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INTERNATIONAL MONEY MARKETS

International Monetary System


It involves the management of three processes (I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates; (2) the financing of payments imbalances among countries by the use of credit or reserves; and (3) the provision of international money (reserves).

International Money Market Instruments


Treasury Bills Commercial papers Bankers acceptance

Certificate of deposits
Repurchase agreements

Treasury Bills - short-term obligations issued by the U.S.

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government Commercial Paper - short-term unsecured promissory notes issued by a company to raise short-term cash Banker Acceptances - time draft payable to seller of goods, with payment guaranteed by a bank Negotiable Certificates of Deposit - negotiable bankissued time deposit with specified interest rate and maturity Repurchase Agreements - agreement involving the sale of securities between parties with a promise to repurchase the security at a specific date and price

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Instrument

Principal Issuer

Principal Investor

Treasury bills

U.S. Treasury

Repurchase agreement

Commercial Paper Negotiable CDs Bankers acceptances

FRS; Comm banks; Brokers and dealers; Other FIs Comm banks Other FIs; Corps Commercial banks Commercial banks

FRS; Comm banks; Brokers and dealers; Other FIs; Corps FRS, Comm banks Brokers and dealers Other FIs, Corps Brokers and dealers Corporations Brokers and dealers; Corps; Other FIs Comm banks; Corps; Brokers and dealers

5-6 Methods of calculating yields

Treasury Bills - discount yield, 360 day basis. Also as bond equivalent basis using 365 day basis Repurchase Agreements - bond equivalent basis, 360 day basis Commercial Paper - discount yield, 360 day basis Negotiable Certificates of Deposit - discount yield, 360 day basis Banker Acceptances - discount yield, 360 day basis

Treasury 5-7 Basics Bill


Issued by the U.S. Treasury to cover

government budget deficits and to refinance maturing debt Standard Original Maturities of 13 weeks, 26 weeks, or 52 weeks Denominations are $1,000 but typical round lot is $5 million Virtually default risk free

The Auction Process for T-bills


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Amount of new 13-week and 26-week T-bills offered

announced weekly Bids submitted by government securities dealers, financial and nonfinancial corporations and individuals Individual competitive bidders limited to 35% total issue size, can submit more than one bid, allocations made beginning with highest bidder Noncompetitive bidders indicate quantity desired and agree to pay a weighted-average of the rate on winning competitive bids; get preferential allocation

5-9 The Secondary Market for T-bills

The largest of any U.S. money market security Approximately 30 financial institutions make a

market in T-bills by buying and selling securities for their own accounts and by trading for their customers, including depository institutions, insurance companies, pensions funds, etc. T-bills are the FOMCs instrument of choice for its open market operations

T-bill Rates and Yields


No interest paid on T-bills (coupon rate is
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zero), issued at a discount from their par (or face) value T-bill rates are quoted in Wall Street Journal Discount Yield

the price dealers are willing to pay T-bill holders to purchase their T-bills for them

Asked the discount yield based on the current purchase price set by dealers that is available to investors Spread the percentage difference in the ask and bid yield; part of transaction cost; the profit for dealers

Repurchase Agreements (RPs or Repos) 5-11


An agreement involving the sale of securities

by one party to another with a promise to repurchase the securities at a specified price on a specified date Essentially a collateralized fed funds loan with collateral in the form of securities (e.g. T-bills and Fannie Mae securities) Reverse repurchase agreement

involves the purchase of securities between parties with the promise to sell them back at a given date in the future

Trading Process for Repurchase 5-12 Agreements


Arranged either directly between two parties or

with the help of brokers and dealers The repo buyer arranges to purchase T-bills from the repo seller with an agreement that the seller will repurchase the T-bills within a stated period of time

Commercial Paper 5-13


An unsecured short-term promissory note issued

by a corporation to raise short-term cash, often to finance working capital requirements The largest (in terms of dollar value) of the money market instruments Generally sold in denominations of $100,000, $250,000, $500,000 and $1 million with maturities of 1-270 days (if maturity is greater than 270 days, SEC requires registration) Generally held until maturity so there is not an active secondary market

Trading Process for Commercial 5-14 Paper


CPs are sold either directly to investors (25%) or

indirectly through brokers and dealers such as investment banks or major bank subsidiaries Selling through brokers more expensive for issuer due to underwriting costs

Negotiable Certificates of Deposits 5-15


A bank-issued time deposit that specifies an

interest rate and maturity date and is negotiable in the secondary market Bearer Instrument

whoever holds the CD when it matures receives the principal and interest

Denominations range from $100,000 to $10

million; $1 million being the most common Often purchased by money market mutual funds with pools of funds from individual investors

Trading Process for NCDs 5-16


Banks issuing NCDs post daily rates for the

more popular maturities and subject to funding needs, tries to sell to investors who are likely to hold them as investments rather than sell them to the secondary market In some cases, the bank and investor negotiate the size, rate and maturity Secondary market consists of a linked network of approximately 15 brokers and allows investors to buy existing CDs rather than new issues

Bankers Acceptances 5-17


A time draft payable to a seller of goods with

payment guaranteed by a bank Arise from international trade transactions and are used to finance trade in goods that have yet to be shipped from a foreign exporter (seller) to a domestic importer (buyer) Foreign exporters prefer that banks act as guarantors for payment before sending goods to importer

International Aspects of Money Markets 5-18


While U.S. money markets are the largest, the

international market is growing


U.S. securities bought/sold by foreign investors foreign money market securities

Euro money market instruments Eurodollar deposits, Eurodollar CDs, Euro notes, Euro CP London Interbank Offered Rate (LIBOR) the rate paid on Eurodollars

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