Professional Documents
Culture Documents
1
Introduction
2
Introductio
n
Introduction
All debt markets have a common
feature
On one hand we have On the other hand we
parties ready to borrow have parties willing to
by issuing securities lend in the process of
acquiring securities
capital needs 3
Introductio
n
Purpose of borrowing
4
Introductio
n
Types of financial assets
short-term securities
5
Introductio
n
Term to maturity
Loans in the money market have an
original term to maturity of <1 year
8
Example
Disbursements must be
made throughout the When tax revenues arrive
year to meet expenses the government will be
such as Wages, Salaries, temporarily flush with
Office supplies, Fuel funds
costs At such points in time it
will enter the money
market as a lender
9
Example
Example – Business
11
Example
Example – Business
12
Introductio
n
Why the attention?
Why are we so concerned about short-
term transactions?
Money is an extremely perishable
commodity
When idle cash is not invested there is an
opportunity cost - interest income is
foregone
Income that is lost is lost forever
When large amounts of funds are involved,
the income that is lost from not profitably
investing idle funds for even a day can be 13
Introductio
n
Example
A firm has 12MM dollars available
overnight.
Assume interest rate @ 12% p.a.
Assume the year has 360 days
A common assumption in money markets
If money is kept idle the lost income will
be:
12,000,000 x 0.12 x (1/360) = $4,000
If the money were to remain idle for a
14
Introductio
n
Borrowers & Lenders
It is very difficult to classify an
economic entity as a borrower or a
lender.
The same institutions frequently operate on
both sides of the market
E.g. Citibank
Borrower Lender
It will borrow regularly At the same time it will
in the money market by be making short term
way of Certificates of loans to corporate
Deposit, borrowings of borrowers
Federal Funds etc. 15
Introductio
n
Borrowers & Lenders
Borrower Lender
Frequently a corporation will Only to come back into
borrow millions of dollars on the market as a lender a
a single day few days hence due to a
sudden upsurge in cash
Institutions that are presentreceipts
on both sides of the
market include Large banks, Finance companies, Non-
financial corporations, Central Banks of countries
One institution that is usually
always on the demand side is
the government. At any point
in time the U.S. Treasury is
the largest borrower in the
world 16
Introductio
n
What do investors want?
unanticipated fashion. 17
Introductio
n
Liquidity
A liquid market is characterized by the
presence of a large number of buyers
and sellers at all time.
What would happen if the market were
to be illiquid?
If there is excess demand large buy orders
will send prices shooting up
If there is excess supply large sell orders
will send prices crashing down.
18
Introductio
n
Liquid market
In a liquid market large trades can be
executed without a major price impact
Liquid markets are characterized by low
bid-ask spreads
Since transactions are frequent dealers
can afford to operate with a smaller
profit per round trip transaction
Bid the price at which the dealer buys
from the public
Ask the price at which the dealer sells to
the public
Round trip a purchase followed by a
subsequent sale
19
Introductio
n
Safety
20
Introductio
n
Safety - Examples
1970: Penn Central Transportation
Company defaulted on its short-term
commercial notes.
The short-term commercial paper market
ground to a halt
Investors refused to buy even paper issued
by top grade companies
1980s: Continental Illinois Bank had to
be propped up by government loans.
Immediately rates on all short-term bank
CDs rose
There was a fear that all large bank CDs had
21
Introductio
n
Risks in the Market
Risks
Re-
Market Default Inflation Currency Political
investment
Risk Risk Risk Risk Risk
Risk
22
Introductio
n
Risks in the Market
23
Introductio
n
Risks…(Cont…)
29
Introductio
n
Central Banks
The market is overseen by the Federal
Reserve Bank in the U.S. and by the
central banks of other countries. These
are:
U.K. – Bank of England
Japan – Bank of Japan
Europe – European central bank
Germany – Bundesbank
Australia – Reserve Bank of Australia
30
Introductio
n
Features (Cont…)
32
Categories of
MMI
Categories
Money
Market
Instruments
Off-balance-sheet Derivative
Cash Instruments
Instruments Instruments
33
Categories of
MMI
Categories
Cash instruments - A contract for the
immediate borrowing or lending of
funds
Off-balance-sheet instruments (OBS) -
Arrangements for borrowing or lending
at a future point in time
The price is fixed in advance
This cannot be recorded on the balance
sheet of the parties
Balance sheet can only reflect current
borrowing/lending 34
Categories of
MMI
Cash Instruments
Cash
Instru-
ments
Bank bills
Certifi- Re-
Deposits & Commer-
Treasury cates Euro purchase
& Bankers’ cial
Bills Of notes Agreee-
Loans Accept- Paper
Deposit ments
ances
35
Categories of
MMI
Illustration
% p.a.
