If you wish to sell a bill, what are you doing? Raising funds or investing?
What rate of interest would you prefer? High or low?
The bank quotes 6.55/50. What rate will you get from the bank?
Low
6.55
Raising
Questions for discussion
The bank quotes 7.00/6.95. If you wish to buy a bank bill, are you raising funds or investing?
What rate would you prefer?
What rate will you deal at?
7.00
6.95
Investing
Questions for discussion
You get 3 quotes:
Bank X 7.92/87
Bank Y 7.94/89
Bank Z 7.90/85
If you wanted to invest, at what rate would you deal?
If you wanted to borrow, at what rate would you deal?
Bank Y 7.89
Bank Z 7.90
RMIT University©
47
Overview: Money Market
Characteristics of Money Market
Participants in Money Market
Pricing of Money Market Instruments
Use of market data and information
Money Market Instruments
Data and information
Dealers rely heavily on live data services such as Reuters, Bloomberg, etc. These services provide:
Latest market prices
Volume of transactions
Financial, political, economic news
The majority of deals are conducted over the telephone by “front office” personnel
The “back office” personnel prepare the paperwork to conclude the transaction
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