Chat with AIExam 10: Introduction to the Money Market and the Roles Played by Governments and Security Dealers
The money market is characterized by very large financial institutions. Who are the principal borrowers and lenders in this market?
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VerifiedThe major players in the money market are banks, nonfinancial corporations, government units, finance companies and S&Ls. It is difficult to define any of these as principal borrowers or lenders because they frequently play both roles. The only institution which is almost always a borrower in the money market is the U.S. Treasury.
In what different ways do security dealers generate income and possibly make a profit?
(81) Verifieda. Income from the spread between bid prices and asked prices for securities (making a market). Risks: Because the dealer adds securities purchased to his portfolio, there is risk of loss from price decreases if interest rates increase; also dealers must be ready to buy and sell on customer demand despite the condition of the market.
b. Position Profits: By anticipating rate movements and changing their long/short position dealers can
earn sizable profits. Risks: incorrectly anticipating interest-rate movements.
c. Carry Income: Difference between securities' yields and interest rates on borrowed funds. Risks:
adverse changes in rates or yields that might lower any income and even make it negative.
d. Commissions and Fees for Services: Dealers manage cash positions for their customers and render
advice and assistance in mergers and acquisitions. Risks: fluctuations in the economy and industry conditions can cause changes in demand for the dealers' services.
How does the method for determining Treasury bill yields differ from the primary method used to calculate yields on most bonds? Why is this difference important?
(75) VerifiedBill yields are determined by the bank discount method, which does not compound interest rates and uses a 360-day year for simplicity.
In contrast, the calculation of yields on most bonds compound interest and use a 365-day year. So, to make realistic comparison with other securities, bill yields must be converted to an investment (bond- or coupon-equivalent) yield.
The investment yield or rate (IR) on T-bills
= Par value - Purchase price ´ 365 . Purchase price Days to maturity
Because of the compounding of interest and the use of a 365-day year, the investment yield (IR) on a bill is always higher than its discount rate (DR).
What are federal funds and how do they differ from clearinghouse funds?
(87) As the U.S. Treasury has shifted its borrowing vehicles more heavily toward longer-term debt issues, the total marketable debt of the US government T-bills has declined from more than one third of the financing to just over
(80) Which of these two types of funds - federal funds versus clearinghouse funds - are more important in the money market and why is this so?
(85) Suppose the yield spread between the three-month U.S. Treasury bill rate and the three-month bank CD rate were 35 basis points. An investor has $250,000 to invest in either of these instruments for three months. How much does the investor surrender in total interest income for three months if he or she invests in Treasury bills instead of CDs? Does the investor receive any offsetting benefits by buying the bills and not the CDs?
(75) Who are the principal buyers of Treasury bills today? Please make a list of the key factors that you believe motivate these investors to buy bills.
(87) What is the difference between actual maturity and original maturity of a financial asset? Why is this difference important in the money market?
(84) Ninety-one day Treasury bills carry an investment yield (IR) of 6.25%. What is their purchase price?
What is their discount rate?
(92) What are the principal goals usually pursued by money market investors?
(84) The market for prime-rate bank loans is a direct competitor with the commercial paper market.
(71) A government securities dealer is currently borrowing $25 million from a money-center bank using repurchase agreements based on Treasury bills. If today's RP rate is 6.25 percent, how much in interest will the dealer owe for a 24 hour loan?
(74) An automobile company, NISSAN, has a temporary cash surplus and lends its funds overnight through a repurchase agreement to a government securities dealer, earning $55,600 in interest income when the RP loan rate stood at 5.70%. What was the size of the loan that NISSAN granted to the securities dealer?
(80) Check the most recent issue of The Wall Street Journal you can find. Calculate the yield spreads in basis points between U.S. Treasury bills of varying maturity, the Federal funds rate and commercial paper, CD and bankers' acceptance rates. How do your calculated yield spreads compare with those shown in Exhibit 10-5? Can you explain the observed differences in yield spreads using your knowledge of the factors explaining movements in interest rates discussed in Chapters 5 through 9.
Refer to the interest rates released by the Federal Reserve on page 113.
(82) From the following sets of figures: (1) calculate the bank discount rate on each T-bill; and (2) convert that rate to the appropriate investment (or coupon-equivalent) yield.
(77) The risk that an investor will be forced to place earnings from a loan or a security into a lower-yielding investment because interest rates have subsequently fallen is known as:
(85) Define the following:
a. Money or Market risk
b. Default risk
c. Inflation risk
d. Currency risk
e. Political risk
Which of these risks listed above are minimized by purchasing money market instruments? Does investing in the money market avoid all of the foregoing risks?
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