36
Categories of
MMI
Derivative Securities
Some off-balance-sheet-instruments do
not involve future borrowing / lending
They are used for managing risk
Only a return is paid
Instruments
39
Key Dates in Cash Market
Instruments
40
Key Dates
Key Dates
Transaction date
Value date
Maturity Date
41
Key Dates
Transaction Date
42
Key Dates
Value Date
43
Key Dates
Value Date
44
Key Dates
Maturity Date
The date on which the instrument
ceases to accrue a return
Maturity date is often not a date
It is a term to maturity which is a whole
number of weeks/months after the value
date
Date of maturity follows two
conventions
The Modified Following Business Day
Convention 45
The Modified Following Business Day
Convention
This convention consists of the following
three rules
1. Maturity is set for the same date as the
value date
If the value date is 21 March
The one month maturity will be 21 April
The two month maturity will be 21 May
2. If the maturity as per rule 1 is a non-
business day, then it is moved to the
following business day
46
Modified…(Cont…)
3. If the following business day according to
rule 2 falls in the next calendar month, then
the maturity date is moved back to the last
business day of the calendar month.
47
The End/End Rule
If the value date is the last business day
of the current calendar month, then the
maturity date will be the last business
day of the relevant calendar month.
Consider a one month deposit with a value
date of 31 May.
It will mature on 30 June if it is a business
day.
Consider a one month deposit with a value
date of 30 June
It will mature on 31 July if it is a business day
48
The End/End Rule (Cont…)
Consider a one month deposit with a value
date of 31 January
It will mature on 28 or 29 February
Consider a one month deposit with a value
date of 28 or 29 February
It will mature on 31 March
If the maturity date as per this rule were
to be a holiday then the modified
following business day convention
would apply.
49
Fed Funds & Clearinghouse
Funds
50
Fed Funds
51
Fed Funds
Fed Funds…(Cont…)
When a dealer firm buys
securities from a trader…
53
Fed Funds
54
Fed Funds
Process
55
Fed Funds
Funds availability
Clearinghouse funds are not accepted in
money markets
For money market transactions these
transactions are far too slow and risky
57
Global Money Mkts
59
Types of National MoneyGlobal Money Mkts
Markets
Securities dominated market most
borrowing and lending is through open
market trading of financial instruments.
Western markets are largely securities
dominated.
Bank dominated market bank
borrowing and lending is at the centre
of most transactions.
Asian markets tend to be largely bank
dominated.
These markets have a potential weakness -
they yield more easily to government 60
Global Money Mkts
61
Securities & Relative Volumes
62
Sec & Rel vols
Growing Volumes
67
Interbank
Mkt
Interbank Market
It is a market for large or wholesale
loans and deposits
It is an arena for transactions between
commercial banks
Borrowing / lending is for periods <= 12
months
Participants
Commercial banks
Insurance companies
Pension funds
68
Interbank
Mkt
Need for Interbank Market
intermediary
70
Interbank
Mkt
Types of Loans
74
Interbank
Mkt
BBA LIBOR
BBA British Bankers’ Association
It is the most widely used benchmark
for short term interest rates
Rate is complied by BBA and Reuters
and released after 11 a.m. London time
BBA maintains a panel of 8 banks
It provides a reference panel which
reflects the balance of the market by
Country
Type of institution
75
Interbank
Mkt
LIBID
bank
LIBID LIBOR
Rate that banks with Rate that banks
surplus funds might seeking to borrow
have to accept on might have to pay
interbank deposit
Rate is lower Rate is higher
P x (r/100) x (T/360)
P Principal
T No. of days
r Rate of interest
80
Interbank
Mkt
Illustration
Bank makes a loan = $7.5 MM
Period: 1 year (365 days)
Interest rate = 5.25% p.a.
81
Securities and Relative Interest
Rates
82
Sec & Rel. Int.
Rates
T-Bills
86
T-Bills
Treasury Bills
Purchases / Sales of T-bills often
represent the largest volume of daily
transactions in the money market.
Interest rates on such bills are the
benchmark for all other money market
rates.
