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Processing System (TAAPS-Link) Institutions must set up an account with the Treasury Payments to the Treasury are withdrawn electronically from the account Payments received from the Treasury are deposited into the account 9 Money Market Securities (cont’d) Treasury bills (cont’d)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