Understanding Money Markets

• Money markets refer to the network of corporations, financial institutions, investors, and governments dealing with short-term capital flow.
• It provides loans necessary for financial institutions and governments to manage daily operations.

Money Market Usage

• Banks use the money market to fulfill short-term obligations to customers.
• This helps address mismatches between available money and loan demands.
• The money markets connect borrowers and investors, avoiding high intermediation costs.
• Each currency has a distinct money market due to varying interest rates.
• These markets are interconnected, with investors and borrowers shifting currencies based on interest rates.
• Most money market transactions occur in the investor's home currency.

Money Market Participants

• Companies use money markets to cover payroll or running costs by issuing commercial paper.
• Banks issue certificates of deposit when long-term loan demand exceeds deposits.
• Investors seek low-risk investments, such as financial instruments.

Money Market Dynamics

• Money markets operate without a single location or set of rules.
• Participants are linked via telecommunications.
• The central bank influences short-term interest rates.
• Diverse players seeking optimal rates maintain market competitiveness.
• Money markets relate to bond markets, facilitating longer-term borrowing and lending.
• Money-market investors extend credit without ownership or control.
• Active money markets set short-term rates, fostering confidence in longer-term rates.

Money Market Securities

• Money market securities are short-term, maturing in less than a year.
• Used to "warehouse" funds until needed, with low returns due to low risk.

Commercial Paper

• It is a short-term debt obligation for private firms or government-sponsored corporations.
• Issuers need good credit ratings.
• These are traded like securities.
• Lifetime or maturity typically ranges from 90 days to less than nine months.
• Commercial paper may be secured by specific assets or guaranteed by a bank.

Banker's Acceptance

• It was a primary means for raising short-term funds before the 1980s.
• It involves a promissory note from a non-financial firm to a bank for a loan.
• The bank resells the note at a discount, guaranteeing payment.
• Maturities are usually under six months.
• Tied to specific goods' sale or storage, unlike commercial paper.
• It does not bear interest; investors purchase at a discount and redeem at face value.

Treasury Bills (T-bills)

• These are securities with a maturity of one year or less issued by national governments.
• Seen as the safest investments.

Government Agency Notes

• National and government-sponsored agencies borrow heavily in money markets.
• E.g., development banks and housing finance corporations.
• Provincial or local governments and agencies issue these; the ability varies by country.
• National approval may be needed, or local agencies may be restricted to bank borrowing.

Interbank Loans

• These are loans between unaffiliated banks.
• Often occur internationally and are used for relending.
• Banks lend large sums in their own currency.
• Overnight loans are short-term unsecured loans used for financing or reserve balancing.

Time Deposits

• Also known as Certificates of Deposit (CDs).
• These are interest-bearing bank deposits with penalties for early withdrawal.

Time Deposit Details

• Terms range up to five years, with shorter terms competing with other money market instruments.
• Shorter terms of 30 days are common.
• Interest rates depend on maturity length, with longer terms earning better rates.
• Main risks include being locked into low rates and early withdrawal penalties.

Repurchase Agreements (Repos)

• They maintain market liquidity for new money-market instruments.
• A repo combines two transactions.
• First, a dealer sells securities to an investor with an agreement to repurchase them at a higher price later.
• Second, the repo is unwound when the dealer buys back the securities.
• Investors lend less than the security's market value; this difference is the spread or haircut.

Capital Market Defined

• A financial market that trades longer-term debt (one year or more) and equity instruments.
• Includes securities like bonds, stocks, and mortgages.
• Often held by financial intermediaries like insurance companies and pension funds.

National/Local Government Participation

• Issues long-term notes to provide funds for the national debt.
• Issue notes to provide funds for capital projects.

Corporate Participation

• Corporations issues both bonds and stocks to provide funds for investments.

Primary vs Secondary Market

• Primary market introduces new issuances of stocks and bonds.
• Secondary market is where previously issued securities are sold.

Bond Defined

• Any long-term promissory note issued by a firm.
• The bond certificate is proof of debt issued by an entity.
• Bonds are interest-only loans in which investors receive periodic interest payments through to the principal.

Corporate bond trading

• Bonds are sold either through a public offering or private placement.
• Most bonds are sold through investment banking firms or underwriters.

Underwriting process

• The investment bank guarantees the firm a price for newly-issued bonds through the auction
• The investment bank then seeks to resell these securities at at a higher offering price to investers.

Competitive sale

• The investment bank can purchase the bonds through bidding or directly negotiating with the issuer.

Negotiated sale

• Single investment bank obtains the exclusive right to originate, underwrite and distribute the new bonds through a one-on-one negotiation process.

Bond advantages

• Lower rate of return because it is view as a safe investment
• Interest expenses are tax deductible.
• Bondholders are not entitled to voting rights.

Bond Disadvantages

• Results in interest payments that can force into bankruptcy.
• Produces fixed charges which limits future financial flexibility.

Bond Features and Prices

• Par Value the face value of the bond that is returned to the bondholder at maturity
• Coupon Interest Rate the amount payed out annually in interest.
• Maturity is the length of time until the bond issuer returns the par value to the bondholder and terminates the bond
• Indenture - the agreement between the firm issuing the bonds and the bond trustee
• Current Yield refers to the ratio of the annual interest payment to the bond's market price

Credit Quality risk

• It is the chance that the bond issuer will not be able to make timely payments
• Ratings are provided by agencies, such as Moody's, Standard and Poor's and Fitch IBCA, Inc. Dominion Bond Rating Services.

Bond rankings

• A low utilization of financial leverage
• Profitable operations
• the lower the rating the higher the rate of return demanded