Exam 10: Introduction to the Money Market and the Roles Played by Governments and Security Dealers

A dealer in government securities currently holds $875 million in 10-year Treasury bonds and $1,410 million in 6-month Treasury bills. Current yields on the T-bonds average 7.15 percent while 6-month T-bill yields average 3.38 percent. The dealer is currently borrowing $2,300 million through one-week repurchase agreements at an interest rate of 3.20 percent. What is the dealer's expected (annualized) carry income? Suppose that 10-year T-bond rates suddenly rise to 7.30 percent, T-bill rates climb to 5.40 percent and interest rates on comparable maturity RPs increase to 5.55 percent. What will happen to the dealer's expected (annualized) carry income and why? Should this dealer have moved to a long position or a short position before the interest rate change just described? Should the dealer alter his or her borrowing plans in any way? Please explain your answer.

What causes the positions in securities that dealers hold to change over time?

To what types of risk is each form or source of dealer income subject? How might a dealer handle these different forms of risk exposure?

Suppose that a dealer borrows cash through a $40 million RP from a manufacturing corporation for one day. If the dealer will have to pay $3,500 in interest on this loan, what is the current RP loan rate?

What is a demand loan? How does it help security dealers obtain the financing they need?

How do money markets around the world differ from one another?

What is the "normal" or "typical" shape of the yield curve for T-bills? What other shapes have been observed and why do you think these occur?

According to your text, the windfall profits tax levied by Congress is an example of political risk.

Please explain why Treasury bills are so popular with investors (savers) all over the world?

Explain why security dealers are essential to promote the smooth functioning of the securities markets and especially the money market.

How much interest would be earned (on a simple interest basis) from a three-day money market loan for $1 million at an interest rate of 12 percent (annual rate)? Suppose the loan were extended on the third day for an additional day at the going market rate of 11 percent. How much total interest income would the money-market lender receive?

Calculate the holding-period yield for the following situations:

Please explain why there is a critical need within the economy and financial system to have money market instruments available to anyone who can afford them?

Please explain how a Treasury bill auction works in the United States. Can you find some advantages stemming from this type of sale?

According to the textbook, money markets of the future will become more:

What is a repurchase agreement or RP? Explain what an RP's role is in financing the operations of security dealers.

Why have governments found the Treasury bill such an effective instrument for raising new funds?