1 Chapter 6 Money Markets Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Money market securities  Institutional use of money markets  Valuation of money market securities  Risk of money market securities  Interaction among money market yields  Globalization of money markets 3 Money Market Securities  Money market securities:  Have maturities within one year  Are issued by corporations and governments to obtain short-term funds  Are commonly purchased by corporations and government agencies that have funds available for a short-term period  Provide liquidity to investors 4 Money Market Securities (cont’d)  Treasury bills:  Are issued by the U.S. Treasury  Are sold weekly through an auction  Have a par value of $1,000  Are attractive to investors because they are backed by the federal government and are free of default risk  Are liquid  Can be sold in the secondary market through government security dealers 5 Money Market Securities (cont’d)  Treasury bills (cont’d)  Investors in Treasury bills  Depository institutions because T-bills can be easily liquidated  Other financial institutions in case cash outflows exceed cash inflows  Individuals with substantial savings for liquidity purposes  Corporations to have easy access to funding for unanticipated(dung truoc, huong truoc) expenses 6 Money Market Securities (cont’d)  Treasury bills (cont’d)  Pricing Treasury bills  The price is dependent on the investor’s required rate of return:  Treasury bills do not pay interest  To price a T-bill with a maturity less than one year, the annualized return can be reduced by the fraction of the year in which funds would be invested n m kP )1/(Par += 7 Computing the Price of a Treasury Bill A one-year Treasury bill has a par value of $10,000. Investors require a return of 8 percent on the T-bill. What is the price investors would be willing to pay for this T-bill? 259,9$ )08.1/(000,10$ )1/(Par = = += n m kP 8 Money Market Securities (cont’d)  Treasury bills (cont’d)  Treasury bill auction  Investors submit bids on T-bill applications for the maturity of their choice  Applications can be obtained from a Federal Reserve district or branch bank  Financial institutions can submit their bids using the Treasury Automated Auction Processing System (TAAPS-Link)  Institutions must set up an account with the Treasury  Payments to the Treasury are withdrawn electronically from the account  Payments received from the Treasury are deposited into the account 9 Money Market Securities (cont’d)  Treasury bills (cont’d)  Treasury bill auction (cont’d)  Weekly auctions include 13-week and 26-week T-bills  4-week T-bills are offered when the Treasury anticipates a short-term cash deficiency  Cash management bills are also occasionally offered  Investors can submit competitive or noncompetitive bids  The bids of noncompetitive bidders are accepted  The highest competitive bids are accepted  Any bids below the cutoff are not accepted  Since 1998, the lowest competitive bid is the price applied to all competitive and noncompetitive bids 10 Money Market Securities (cont’d)  Treasury bills (cont’d)  Estimating the yield  T-bills are sold at a discount from par value  The yield is influenced by the difference between the selling price and the purchase price  If a newly-issued T-bill is purchased and held until maturity, the yield is based on the difference between par value and the purchase price . 1 Chapter 6 Money Markets Financial Markets and Institutions, 7e, Jeff Madura Copyright ©2 006 by South-Western, a division. ©2 006 by South-Western, a division of Thomson Learning. All rights reserved. 2 Chapter Outline  Money market securities  Institutional use of money markets  Valuation