125220_16(T6): Money Markets

  1. What are the money markets? Who uses them?
    Money markets deal in loans & financial assets by which Govt, FIs & companies raise S/T debt finance for working capital or invest surplus funds from overnight - up to a year
  2. How do firms obtain debt funding? What types are traded?
    • The securities are ranked by type of issuer, their creditworthiness & general risk associated with investment
    • Trade credit (non-marketable part of MM markets) – by suppliers of good & services 
    • Intercompany loans
  3. Short-term debt financing instruments
    • Trade credit
    • Bank overdraft
    • S/T bank loans
    • Direct financing via money markets
  4. Two Types of Short term Money Markets in NZ
    • Official S/T money markets - trades in govt. securities
    • Non-Govt S/T money market
  5. Official S/T money markets - Treasury bills (T-bills)
    • For funding govt expenditure.
    • T-bills issued directly in money markets as discount (zerocoupon) instrument as interest included with nominal value (par value) repaid at maturity
    • T-bill interest rate regarded as benchmark interest rate
  6. T-bills history
    • T- bills first issued in 1969
    • Originally sold on tap by NZRB
    • Since 1984, sold weekly by tender by NZDMO.
    • “On-tap” - govt quoted interest rate - you ordered what you wante
  7. T-bill formula
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    • N = par (principal) of T-bill
    • i = yield divided by 100
    • n = number of full days from settlement date to maturity
  8. 2. Non-Govt short/term money market
    • Deals with flows of money in private sector.
    • Banks, merchant & investment banks, & brokers channel surplus funds to companies & individuals requiring funding.
    • Important function of money market- smoothing out cash flows for banks & corporates
    • Securities in S/T debt markets - mostly discount ones. – Issued at discount to face value
  9. Key S/T Debt Instruments- Bills of Exchange
    Negotiable instrument maturing within a given time period (usually 1-6 months), sold at a discount to face value which market believes to be the obligation (debt) of a good creditworthy name
  10. Four parties involved (potentially) in Bank-accepted bill issue
    • Drawer
    • Acceptor
    • Payee
    • Discounter
    • Endorser
  11. Four parties involved (potentially) in Bank-accepted bill issue - (a) Drawer
    • Issuer of the bill = company (draws up the bill)
    • Wants to borrow the funds= company S/T financing
    • Secondary liability for repayment of the bill to holder (after the acceptor)
  12. Four parties involved (potentially) in Bank-accepted bill issue - (b) Acceptor
    • Undertakes to repay the face value to the holder of the bill at maturity Acceptor usually a bank or sometimes investment bank
    • Gives the bill a high credit status ⇒ easier to sell & at lower yield
    • In case of bank, it quickly is repaid funds by drawer
  13. Four parties involved (potentially) in Bank-accepted bill issue - (c) Payee
    • The party to whom the bill is specified to be paid
    • Usually the drawer, but drawer could select other party as payee e.g. subsidiary of company
  14. Four parties involved (potentially) in Bank-accepted bill issue - (d) Discounter
    • The party that purchases the bill in primary money market (supplies the funds-investor)
    • Discounts the face value & buys the bill
    • The lender of the money
    • May also be the acceptor of the bill
  15. Four parties involved (potentially) in Bank-accepted bill issue - (e) Endorser
    • (e) Endorser
    • Any previous holder of bill but has sold it.
    • Has a contingent liability
    • Once the bill has been drawn up by issuer & accepted by a bank, it can be sold in the market place to the discounter who provides the funds
  16. Advantage of Bill Finance
    • Lower cost than other S/T borrowing forms (i.e. overdraft, loans= indirect finance)
    • Lower as direct finance avoids the cost of intermediation
    • Borrowing cost (yield) determined at issue date (not affected by subsequent changes in interest rates)
    • Term of loan may be extended by ‘roll-over’ at maturity- at new prevailing interest rate
  17. Discount Securities—Calculating Price
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    Yield not expressed as decimal (i.e. 8.75%)
  18. Discount Securities—Calculating Price Example 1: A large company issues a 90-day bill with face value $100,000 yielding 8.75% p.a. What initial amount will the company raise with this issue?
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  19. Example 2: A company needs ongoing S/T funds of 1.5M & a bank agrees to arrange a bank bill facility & issue 90-day bills at current market yields of 7% + 325 basis points for issuing fees. How much will company first raise by issuing directly a bank bill?
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  20. Discount Securities—Rediscounting Example 3: A discounter initially buys a 180 day bill with face value $100,000. The bill now has 90 days to maturity & current 90-day bill yields are 7.80% p.a. Calculate the rediscount price(selling price)
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  21. Discount Securities—Calculating Face Value
    • A company may need to raise a specific amount of funds from a bill issue.
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  22. Discount Securities—Calculating Face Value Example 4: A large company needs to raise $500,000 from issue of 60-day bill roll-over facility, at a yield of 8.50%.At what face value will the bill need to be drawn?
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  23. Discount Securities — "Yield" definition
    Yield is the rate of interest on the amount outlaid to purchase the bill (or other discount instrument)
  24. Discount Securities—Calculating Yield
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    • If the bill is Sold before maturity, then face value becomes selling price
  25. Discount Securities—Calculating Yield Example 5: A 180 day bill with a face value of $100,000 & sold at $96,000 with 180 days to maturity is yielding:
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  26. Discount Securities—Calculating Yield Example 5 continued - 180 day bill with a face value of $100,000 & sold at $96,000 was discounted at 8.449%. After 6 days, the discounter decides to sell for $96,600, what is yield for original discounter?
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  27. Discount Securities—Calculating Yield - Example 5 - continued - 180 day bill with a face value of $100,000 & sold at $96,000 was discounted at 8.449%. After 6 days, the discounter decides to sell for $96,600, what is yield for new purchaser who holds it to maturity
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  28. Factors influencing bill rates
    • On any, day the AUS & NZ money markets will set bill rates.
    • Note bank-accepted bills at slightly higher yield than T-bills - About 20 basis points above T-bills
    • Expectation of interest rate movements over term of the bill
    • The demand & supply of bills in the market.
    • The maturity of bills offered.
    • The names of the parties of the bill & their status.
  29. Promissory Nortes (P-Notes)
    • Discount securities issued by corporations without an acceptor or endorsement
    • Issued directly by high credit-rated company (S&P BBB & higher) with face value payable at maturity, but discounted upon issue at current market yield
    • Calculation—use discount securities formula
    • Issue Programs- overseas usually by CP dealers
  30. For Underwritten P-note Issues
    • Guarantees the full issue of notes is sold
    • Underwriter usually a commercial bank, investment bank or merchant bank-takes fee about 0.02%
    • can incorporate a roll-over facility, effectively extending borrower’s line of credit beyond short-term life of CP-note issue
  31. Negotiable Certificates of Deposit (CDs)
    • Short-term discount security issued by banks
    • Maturities range up to 180 days (does vary with country)
    • Bearer form
    • Issue them to manage their liabilities & liquidity
    • Usually issued to international institutional investors in wholesale money markets
  32. Investment Bank Cash Advance Facility
    • Made to large corporations
    • Generally for a term of a number of years but also available short-term Priced at a margin above a reference rate
    • Reference rate fixed for short-term loans (up to 180 days) but may be periodically revised for longer-term loan
  33. Factoring
    • Company sells its accounts receivable to a factoring company Converts a future cash flow (receivables) into a current cash flow
    • Recourse arrangement: factor has a claim against vendor if a receivable is not paid
    • Non-recourse arrangement: factor has no claim against vendor company
Card Set
125220_16(T6): Money Markets