CHAPTER 6
MONEY MARKET YIELDS AND RATES
• The money market is the market for short-
term securities with maturity of one year or
less.
• The market is a dealer market.
• The dealer or market maker will stand ready
to buy or sell the securities in the money
markets. Bid and ask prices will be
available for securities.
Money Market Instruments
• Treasury bills
• Commercial paper
• Repurchase agreements
• Banker’s acceptances
• Negotiable certificates of deposit
• Federal funds
Discount Instruments
• These securities trade at a discount from par
and do not have a stated rate of interest:
• Treasury bills
• Commercial paper
• Repurchase agreements
• Banker’s acceptances
Par Plus Accrued Interest
• These instruments accrued interest at a
stated rate and will trade at a price that
reflects par plus accrued interest:
• Negotiable certificates of deposit
• Federal funds
Security Analysis
• Analysis of money market instruments
should consider the following factors:
• Credit risk
• Liquidity risk
• Maturity risk
• Other characteristics
BANK DISCOUNT YIELD
• D = [ (Par - P0)/ Par] * (360 / n)
• P0 = Par - (Par * D * n / 360)
BANK DISCOUNT YIELD
• Assume that a dealer quotes a rate of
4.00% for a T-bill maturing in 90 days.
• Price = P0 = 100- (100* .04 * 90/360) =
99.00
• For $1 million of bills the price would be
$990,000.00
ANNUAL YIELD
(NO COMPOUNDING)
• Y = [( Par (or P1) - P0) / P0] * (365 / n)
Or alternatively:
• Y = (365 * D) / (360 - D*n)
Y is also known as bond equivalent yield or
coupon equivalent yield.
ANNUAL YIELD
(NO COMPOUNDING)
• For the bill with the 4.00% BDY, the Y
would be as follows:
• Y = [( Par (or P1) - P0) / P0] * (365 / n)
• Y = (100 – 99) / 99 * 365/ 90 = 4.10%
Effective Annual Yield
• Allowing for the compounding results in a
higher number.
• Y* = Effective Annual Yield
• Y* = [( P1 / Po) ^ (365 / n)] -1
Effective Annual Yield
• For the bill with the 4.00% BDY, the Y
would be as follows:
• Y* = [( P1 / Po) ^ (365 / n)] -1
• Y* = (100/99) ^ (365/90) –1 = 4.16%
U.S. Treasury Bills
• No credit risk.
• Excellent liquidity.
• Original maturities of 91-days, 182-days
and 364-days.
• Sold on an auction basis. Weekly for the
91-days and 182-day bills. Monthly for the
one-year bill.
U.S. Treasury Bills
• Credit Markets page in the WSJ:
• http://online.wsj.com/page/0,,2_0031,00.ht
ml?mod=2%5F0031
Primary markets
• Primary market page from the WSJ:
• http://online.wsj.com/documents/mktindex.
htm?rates.htm
U.S. Treasury Bills
• Secondary market for T-bills
• Secondary market page from the WSJ:
• http://online.wsj.com/documents/tsyquote.htm
Days
Ask
Maturity to Bid Asked Chg
Yield
Mat.
Feb 08 07 2 4.81 4.80 +0.10 4.87
Feb 15 07 9 4.86 4.85 +0.14 4.92
Feb 22 07 16 4.95 4.94 +0.07 5.02
Mar 01 07 23 4.97 4.96 +0.06 5.04
Mar 08 07 30 5.02 5.01 +0.06 5.10
Mar 15 07 37 5.00 4.99 +0.03 5.09
Mar 22 07 44 4.98 4.97 .... 5.07
Mar 29 07 51 5.00 4.99 +0.02 5.10
Apr 05 07 58 4.99 4.98 .... 5.09
Apr 12 07 65 5.01 5.00 +0.01 5.12
Apr 19 07 72 5.00 4.99 .... 5.11
Apr 26 07 79 5.00 4.99 .... 5.12
May 03 07 86 5.00 4.99 -0.01 5.12
May 10 07 93 5.01 5.00 -0.01 5.14
May 17 07 100 4.99 4.98 -0.01 5.12
Commercial Paper
• Commercial paper is a short-term, unsecured
promissory note issued by well-known,
creditworthy firms.
• Credit risk depends on the credit quality of the
issuing firm. Ratings range from prime1, 2, or 3
to Not Prime.
• Maturities range from a few days up to 270 days
and can be specified by the buyer.
• A secondary market exists but is relatively
inactive.
Commercial Paper Ratings
Moody’s short-term ratings are opinions of the ability of issuers to honor short-
term financial obligations. Ratings may be assigned to issuers, short-term
programs or to individual short-term debt instruments. Such obligations generally
have an original maturity not exceeding thirteen months, unless explicitly noted.
Moody’s employs the following designations to indicate the relative repayment
ability of rated issuers:
P-1 Issuers (or supporting institutions) rated Prime-1 have a superior ability to
repay short-term debt obligations.
P-2 Issuers (or supporting institutions) rated Prime-2 have a strong ability to
repay short-term debt obligations.
P-3 Issuers (or supporting institutions) rated Prime-3 have an acceptable ability
to repay short-term obligations.
NP Issuers (or supporting institutions) rated Not Prime do not fall within any of
the Prime rating categories.
Note: Canadian issuers rated P-1 or P-2 have their short-term ratings enhanced by
the senior-most long-term rating of the issuer, its guarantor or support-provider.
Repurchase Agreements
• A repurchase agreement or repo is the sale of
securities with a simultaneous agreement to
repurchase the securities on a specified date.
• Reverse repo is a purchase with agreement of
resell.
• Credit risk depends on the quality of the securities
with a “haircut” for lower-quality and long-
maturity securities.
• Quotes are difficult to get beyond 90 days.
• Secondary market is very illiquid.
Banker’s Acceptance
• A banker’s acceptance is a commercial time draft
“accepted” by a commercial bank.
• BA’s are most often used to finance international
trade.
• Credit risk depends on the quality of the accepting
bank. It is “double-barreled” paper.
• Since BA’s are frequently discounted and sold in
the secondary markets, an active market exists.
• Availability of quality paper is good up to 60 days.
SHORT-TERM INTEREST-
BEARING SECURITIES
• These formulae are for money market
securities with a stated interest rate:
• I = [( P1 – P0 ) / P0] * (360/n)
• P1 = P0 + (I * P0 * n/360)
Negotiable Certificates of Deposit
• NCDs are large denomination CDs (>100k)
issued by large banks.
• Credit quality depends on the bank since
only the first $250,000 is FDIC insured.
• Original maturity is between two weeks and
one year and can be negotiated by the
depositor.
• A secondary market exists for NCDs.
Federal Funds
• Fed funds are funds transferred (loaned or
borrowed) between financial institutions usually
for a period of one day.
• Terminology is purchased and sold.
• The FRB does not directly control the Fed Funds
rate but moves it by adjusting the level of reserves
through its purchases & sales of T-bills.
• Most Fed Funds transactions are unsecured.