What are the important features of T-
bills?
a. Zero default risk
b. Ready marketability 87
T-Bills
U.S. T-Bills
U.S T-bills are direct obligations of the U.S.
government
By law T-bills in the U.S must have an original
maturity of <1 year
The government’s fiscal year runs from 1 Oct to
30 Sep
market conditions
89
T-Bills
94
T-Bills
bids
The Treasury entertains 2 types of bids.
Competitive bids typically are submitted
by large investors including banks and
securities dealers.
They bid for several million dollars worth of
securities at a time.
Non-competitive bids submitted by small
investors who agree to accept the price set
at the auction.
The Treasury generally fills all non-
competitive bids. 96
T-Bills
At the auction
Bids are arranged in descending All competitive bids
order from the highest price or in must be submitted to
ascending order from the lowest three decimal places
yield
Illustration
98
T-Bills
Pricing at auctions
100
T-Bills -
Yields
Example 1
Assume that a T-bill with
Face value = $100
90 days to maturity
Selling price = $97.50
101
T-Bills -
Yields
Example (Cont…)
102
T-Bills -
Yields
Example – Investment Rate
Rate of return for an investor who buys a bill at
a discount rate of DR will always be higher
than the quoted yield
Investment rate
HPR = P2 – P1 360
_______ x _______
100 Tm1-Tm2
= Tm1DR1 – Tm2DR2
_________________
Tm1 – Tm2
105
T-Bills -
Yields
HPR terms
106
T-Bills -
Yields
Example 2
Assume that an investor buys a
180 day bill at a discount of 6%
Sells it 30 days later at a discount of
5.80%
HPR is
(180x6.00) – (150x5.80)
_______________________ = 7%
180 - 150
107
T-Bills -
Yields
Yield to Maturity
Calculate the Yield to Maturity of a T-bill
that has more than 182 days to
maturity
A coupon paying bond with a time to
maturity >182 days will make a coupon
payment before maturity
To facilitate a comparison between the yield
for a discount instrument with >182 days to
maturity & the YTM of a conventional bond,
the discount security must be treated as if108
it
T-Bills -
Yields
Yields (Cont…)
109
T-Bills -
Yields
Yields (Cont…)
110
T-Bills -
Yields
Example - BEY
111
T-Bills -
Yields
Yields (Cont…)
P = $959111.11
Therefore:
112
T-Bills
Primary Dealers
The money market depends heavily on
the buying and selling activities of
securities dealers.
Primary Dealer
A dealer firm which is qualified to trade
securities directly with the Federal Reserve
Bank of New York
The firm must agree to be available to trade
securities at all times and post a capital of
at least $50m
113
T-Bills
Exclusive Privileges
Until recently the primary dealers
possessed several exclusive privileges
in dealing with the U.S. government
1. They held exclusive membership on the
Treasury Borrowing Advisory Committee
which helps the government decide what
kinds of securities to sell at each auction
2. They were the only traders along with
banks who could place bids for new
government securities on behalf of
themselves and their customers without
posting the normally required 5% cash
deposit on each bid amount. 114
T-Bills
Exclusive Privileges
Why collude?
In a large and highly competitive
market there was the risk that:
Primary dealers could overbid thereby
eliminating potential profits
They could underbid which would mean
that they would receive no securities at all
Thus dealers had a strong incentive to
share information with each other on
the size of the orders they wished to place
the prices they hoped to bid
116
T-Bills
Winners’ Curse
Multiple price auctions encouraged
dealers to bid high in order to increase
the probability of winning.
The higher the price bid, the lower the
expected profit when securities were sold in
the secondary market
Dealers placing higher bids faced a
‘Winners’ Curse’
They incurred a greater probability of loss
when they attempted to resell the
securities.
At best the winners’ curse reduced the
aggressiveness of bidding and probably 120
resulted in the Treasury getting a lower
Funding of Dealer Positions
121
Dealer
Positions
Funding of Dealer Positions
123
Dealer
Positions
Demand Loans
Every major bank posts rates at which it
is willing to make short-term loans to
dealers.
Generally two rates are quoted
One for new loans
A lower rate for the renewal of existing
loans
A demand loan may be called at any
time.
124
Such loans are virtually riskless because
Repurchase agreements
125
Repurchase
Agreements
Repos
Repurchase agreements are an
increasingly popular alternative to
demand loans.
