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The Roles Played by Banks in the Money Market Principal channel for payments for loans, securities & other transactions Banks’ Money Market Roles Agents in trust for proper[r]
(1)(2)Chapter 11
Commercial Banks, Major
(3) Learning Objectives
• To discover how banks and other depository institutions
borrow and lend funds and supply other critical services in the money market
• To explore the nature and characteristics of commercial papers as well as the roles played by large corporations in the money market
• To learn how federal credit agencies provide financial aid to
(4) Learning Objectives
(5)Introduction
• The money market supplies the cash needs of shortterm
borrowers and provides savers who hold temporary cash surpluses with an interestbearing outlet for their funds
• In this chapter, we will explore how commercial banks, major
(6)(7)Federal Funds Provided by the Banking System
• Federal funds are any monies available for immediate
payment (i.e. sameday money)
• They are generally transferred from one depository institution to another by simple bookkeeping entries requested via an on line computer system, by wire, or by telephone
• Federal funds are the principal means of making payments in
(8)Federal Funds Provided by the Banking System
• The term federal funds came about because early in the
development of the market, the principal source of
immediatelyavailable money was the reserve balance that each Federal Reserve System member bank had to keep at the Federal Reserve bank in its region
• Today, the federal funds market is broader in scope – some
(9)Federal Funds Provided by the Banking System
• Banks and other depository institutions must hold in a special
legal reserve account liquid assets equal to a fraction of the funds deposited with them by the public
• This legal reserve requirement is calculated on a daily average basis over a twoweek period, known as the reserve
computation period
• The federal funds market is an indispensable tool for such
(10)Federal Funds Provided by the Banking System
• There are three principal segments of the Fed funds market
among banks today:
brokered funds
nonbrokered direct loans among major banks
(11)Federal Funds Provided by the Banking System
• Commercial banks borrow billions of dollars each day in the
federal funds market
• Most federal funds loans are either overnight transactions or continuing contracts that have no specific maturity and that can be terminated without advance notice by either party
• Oneday loans carry a fixed rate of interest, but continuing
(12)(13)Federal Funds Provided by the Banking System
• Beginning 1989, the Federal Reserve has routinely set target
levels for the federal funds rate, and raised or lowered those targets depending on whether it wishes to slow down
borrowing and spending in the economy or speed them up
• Through daily open market operations (buying and selling
(14)Intended Federal Funds Rate
0 10
1/1/91 1/1/93 1/1/95 1/1/97 1/1/99 1/1/01
%
Intended Federal Funds Rate
(15)Negotiable Certificates of Deposit
• A certificate of deposit (CD) is an interestbearing receipt for
funds left with a depository institution for a set period of time
• True money market CDs are negotiable CDs that may be sold
any number of times before maturity and that carry a minimum denomination of $100,000
• They were introduced in 1961 to attract lost deposits back into
(16)Negotiable Certificates of Deposit
• CD interest rates are computed as a yield to maturity (ytm) on
a 360day basis
Interest = term in days deposit promised
income 360 principal ytm
• In secondary market trading, the bank discount rate (DR) is used as a measure of CD yields
DR = Par value – Purchase price 360
(17)(18)Negotiable Certificates of Deposit
• The principal buyers of negotiable CDs include corporations,
state and local governments, foreign central banks and
governments, wealthy individuals, and a variety of financial institutions
• Most buyers hold CDs until they mature. However, primerate
(19)Negotiable Certificates of Deposit
• Bankers are becoming increasingly innovative in packaging
CDs to meet the needs of customers
• New types of CDs include variablerate CDs, rollover or
(20)Eurocurrency Deposits
• The Eurocurrency market has arisen because of the
tremendous need worldwide for funds denominated in dollars, Euros, pounds, and other relatively stable currencies
• The Eurocurrency market represents the largest of all money