FI 301 1st Edition Exam 2 Study Guide Lectures 9 16 Chapter 6 1 Money Market Securities 1 Market securities mature less than a year it tells you that the yield is very small They are a huge investment tool because you can put a lot of money in it and sill make a lot of money diversifies risk companies risk adverse investors Large corps and organizations invest in these sometimes senior citizens invest for safe investment 2 Primary market issued by investment brokers and commercial banks 3 Short term 4 They are a liquid investment you are not going to loose money in most cases 99 are paid 2 Treasury Bills 1 Money market security issued for a year or less 2 Also a 52 week bill 3 Treasury notes are between 2 and 10 year investment 4 Treasury bonds are over 10 years 5 The FED issues these this is their debt 6 If you are making 5 dollars in interest you give them 9555 then they give you 1000 back 7 They are free from default risk because it is backed by the FED 8 HIGHLY LIQUID mostly commercial and foreign investors invest China Japan 9 Depository institution 10 Maturity matching they re trying to make money on assets while they are paying off their liabilities similar to interest on your savings account 11 This cash flow issue occurs because banks can lend out all their money and get more from the government they may take on too much debt 12 Safety sure return cover cash flow 13 Treasury Bill Auction Exhibit 6 2 1 Investors can submit bids online for newly issued T bills at www treasurydirect gov 2 Investors have the option of bidding competitively or noncompetitively 3 Once every 2 weeks 4 Competitive 1 000 or more bid on interest rates I want to get paid 1 1 5 2 3 40 billion in bids 2 everyone gets paid high bid below 2 cause it gets cut off at 2 5 Noncompetitive 5 million we will take whatever interest rate you pay They just give you any interest rate such as 2 You would do this because you are going to get paid for sure this way 14 Estimating the yield SP PP 365 PP n where SP selling price PP purchase price n number of days of the investment holding period YT 1 15 Estimating the discount YT Par PP 360 Par n 1 3 Commercial Paper 1 Huge form of debt for corporations very short term note basically 270 days or less Big companies are borrowing company to cover things like inventory and cash flow or other debts 2 Unsecured no assets backing 3 270 days or less don t have to report to the SEC saves a lot of paperwork if they borrow for a short period of time 4 The minimum denomination of commercial paper is usually 100 000 5 Maturities are normally between 20 and 45 days but can be as short as 1 day or as long as 270 days 6 Ratings 1 Assigned by rating agencies Who are these agencies again 1 S P Moodys and FITCH established ratings grades commercial paper default risk about 99 2 Serves as an indicator of the potential risk of default 7 Credit Risk during the Credit Crisis 1 Historically the of issues that have defaulted is very low 2 During the credit crisis in 2008 one very large company made headlines by failing due to commercial paper Who was it 1 First companies that defaulted Fannie Mae Leiman Brothers Citigroup Countrywide bought out by bank of america AIG 2 Borrowing money to invest financial leverage 8 Backing Commercial Paper 1 Some backed by assets of the issuer secured loans Which would offer the investor a higher yield secured or unsecured 2 Issuers of commercial paper typically maintain backup lines of credit What is a line of credit 3 General motors goes to securities firm like merill lynch I need 500 million they go to pension funds and investors and ask them to buy it 4 Not traded on an exchange its over the phone over the counter trade 5 Some are secured and some are unsecured unsecured pays the higher yield 9 Placement Firms place commercial paper directly with investors or rely on commercial paper dealers to sell their commercial paper 10 Estimating the Yield Commercial paper does not pay interest and is priced at a discount from par value like a T Bill Which pays a higher yield and why Commercial paper pays higher Certificate of deposit make it at a bank pay low amount 11 Commercial Paper Yield i Ycp Par PP PP x 360 n 4 Negotiable Certificates of Deposit 1 NCD is a investment of the bank A CD works by you plan for a certain amount of time and you get a yield on it 2 Short term investment many of them are a year or less NCD period is the amount of money have to be at least 100 000 can be sold to investors NCD with corporation 3 Need CDS because they are a good investment to diversify with senior citizens like CDs 4 Placement Some issuers place their NCDs directly others use a correspondent institution that specializes in placing NCDs 5 Premium Offer a premium above the T bill yield in order to compensate for less liquidity and safety 6 Yield Provide a return in the form of interest along with the difference between the price at which the NCD is redeemed or sold in the secondary market and the purchase price YNCD SP PP interest PP 5 Repurchase Agreements 1 Fed uses them we buy them temporarily and they buy or sell them back quickly can be overnight or up to 2 weeks they are trying to temporarily increase the money supply 2 2 they participate in repos because they solve liquidity issues this says that theyre low on cash they may need to borow money for a short time before they get cash flow 3 From fed to corp to banks huge market 4 Solve short term liquidity problems 5 Placement Negotiated through a telecommunications network Dealers and repo brokers act as financial intermediaries to create repos for firms with deficient or excess funds receiving a commission for their services 6 Impact of the Credit Crisis Many financial institutions that relied on the market for funding were not able to obtain funds Investors became more concerned about the securities that were posted as collateral 7 Estimating the Yield Repo rate SP PP 360 PP n YT for treasury yield YR for repo rate Bear Sterns defaulted on their repurchase agreements they were borrowing money to invest using financial leverage 6 Federal Funds 1 This rate is the rate banks loan to each other federal funds rate 2 Discount rate is rate fed loans to banks 3 Federal funds is rate at what banks lend to other banks 4 FOMC 0 0 025 federal funds rate they help by adding money to money supply 5 This rate is higher than the T bill rate 6 The most active participants are commercial …