They represent a temporary extension
of credit collateralized by marketable
securities
Dealer Sells securities Lender
Providers
of Repos
Non- Foreign
Large State Local Insurance
Finance Financial
Banks Govts Govts Cos
Cos Institutions
128
Repurchase
Agreements
Custodial Account
Securities for the collateral are
supposed to be placed in a ‘custodial
account’ at a bank.
When loan is repaid the dealer’s liability is
canceled and the securities are returned
There is evidence that this safety
feature is not scrupulously followed.
If a dealer goes out of business, lender may
have difficulty in recovering the securities
Dealer firms have collapsed and many S&Ls
lost money from inadequately collateralized
loans.
Fed authorities have imposed strict 129
Repurchase
Agreements
Types of Repos
Term Repos Contracts for terms
longer than overnight e.g. contracts for
periods ranging from 1 - 3 months or
even longer
Dollar repos They permit the
borrower to repurchase securities that
are similar to but not necessarily the
same as the securities originally sold
FLEX repos They permit lenders to
withdraw a part of the loan whenever
cash is needed.
130
Repurchase
Agreements
Value of Collateral
The interest rate of repos is closely
linked to other money market rates.
Usually the collateral is valued at the
current market price plus accrued
interest less a small discount called a
Haircut to reduce the lender’s exposure
to market risk.
The longer the term of the repo, and the
riskier and less liquid the security that is
pledged, the larger will be the Haircut. 131
Repurchase
Agreements
Value of Collateral
market.
collateral.
132
Repurchase
Agreements
Example of Repo - 1
A party has made an overnight loan of
$100 MM to a dealer at 7.2%
Thus the interest payable the next day
is:
100,000,000 x 0.072 x 1
___ = $20,000
360
133
Repurchase
Agreements
Illustration - 2
Take the case of a dealer who is looking
for a 30 day loan and is willing to pledge
T-notes as collateral.
Assume accrued interest = $205,700
The quoted price per $100 of face value
is $100.9375
The repo is for 30 days
The rate of interest is 9% p.a.
The haircut is 0.005 price points
134
Repurchase
Agreements
Illustration - 2 (Cont…)
The amount that can be borrowed against the
securities is:
5,000,000 (1.009375 - 0.005) + 205,700
= $5,227,575
135
Repurchase
Agreements
Illustration - 2 (Cont…)
137
Repurchase
Agreements
Credit Risk
Interest rates rise Interest rates
If interest rates rise decline
If interest rates decline,
sharply, the value of the value of the
the collateral will collateral will rise.
decline and the lender
will be vulnerable
In this case, if the If the lender goes
borrower were to go bankrupt, the borrower
bankrupt, the lender will be left with an
will be left with assets amount that is less
which may be worth than the market value
less than the loan of the securities.
amount.
138
Repurchase
Agreements
Margins
140
Repurchase
Agreements
Reverse Repo
Such transactions offer a convenient
route for lenders to park excess funds
for short periods.
From the perspective of the lender such
an arrangement is called a reverse
repurchase agreement or a reverse
repo.
Thus every repo must be matched by a
reverse repo.
A dealer looking to borrow funds will do a
repo.
A dealer looking to place funds will do a 141
Repurchase
Agreements
Matched Book
148
Fed Funds
Federal Funds
149
Fed Funds
Federal Funds
History Today
The name federal funds Today the Fed funds
came about because in the market is far broader in
earlier years the principal scope than just reserves on
source of immediately deposit with Federal
available money was the Reserve Banks
reserve balance that each
bank held with the regional
Federal
If a bankReserve
neededBank
to Virtually all banks maintain
transfer funds to another it deposits with large
needed to only contact the correspondent banks in
regional FRB and funds major cities. These
would be transferred in a deposits may be readily
matter of seconds by transferred from the
computers account of one bank to that
150
Fed Funds
institution.
151
Fed Funds
State &
Securities Corpora- Insurance Commercial
Local S & Ls
dealers tions Cos banks
Govts
Trading
153
Fed Funds
Illustration 1
Take for example two banks that are located in New York
This is payable
The borrower would be
immediately. Fed funds
handed a check drawn on the
would be transferred to the
lender’s reserve account at
borrower’s reserve account
the Federal Reserve Bank of
before the close of business
New York
155
Fed Funds
Illustration 2
If the institutions are not located within the same
district the transaction would proceed in the same
way except that two Federal Reserve banks would be
involved
The borrower and the lender agree on the
terms of the loan
Contact Mechanisms
b. Telephone
maturity date
158
Fed Funds
160
Nego CDs
What is a CD?
Negotiable CDs
163
Nego CDs
Non-negotiable Time Deposits vs.
Negotiable CDs
Calculations
Consider a CD with a face value of V.
The funds owed on maturity is given by:
V + Tm
____ x V x i
360
where:
Tm original term to maturity
i interest rate
165
Nego CDs
Example
Calculations (Cont…)
To convert the yield to a true yield for a
365 day year, multiply the quoted rate
by 365/360.
Thus
YTMCD = i x 365
____
360
167
Nego CDs
Example
i = 0.075
168
Nego CDs
Yield on CDs
169
Nego CDs
Types of CDs
1. Variable or floating rate CDs
2. Rollover or Rolypoly CDs
3. Jumbo CDs
4. Yankee CDs
5. Brokered CDs
6. Deposit notes
7. Bear and Bull CDs
8. Installment CDs
9. Rising rate CDs
10.Foreign-index CDs
170
Nego CDs
2. Rollover CDs
In the 1970s the Rollover or Rolypoly CD was
introduced.
6 month CDs are the maximum maturity traded in
the secondary markets.
Rollover CDs are longer term CDs with higher
rates but in packages composed of a series of
6 month CDs extending for at least 2 years.
This promised higher returns plus the ability to
retire some components of the package early
to meet cash needs.
The customer is however obligated to
purchase the remaining certificates on each 6
month anniversary date till the contract
expires.
172
Nego CDs
Other CDs
6. Deposit notes
174
Nego CDs
Other CDs
Other CDs
178
Nego CDs
179
Nego CDs
Yields on CDs
supply.
CDs are not riskless because the issuing
Illustration
A bank is quoting 8% p.a. on a 3 month
deposit
Reserves @ 5% and are non-interest
bearing
Effectively $8 interest is being offered
on $95 of usable funds
Effective rate =
8
95 = 8.42%
181
Nego CDs
Illustration
Effective cost is
182
Commercial Paper
183
Comm
Paper
Commercial Paper
Unsecured promissory notes are known
as commercial paper
Large corporations borrow billions of
dollars in the money market through
these
A study in U.S. found that 1000+
corporations were regularly selling
commercial paper to money market
investors
Such paper consists of short-term
unsecured promissory notes issued by
well known companies that are
184
financially strong and carry high credit
Comm
Paper
Funds raised for
185
Comm
Paper
Bridge Financing
186
Comm
Paper
Buyers of Commercial Paper
Paper is generally issued in multiples of
$1,000 & in denominations designed to
meet the needs of the buyer.
It is traded mainly in the primary
market.
Opportunities for resale in secondary
market are limited
Investors are careful to purchase those
issues whose maturity matches their
planned holding periods. 187
Comm
Paper
Credit rating
Most issuers of paper enjoy a high credit
rating.
To reduce risk for investors, borrowers
usually secure a line of credit at a
commercial bank for a small fee or a
deposit.
The line of credit cannot be used to directly
guarantee payment if company goes
bankrupt.
The lender may renege on the credit line if
the borrower has had a `material adverse
change’ in his condition. 188
Comm
Paper
Letters of Credit
Many issuers also take out irrevocable
letters of credit prepared by their banks.
Such a letter of credit makes a bank
unconditionally responsible for repayment if
the corporation defaults.
Banks usually charge 50 to 150 b.p. on
the amount of the guarantee that is
issued.
Insurance companies and parent
companies of paper issuers also
guarantee issues of commercial paper.
189
Comm
Paper
Types of Commercial Paper
190
Comm
Paper
Direct Paper
The main issuers of direct paper are
Large finance companies
Bank holding companies
Issuers deal directly with investors
rather than use securities dealers as
intermediaries.
Such companies announce the rates
that they are paying on various
maturities
Investors select maturities that closely
match their expected holding periods and
buy the paper directly from the issuer.
Interest rates may be adjusted during the 191
day that the paper is sold to regulate the
Comm
Paper
Direct Paper (Cont…)
Leading finance companies that borrow
in the direct paper market include
General Motors Acceptance Corporation
(GMAC)
General Electric Capital Corporation (GE
Capital)
Such firms have
An ongoing need for short-term money
Possess top credit ratings
Have established working relationships with
192
Comm
Paper
Direct Paper (Cont…)
Directly placed paper must be sold in
large volume to cover the substantial
costs of distribution and marketing.
On an average each direct issuer in the U.S.
borrows at least $1bn per month
Issuers of direct paper do not have to
pay dealers’ commissions
They must maintain a marketing division to
maintain constant contact with active
investors
Issuers like Citicorp sell paper in weekly
auctions in which buyers bid for 193
Comm
Paper
Funds used for
Sometimes direct issuers must sell their
paper even when they have no need for
funds
They have to maintain a good working
relationship with active investor groups.
They also have to pay fees to banks for
supporting lines of credit.
They have to pay agencies that rate their
issues
They have to pay agents like trust
194
companies that collect funds and disburse
Comm
Paper
Industrial Paper
The other variety of commercial paper
is dealer paper that is issued by security
dealers on behalf of their corporate
customers.
Such paper is also known as Industrial
Paper.
This is issued mainly by non-financial
companies, smaller bank holding
companies and financial companies
These borrow less frequently than
companies that issue direct paper. 195
Comm
Paper
Buyers of Industrial Paper
The issuing company may sell the paper
directly to the dealer who buys it less a
discount and commissions, and then
attempts to resell it at the highest
possible price in the market.
Alternatively the issuing company may
bear all the risk with the dealer only
agreeing to sell at the best price
available less commissions.
This is referred to as a best efforts
transaction.
196
Comm
Paper
Value of Paper
199
Comm
Paper
Documented notes
202
Comm
Paper
International Paper – Canada
Like in the U.S. paper issues in Canada
must be backed by a bank line of credit
in order to catch the attention of the
market.
The Canadian market has a broader
range of maturities ranging from 24
hours to a year.
Paper in Canada tends to be issued in
large denominations usually $100,000+
Most Canadian paper is therefore
purchased by large institutions rather
203
Comm
Paper
International Paper - Euro
207
Comm
Paper
Maturity of US Paper
Maturities of US paper range from 3
days (weekend paper) to 270 days
Most paper has an original maturity of
60 days or less with an average
maturity of 20 to 45 days
US paper is generally not issued with a
maturity exceeding 270 days
Because any security with a maturity in
excess of 270 days must be registered with
the SEC
208
Comm
Paper
Yield on Commercial Paper
209
Comm
Paper
Denomination for Paper
The minimum denomination for paper is
usually $25,000
Among institutional investors the
minimum denomination is usually
$1,000,000
Notes are typically issued in bearer form
to make resale easier.
On maturity, payment is made on
presentation to the bank which is
designated as the agent.
Settlement is made in Federal Funds on
the same day.
210
Comm
Paper
Advantages with paper market
211
Comm
Paper
Example
Take the case of a firm that borrows
$100MM @ 8% with a compensating
balance of 20%
212
Comm
Paper
Advantages with paper market
215
Comm
Paper
Risk of Paper
216
Comm
Paper
Master Note
A recent innovation in the direct paper
market
This is frequently issued to bank trust
departments and other permanent
investors by finance companies.
Under such an arrangement the
investing firm agrees to take some
paper each day up to an agreed upon
maximum amount.
Interest is calculated on the daily
average balance of paper taken by the
investor.
217
Comm
Paper
Medium Term Note
An extension of the paper market is the
Medium Term Note.
Such notes have maturities ranging
from 9 months to 10 years and are
issued by investment grade
corporations.
They carry fixed rates of interest and
are generally non-callable unsecured
obligations marketed through dealers.
Particularly suited for companies with
substantial quantities of medium term
assets
E.g. who wish to balance such assets with
liabilities that are longer in maturity than 218
conventional commercial paper.
Comm
Paper
Ratings and Rating Agencies
Depending on the credit standing of the
issuer paper is rated as:
Prime
Desirable or
Satisfactory
Firms issuing paper generally seek
ratings from multiple issuers.
It is extremely difficult to market unrated
paper.
About 75% of the firms that currently sell
paper are prime rated.
Generally notes bearing ratings from at
least two agencies are preferred by 219
investors.
Comm
Paper
Rating Agencies
Prominent rating agencies include:
Moody’s Investors Service
Standard & Poor’s Corporation
Fitch Investor’s Service
Canadian Bond Rating Service
Japanese Bond Rating Institute
Dominion Bond Rating Service
IBCA Ltd.
220
Comm
Paper
Summary of the Rating Systems
221
Comm
Paper
Credit Rating
225
Fed Agency
Sec
Agencies
US government attempts to aid
disadvantaged sectors e.g.
Agriculture
Housing
Small businesses
College students
Government has created special
agencies to make loans to these sectors
These agencies are large enough to
complete for funds in the open market
226
Fed Agency
Sec
Types of Federal Credit Agencies
229
Fed Agency
Sec
Features of agency securities
They are subject to fed income taxes
Exempt from state and local taxes
They are short to medium term with
maximum maturity of 10 years
Longer term have denominations of as less
as $1,000
Shorter term are usually sold in
denominations of $50,000
230
Fed Agency
Sec
Solicitation Method
A fiscal agent in NY will
assemble a group of
bankers, dealers, brokers to This pricing information is
bring each issue to the conveyed to the fiscal agent
market
232
BAs
What is a bill?
It is an undertaking to pay a specified
amount of money at a future date –
upto 12 months in the future
It is a form of short-term finance for the
debtor
Bills can be sold in the money market at
any time prior to their maturity date
Bills are classified on basis of the entity
which gives the undertaking to pay
T-Bills
Bank bills
Trade bills
233
BAs
Bills of Exchange
In international trade when goods are
exported the exporter will draw up a
Draft or a Bill of Exchange.
A Draft is an instrument that instructs
the importer to pay the amount
mentioned upon presentation.
A Draft may be a
Sight Draft
Time Draft
234
BAs
Sight Drafts
235
BAs
Time Drafts
These are also known as Usance Drafts.
The bank will release the shipping
documents in such cases as soon as the
importer accepts the draft by signing on
it.
The importer need not pay immediately.
In other words the exporter is offering
him credit for a period.
When the importer accepts a draft it
becomes a ‘Trade Acceptance’. 236
BAs
LC Based Transactions
In the case of a sight draft the
importer’s bank will pay on
presentation.
In the case of a time draft it will accept
it by signing on it.
A draft that is accepted by a bank is
called a Banker’s Acceptance
It is obviously more marketable than a trade
acceptance. 238
BAs
240
BAs
Trade Bills
These are issued by a commercial
enterprise
They are bills drawn by one non-bank
company on another demanding
payment for a trade debt
They may be used for domestic /
international trade transactions
Financial institutions will buy only the
finest trade bills in the market
241
BAs
Bank Bills
acceptance
242
BAs
243
BAs
money market
interest
Illustration
Illustration (Cont…)
Purchase price:
= $4,890,625
Sale price:
= $4,920,833.33
247
BAs
Illustration (Cont…)
Profit:
$4,920,833.33 - $ 4,890,625 = $
30,208.33
(30,208.33/4,890,625) * (360/30)
= 7.41%
248
Eurocurrency Deposits
249
Eurocurrency
Deposits
What is Eurocurrency?
it belongs.
Dollars deposited outside the US are
Eurodollars
250
Eurocurrency
Deposits
Illustration
A french exporter ships champagne to a
New York importer accompanied by a
bill for $10,000
The importing firm pays for the
champagne by issuing a cheque
denominated in dollars and deposits it
in a US bank – First American bank –
where the French firm has a checking
account
251
Eurocurrency
Deposits
Illustration (Cont…)
After the check clears the results are:
French Exporter’s Account
Assets Liabilities
Assets Liabilities
Deposit owed to French Exporter
= $10,000
252
Eurocurrency
Deposits
Illustration (Cont…)
253
Eurocurrency
Deposits
Illustration (Cont…)
The 4 transactions will be:
French Exporter’s Account
Assets Liabilities
Assets Liabilities
Reserves transferred to Deposit owed to French Exporter
Correspondent Bank = - $10,000 = - $10,000
254
Eurocurrency
Deposits
Illustration (Cont…)
Assets Liabilities
Reserves transferred from Deposit owed to Paris Bank =
First American Bank = $10,000
$10,000
Paris Bank’s Account
Assets Liabilities
Deposit with US Correspondent Deposit owed to French Exporter
Bank = $10,000 = $10,000
255
Illustration (Cont…)
256
Eurocurrency
Deposits
Illustration (Cont…)
Assets Liabilities
Loan to British company = +
$10,000
Deposit in Correspondent
Bank = - $10,000
British Oil Company’s Account
Assets Liabilities
Deposit with US Correspondent Loan from Paris Bank = $10,000
Bank = $10,000
257
Eurocurrency
Deposits
Illustration (Cont…)
Assets Liabilities
Deposit owed to French
Amount owed by British Oil
Company = + $10,000
exporter = $10,000
258